Is Australia headed for economic boom or economic nirvana?

The Reserve Bank has lifted its 2021 calendar year economic growth forecast from 4.00 per cent to 5.25 per cent

Is Australia headed for economic boom or economic nirvana?
Is Australia headed for economic boom or economic nirvana?

EXPERT INSIGHT

The word ‘boom’ is used cautiously, principally because booms never end quietly. In other words, booms tend to be followed by busts. The case in point was the boom of the late 1980s that preceded the recession of 1991.

On Friday the Reserve Bank lifted its economic growth forecasts. The Reserve Bank now expects growth of 5.25 per cent on average over the 2021 calendar year. The growth forecast for the 2021/22 year is now 5.00 per cent, up from the 3.75 per cent forecast made in February. And growth in calendar 2022 is now tipped at 4.00 per cent, up from 3.25 per cent.

The jobless rate is now seen at 5 per cent at the end of 2021 before hitting the “full employment” level of 4.5 per cent at the end of 2022.

But over the next 18 months, underlying inflation is not expected to hit 2 per cent (1.75 per cent in late 2022).

Economic nirvana? Perhaps. But it is also important to remember that growth and unemployment have bettered even the most optimistic Reserve Bank forecasts over the past year.

So it’s worth considering the latest ‘upside’ targets from the Reserve Bank. On the Reserve Bank’s most optimistic assumptions, annual economic growth would hit 10.25 per cent in June and 6 per cent in December (admittedly from a low base). The jobless rate would hit the “full employment” threshold late this year but inflation still wouldn’t exceed 1.5 per cent.

The Reserve Bank won’t consider lifting rates until inflation is sustainably within the 2-3 per cent target band. So conceivably unemployment could hit 4.5 per cent by end year with the cash rate still locked at a record low of 10 basis points.

Too good to be true?

It’s important to remember that these forecasts are from the Reserve Bank, one of the most cautious and conservative central banks.

But there appears a growing appreciation for the fact that inflation – not just here but across the globe – has been low for a number of years. And a key reason for that is technology – consumers can buy goods whenever they want from wherever they want. Also, organisations like Airtasker, Uber and Menulog have boosted completion and kept downward pressure on prices. In addition, businesses in white collar industries can also get work done offshore – and this is largely unaffected by Covid-19. While wage growth – a key component of inflation – hit record low levels in Australia at the end of 2020 – with the pace of pay rises easing since the height of the mining construction boom. 

But what happened in 1988?

Cash rates had been falling ahead of the October 1987 sharemarket crash. The cash rate was around 18.8 per cent in August 1986 and had fallen to 11.3 per cent in October 1987. Rates hit lows of 10.65 per cent in February 1988.

But after the sharemarket crash, the feared economic downturn didn’t arrive. Investors instead switched affections from shares to property, underpinned by lower interest rates. According to CoreLogic, home prices rose by 2.8 per cent in October 1987, lifting the annual rate from 5 per cent to 9 per cent. By late 1988, home prices were running at a 30-32 per cent annual rate – far higher than we are witnessing today.

To quell the ‘irrational exuberance’ in housing and general ‘conspicuous consumption’, the Reserve Bank lifted cash rates over 1988 and 1989, with rates hitting highs of 18.2 per cent in November 1989.

Under the pressure of high interest rates, the economy contracted in December quarter 1989 and September quarter 1990 ahead of the recession in the first half of 1991. Interest rates were progressively cut from 1990 and didn’t stop falling until 1994.

What are the implications for investors?

No two periods are alike. The environment in 1988 was starkly different to current times. But in all times, investors need to be aware of the risks and opportunities.

The Covid-19 pandemic shocked economies across the globe in 2020 and the response to the pandemic has varied. Those shocks are still reverberating. Australia has done well in suppressing the virus, and all levels of government and the Reserve Bank acted quickly in supporting businesses and families.

As a result, the economic recovery has been strong, but it is important not to be complacent. Risks lie to the upside and downside. For instance an extended closure of foreign borders may make it difficult for firms to fill open positions. Further, the longer that foreign borders are closed, the greater the risk that demand for homes will reduce, affecting the home building sector. Policymakers must be agile in continuing to watch for the threats to the economic recovery.

But if Australia continues on its current course, strong economic growth will boost employment and give increased security to those in work. A tighter job market should bring higher wage growth. Businesses are well placed to embrace low interest rates to lift investment. Low rates and government grants are boosting home construction and the buoyant house building should continue over 2021.

Note that the Reserve Bank won’t be lifting interest rates until wage growth is closer to 3 per cent. At present wages are “expected to pick up to a little under 2 per cent over 2021, before gradually increasing to around 2¼ per cent by mid 2023.” Even on the “upside” scenario, wage growth won’t hit 3 per cent before 2024, tempering “boom” expectations.

But whether you call it a ‘boom’, economic nirvana or just a strong economic recovery, the economic outlook seems bright.

The current investment environment is positive for consumer discretionary, construction, construction materials and information technology sectors of the Australian sharemarket. Financials will benefit from the expectation of firmer borrowing, but super-low interest rates will cap margins and revenue.

Based on traditional valuations, the sharemarket may seem expensive on the current share price to earnings ratio (PE ratio) of 20.97 (the long-term average is 15.5). But valuations are more difficult to make in an environment of near-zero interest rates. Continued strong economic growth would serve to boost corporate earnings and justify current share prices.

The All Ordinaries index has hit record highs on numerous occasions over the past month. The benchmark ASX 200 is also expected to make new highs in coming weeks. The ASX 200 index is tipped to end the calendar year at 7,200 points.

Craig James

Craig James

Craig James is an economist currently working as chief economist for Commsec. As of September 2012, according to The Australian, James was the third most quoted man in Australian media. Completing regular media appearances in Australia and internationally, his reports such as the iPod index and State of the States are often reported upon and often called a "user-friendly" economic outlook for average individuals.

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Commsec 2021 Property Boom 2021 Property Slowdown

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