Australia seems to have succeeded in leveling the coronavirus curve, but such optimistic health outcomes will not prevent the economy from experiencing a deep decline. Our case base anticipates the greatest contraction since the Great Depression of 1930-1931.
Significant stimulus – both monetary and fiscal – protects households and helps businesses to survive and retain workers. Despite this, Australia’s small open economy has suffered considerable damage and faces challenges from weak global demand and trade. Significant monetary-fiscal coordination to provide further stimulus will be needed to restore the economy over the next few years.
- We anticipate three consecutive quarters of decline in gross domestic product, with the Australian economy contracting by 9% from 4Q 2019 before a gradual recovery begins in 4Q 2020. We do not expect a recovery for pre-outbreak activity levels until 2H 2022.
- For 2020, our base case estimate remains a 6% contraction, unchanged from our previous projections. Better than expected containment of the virus will encourage 2021 growth from 1.6% to 2.5%. The potential for a second wave of outbreaks remains a major downside risk.
- Monetary policy has shifted to support fiscal policy and maintain financial stability. Overnight cash exchange rates are expected to remain on hold at least until 2022, with ongoing quantitative easing to hold yields amid increasing issuance when fiscal packages and automatic stabilizers start.
- How far the unemployment rate rises depends on the participation trend. The labor market looseness will last for years, which will suppress wage growth and inflation.
The Biggest Financial Year Contraction in Australian GDP in 90 Years
Australia’s real success in controlling coronavirus outbreaks has paved the way for the economy to emerge earlier than economic hibernation which is expected to last for six months. But this process tends to be gradual, and will not prevent a significant economic downturn.
Compared to our previous estimates, what has changed is the level and timing of the blow to the economy from actions taken to deal with the health crisis. There has been a significant setback from retail spending in 1Q 2020. This will weigh on consumer spending in 2Q 2020, creating deeper contractions.
There is a non-trivial risk that shopping prevents the Australian economy from contracting in 1Q, although we think this is not possible given the possible decline in the non-retail household consumption sector, and wider economic activity.
We are now lacking confidence in seeing the contraction in activities continue until 3Q 2020. We currently anticipate a small decrease in 3Q GDP, although this depends very much on how the virus restriction is not lifted.
Revocation of restrictions will allow the business to restart. However, triggering demand may not be as easy as giving a hit on household and business confidence, and damage to the balance sheet. The resumption of economic activity will also be accompanied by some temporary fiscal measures which are not attractive, which can reduce income and demand.
Recovery in Economic Activities Will Need Continuous Policy Support
As a small open economy, a weak global economic background can also hamper Australia’s economic recovery. In addition, the risk of a second wave of outbreaks – most likely imported – means that international travel restrictions cannot be reduced immediately. While Australia’s international borders will remain closed for 3-4 months, the potential for easing restrictions on movement in “virus-free” zones, such as with New Zealand, does present an upward risk to prospects.
Preliminary estimates from the labor market confirm that containing the virus has come at a great cost. Despite the substantial fiscal response, the sad reality is that not all businesses and jobs will be saved. Fiscal policy needs to turn from economic survival to stimulus and recovery when the virus starts to be controlled.
Overhangs in the labor market tend to be more prominent than traditional headline indicators suggest. Our forecast combines a sharp rise in the unemployment rate. But even so, the true picture of a decline in labor demand, or the level of excess labor supply, is likely to be obscured by a decrease in participation and a reduction in hours worked per employee.
As aid payments decrease and social distance decreases, labor force participation, and subsequently the unemployment rate, is likely to increase. Significant dislocations in the labor market may last for a long time even if economic growth can recover. The economy must “heat up” – or above potential – for a long period of time not only to reengage unemployed workers, but also to absorb fundamental growth in the supply of labor.
This will burden the wage growth which has been depressed for a long period of time. In turn, the prospect of inflationary pressures driven by dim wages. It is not possible for a company to face a conducive demand environment to lift prices for some time. This will be partly exacerbated by households wishing to rebuild wealth through increased savings, which risks delaying or silencing demand recovery. In balance, these strengths mean that monetary policy will remain accommodative for a long period of time, coordinating with fiscal policy. The stronger and more sustainable the fiscal response, the faster the economy will be able to recover.
Australia Virus Recovery Scenarios
There is a risk of the ups and downs of our prospects. Effective policy support in Australia, China and throughout the world can help the economy increase stronger steps. But the downside risk is quite large:
- The recurrence of other Covid-19 cases in the country could cause Australia to institutionalize another lockout. Even assuming more moderate control measures, the results will be a double-dip for Australia’s growth rate. We estimate that the second outbreak will trigger a contraction of around 3% in 4Q 2020, and cause a 2.1% contraction in 2021.
- The extent of scarring: Even after the resumption of better than expected activities and significant government efforts, the damage still left to the economy may prove to be greater than we thought. Damaged household and business balance can disrupt activities, resulting in recovery that is longer than expected.
- On the plus side, Australia can experience detention and recovery that is better than expected. This could be further driven by the potential twinning of the Australian economy with New Zealand, which has experienced similar success in controlling the plague. The formation of a “trans-Tasman bubble” that may experience a more relaxed movement of people and activities can result in a stronger and earlier recovery for both countries.
BE Australia’s Short-Term Forecast With Scenarios
James McIntyre is a Bloomberg Economics economist covering the economies of Australia and New Zealand. He has previously covered the economies of Australia and New Zealand at Macquarie Bank and Commonwealth Bank. He also has an economic, public policy and political background through his role in the Australian Treasury, the Australian Banking Association, and as an economic advisor in the Prime Minister’s Office. He is based in Sydney.
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