Photographer: Brendon Thorne / Bloomberg

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 - long-term GDP with the forecast

Australian Bureau of Statistics, Reserve Bank of Australia, Butlin, Bloomberg Economics

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

Australia - GDP Forecast profile

Bloomberg’s economy

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.

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