It once was said that Australia’s economy rode on a sheep’s back. The sheep was soon replaced by a mining truck. But while mining is still important to the economy, it’s perhaps fairer to say that the economy now rides on the back of consumers.
With consumer spending accounting for more than half of national output, whether households have the capacity and desire to spend up big is what really drives the economy these days.
In that regard, the economic outlook heading into 2023 is decidedly mixed.
On one hand, the jobs market is strong, with virtually everyone who wants a job gainfully employed. Given labour shortages, wages growth is also starting to gradually lift, providing extra spending power for households.
That said, households face several headwinds. Wages have so far at least not kept up with the rise in consumer prices over the past year, cutting into real incomes. Under pressure from higher interest rates, house prices are also falling – denting household wealth and confidence. And the build-up in excess household savings during the COVID lockdown period has now largely been spent – meaning consumer spending likely won’t outpace income growth much longer.
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How these competing forces play out over the coming year will largely dictate the direction for the economy, though it seems likely that the impressive strength of consumer spending since the lockdowns ended will inevitably fade.
To an extent, that’s exactly what the Reserve Bank of Australia (RBA) wants to see. Strong demand and rising food and energy costs due to erratic weather and Russia’s invasion of Ukraine have pushed up inflation. The RBA wants the economy to slow – to at least reduce the demand pressures and the risk that high inflation becomes entrenched though a lift in inflation expectations.
It’s for this reason that the RBA aggressively lifted interest rates last year, and there are likely to be at least one or two more rate hikes to come in the first half of this year.
The best news is that inflation should moderate this year. The COVID-driven demand for goods is unwinding, and we may once again see falling prices for cars, clothes, furniture and consumer electronics.
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The next piece of goods news is that, while wages growth is picking up, it should remain contained enough to not pose too much of an inflationary risk. As a result, were it up to the RBA, it would likely be content with a relatively soft landing for our economy in 2023 – containing the year-ahead rise in the unemployment rate to not much more than 4 per cent, from 3.4 per cent today.
The bad news, however, is that global economic conditions are less supportive. Due to high wage growth, the US will likely need a recession to contain inflation. Meanwhile, the ongoing Ukraine war could keep Europe in recession, while China may struggle for some time as it manages both COVID and a property bubble.
Indeed, rather than trying to slow the economy, the RBA may well be trying to insulate us from a global recession later this year – such that it could reverse course and cut interest rates from a potential mid-year peak of 3.6 per cent back to the current level of 3.1 per cent by year’s end.
Not comforting to most, other than the RBA and first home buyers, national house prices could drop another 5 to10 per cent before bottoming around mid-year. However, poor affordability and higher unemployment should limit their subsequent rebound.
A weaker global economy should be good news for bond markets, which suffered greatly in 2022 as bond yields surged due to both high inflation and central bank increases in short-term interest rates. Central banks should have stopped lifting rates by mid-2023 and will turn their attention to cutting them. Having started the year around 4 per cent, local 10-year government bond yields could end the year around 3 per cent.
Indeed, investors currently have a narrowing window of opportunity to lock in reasonably attractive interest rates on fixed-rate bond investments.
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For the share market, it could be a year of two halves. We could see downward pressure in the first half as the rise in interest rates over the past 12 months starts to take its toll on global economic growth and corporate earnings. But once inflation is back under control and central banks start taking their foot off the brakes, equity markets could stage a nice rebound in the second half.
As was the case in 2022, our share market may not fall as hard as seems likely in the US – the S&P/ASX 200 may test but hold above its 2022 lows of around 6500.
But once global inflation is better under control and interest rates start falling, the next leg up in equity markets could once again favour the growth and technology areas of the market – which in turn could see the local market give back some of its recent outperformance.
As for the Australian dollar, it likely also faces greater downside risk early this year – possibly breaking below US60c – as weaker global growth hurts commodity prices. However, a subsequent global economic recovery could see it move back above US70c by year’s end.
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What’s your biggest financial concern in the year ahead? Are you worried about Australia’s economic outlook for 2023? If you have an investment or SMSF question, send it to [email protected] and we’ll do our best to answer it or find someone who can.
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