Economic Update - March 2023

Market recap:

Inflation remains elevated globally and is likely to remain above the target range of the RBA for some time. As a result, the RBA and other central banks have continued to raise cash rates (although more recently at a slower pace). 

Following a string of rises in 2022, the Reserve Bank of Australia (RBA) increased its cash rate to 3.35% in February, with more expected to come.

In the US, the Federal Reserve also announced another 0.25% lift in the benchmark rate in February – its eighth consecutive increase – to a range of 4.475-4.5%. Analysts currently expect it to go above 5% (although the rate of increase has slowed). 

Following four rises in 2022, the European Central Bank raised its key rate by 0.5% in February to 2.5%. with another 0.5% increase currently expected in March. 

The global economy grew strongly in 2022 as the impact of the COVID-19 pandemic started to recede, but monetary tightening to combat inflation is expected to result in much slower growth in 2023 and beyond. 

In Australia, household consumption propelled four consecutive quarters of growth to the end of the third quarter of 2022. Retail sales however, which make up about one-third of household consumption, unexpectedly fell by 3.9% in December. Unemployment also remains at near record low levels, rising to 3.7% in January (from 3.5% the month before) the lowest since the mid-1970s. Unemployment is also currently expected to increase slightly in 2023 due to slower growth.

Global share market volatility in 2022 was driven by the impact of the war in Ukraine, supply-chain disruptions and inflationary pressures, resulting in one of the worst years on record for US stocks. The S&P/500 was down 20%, the NASDAQ 100 fell by 33% and the Dow Jones by 8.8%. 

Local markets in Australia fared better with the S&P/ASX 200 down by 5.5% and the All Ords by 7.2%. Last year also saw the lowest number of new listings on the ASX in more than a decade, with only 107 new listings compared with 241 in 2021.
 

The Inflation rate has likely peaked

Annualised Inflation reached 7.8% in Australia by the end of the December quarter, from 7.3% at the end of the September quarter. The core inflation rate hit 6.9% at the end of 2022 which the RBA described as “higher than had been expected”¹.  Despite this, the RBA says inflation likely peaked around the end of 2022 and is forecast to decline to 4.75% over 2023 and to around 3 % by mid-2025.

Other economies have seen a similar plateau in the inflation rate. In the US, the annual Consumer Price Index (CPI) fell to 6.4% in January, down from 6.5% in December. It was the seventh consecutive monthly fall after it hit a high of 9.1% in June 2022².  In the UK, inflation fell to 10.1% in January, down from 10.5% in December and a peak of 11.1% in October 2022³. 

The International Monetary Fund (IMF) currently expects global inflation to fall from 8.8% in 2022 to 6.6% in 2023⁴.  For major developed economies, the Organisation for Economic Co-operation and Development (OECD) currently projects inflation to moderate from 9.4% in 2022 to about 6.6% in 2023 and 5.1% in 2024⁵. 

This downward trend in inflation is expected to continue in 2023 as tighter monetary policies take effect, post-COVID-19 demand pressures subside, and supply chains normalise. The pace of decline will vary across countries and, while a faster fall is possible as areas that saw acute inflation in 2022 reverse, there is still much uncertainty in the outlook. Unemployment remains low and the demand remains robust, which may keep inflation elevated for some time.

Outlook – what’s expected next?

Inflation and interest rates will continue to occupy the minds of investors and economists over the coming months. However, the focus is likely to also include growth and unemployment as the pent-up demand in the economy, post-COVID supply shocks start to wane, and higher interest rates begin to bite. There is still a danger that higher interest rates over an extended period could force the economy to make a harder than expected landing.

While the imminent threat of uncontrollable inflation seems to have been averted, there are still many economic and geopolitical risks. These include the continuing war in Ukraine, the progress of China’s reopening after an extended period of lockdown, and an overly tight labour market with rising wages/strong demand.

At the time of writing this report, economic growth in Australia is forecast to slow this year as rising interest rates, the higher cost of living and declining real wealth takes its toll. The most recent OECD country outlook projects real GDP growth in Australia of 1.9% in 2023 and 1.6% in 2024, roughly in line with the RBA’s own predictions of 1.5% for 2023.
For the global economy, the IMF estimates 3.4% growth in 2022, falling to 2.9% in 2023. That’s below the long-term average but higher than forecast in October 2022. The OECD now projects global GDP growth to slow to 2.2% in 2023, well below the rate predicted before the war in Europe, then recovering to 2.7% in 2024.

Current forecasts for global growth in 2023 suggest a divergence between developed and emerging markets. Growth in the US is expected to hover at about 1% for the next two years and be even lower in the EU and UK. In contrast, the OECD expects the major Asian emerging-market economies will account for close to three-quarters of global GDP growth in 2023; the IMF expects China and India alone to account for 50% of global growth in 2023.

Overall, the outlook remains uncertain – the RBA noted in its February statement that there are “plausible scenarios for both stronger and weaker growth and inflation”⁶.

Rising unemployment and higher interest rates risk further falls in Australia’s property market, following on from the 7% fall in residential property prices nationally in the 12 months to the end of January⁷. This was the largest annual decline in home values since May 2019, although, many economists expect prices to slip further.⁸

Many mortgage holders are also coming to the end of fixed-interest rate loan periods and face refinancing at a much higher interest rate, the same time, they may experience negative equity in their properties.

On the stock market, company shares have continued to rally from the lows of last year. So far in 2023, the ASX 200 gained 6.2% in January, nearly recouping the losses of 2022. By the end of January, the ASX 200 has gained over 16% from the September 2022 lows.