Quarterly Economic Update - October 2022

Market recap

Interest rates have started to rise meaningfully as central banks try to rein in surging inflation by lifting official cash rates. Globally, 29 out of the 37 major central banks lifted cash rates in the three months to June – the highest proportion since 1992. The scale of monetary tightening in the US has led to mounting talk of a possible recession in the first half of next year, with speculation further fueled by two consecutive quarters of declining GDP growth in the US.¹

Locally, the Reserve Bank of Australia (RBA) has been methodically lifting the cash rate – from a 10-year low of 0.1% in May this year to 1.85% in August. Although it moved later than other central banks in lifting its cash rate (the Reserve Bank of New Zealand started its run last year), the RBA’s August rate rise brought Australia’s cash rate to a level not seen since 2016.

The consensus in the global market is that the sequence of very aggressive rate hikes by central banks has plateaued, leading to a recent bounce in share markets. The S&P 500 was up 9.1% in July, the benchmark index’s best monthly performance in nearly two years, while the ASX200 was up 5.8% in the same month.

Inflation remains elevated

Inflation remains high in Australia, being pegged at 6.1% over the June quarter and rising to 6.8% in the month of June alone.

Globally, the trend is similar, and in most cases more pronounced. UK inflation rose to a fresh 40-year high of 9.4% in June 2022 and is expected to soar above 13% by October.² Inflation rose to 8.9% in the EU in the 12 months to July this year,³ while remaining steady at 8.5% in the US.⁴

Most factors driving outsized inflation are outside Australia’s control and largely unavoidable, including the war in Ukraine affecting energy prices and the effect of COVID in tightening labour supply.

Outlook – what’s expected next?

Front of mind over the coming months are rising interest rates and the subsequent impact on households. Investors and economists expect most central banks to keep raising rates rapidly.

The OECD forecasts Australia’s economic activity will continue to lift after recent slowdowns due to a rise in COVID-19 cases and severe flooding in Queensland and NSW.⁵ However, economic risks remain elevated.

Those risks include accelerating inflation, which is putting pressure on the cost of living, a further tightening in the labour market, and limited spare capacity in the economy, which poses a challenge to the newly elected government.

As central banks around the world attempt to balance spiking inflation with softening economic growth, the risk of a hard landing and recession increases. Volatility in energy prices, due to the war in Ukraine, and labour shortages from COVID-19 are additional risk factors.

Inflation is expected to peak in coming months, with the RBA predicting it may climb to a three-decade high of 7.75% by the end of the year. The RBA then anticipates a gradual decline, with an inflation rate a little above 4% throughout next year and about 3% over 2024.⁶

But any decrease in inflation will depend on supply chain issues easing and commodity prices stabilising, as well as reduced demand due to rising interest rates.

Rising interest rates are also expected to affect company earnings and stock prices, particularly in sectors that are unable to pass on rising costs. It’s another challenge for businesses already dealing with higher wages because of a tight labour market and increased production costs due to supply chain disruptions. Property similarly faces headwinds from rate rises, with data confirming the sharpest slowdown in the property market in 30 years.⁷