With vaccination rate targets achieved across states and lockdowns easing, GDP rebounded by 3.4 percent in Q4 2021.

Key issues

  • Initial Omicron wave has peaked, cases are rising again but economic spillover limited

  • High commodity prices and domestic pass-through are lifting inflation

  • Labour market continues to beat expectations

  • Inflation, rate rises and natural slowing in growth will dampen H2 2022 and 2023

  • Fiscal policy settings also tightening as pandemic supports come to an end

Risks to the outlook

  • Emergence of a new COVID-19 variant
  • Uncertain geopolitical environment
  • Faster pace of rate rises to combat inflation
  • Uncertain recovery in migration and services exports
  • Population permanently smaller and older post-COVID-19

Omicron impacts contained in Q1

Household consumption has led the recovery, housing construction and business investment now recovering from Delta wave. The Omicron wave dampened the start of 2022, but better than expected health outcomes have allowed the economy to re-open. Recent floods in Queensland and NSW has also disrupted activity, but we expect the drag to be temporary and partly offset by reconstruction efforts.

The current situation in Ukraine, rising inflation and the potential emergence of another variant are significant downside risks, but underlying momentum remains positive. GDP is forecast to grow by 3.7 percent in 2022 and 2 percent in 2023.

Geopolitical situation pushing up commodity prices

Commodity prices across the board have been elevated for some time, with the recovery in demand running ahead of supply. This trend has been most pronounced in oil and European natural gas markets, with the current conflict in Ukraine adding further upward pressure. But there are now spillovers to other industrial commodities and food, as concerns about future supply mount. Prices are likely to remain elevated in the near term, which will add further fuel to headline inflationary pressures.

Supply chain and logistics disruptions have eased, but could re-emerge

Although Omicron has resulted in some further disruptions in global supply chains (particularly in China), there are tentative signs that pressures are easing; global shipping costs have plateaued in recent weeks and congestion in key ports is falling back. But the cost of many products and inputs is set to remain elevated while conditions normalise, and there is a risk that shipping rates rebound as the fallout from the conflict in Ukraine disrupts freight routes between Asia and Europe. 

Labour market remains buoyant

Omicron’s impact on the economy is clear, with hours worked falling by 8.8 percent in January (the majority of which was explained by significantly more sick leave absences than usual). But there was a sharp rebound in February, with employment rising to 13.4mn and the unemployment rate falling to 4 percent. The tightening of labour markets has started to raise wages growth, with average pay increasing 0.7 percent q/q in Q4 2021. At the industry level, there is something of a dual-paced wage economy; in-demand workers are enjoying pay rises of 2.5+ percent y/y, while those in more unionised sectors are lagging behind.

First cash rate rise expected in August 2022

With the data continuing to beat the RBA’s expectations, Governor Lowe and other Bank officials are now signalling that a first cash rate rise this year is now “plausible”. Headline inflation will rise further as the most recent increase in petrol prices feeds through. Underlying inflation is also expected to pick-up as domestic firms adjust prices in the face of rising input costs and wages. Financial markets continue to expect the RBA to begin raising rates in early Q2 2022. But inflationary pressures are less pronounced here than elsewhere (particularly the US). Notwithstanding the shift in the narrative to a 2022 lift-off, the RBA still want the data to confirm a sustained pick-up in inflation. Given this, we expect the cash rate to remain on hold until August 2022.

Full details on the Australian outlook can be found in KPMG's Economic Outlook: Q1 2022

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