Headline inflation in the March 2022 quarter was 5.1 percent over the year, faster than previously anticipated, which significantly affects the economic outlook for the second half of 2022 and 2023.
Key issues
Inflation is accelerating, putting pressure on the cost of living
Further tightening in the labour market
Limited spare capacity in the economy poses a challenge to newly elected government
Risks to the outlook
- Emergence of a new COVID variant
- Faster pace of rate rises to combat inflation
- Potential for an economic slowdown in medium term
- Uncertain recovery in migration and services exports
- Population permanently smaller and older post-COVID
Mid-year economic update weathering the inflation storm
Global supply shocks and strong domestic demand have combined to generate cost pressures that are now being passed on, with significant price rises seen in fuel, food, durables and new dwelling construction (raw materials).
Growth in household consumption and government spending remains robust. Recent floods and supply chain challenges have however, dampened business investment and residential construction activity. Overall, GDP still increased by 0.8 percent in the first quarter of 2022. Inflation is forecast to average 6.4 percent and GDP expand by 3.6 percent in 2022.
Russia-Ukraine war and China lockdown driving inflation
The Russian invasion of Ukraine has affected both Russian and Ukrainian exports of oil, gas, metals, food and intermediate inputs. This has led to a surge in food and fuel prices globally, and we expect the sanctions imposed on Russia to remain in place for some time, implying that the economic shocks will take time to unwind.
Second, lockdowns in China in pursuit of zero COVID-19 cases have constrained economic activity, particularly in the manufacturing sector. Global supply chains have been impacted by these ongoing restrictions, and while lockdowns have been loosened it will take time for production and supply chains to normalise (and so price pressures to ease). There is also an ongoing risk of future outbreaks and lockdowns.
Limited spare capacity in labour market
The latest data continues to confirm that there is very little spare capacity left in the labour market. The participation rate is at a high of 66 percent, while the unemployment and underemployment rates continue to trend down. Concurrently, the number of job vacancies has been trending up, with only 1.3 unemployed persons per job vacancy in the most recent data.
Monetary conditions tightening around the world
The combination of fiscal stimulus packages and pent-up demand as a result of COVID-19 has created significant demand pressures. Central banks around the world have begun tightening monetary conditions rapidly to manage further robust growth in demand in the presence of continued supply constraints.
Interest rates in the US, UK and Canada have already been raised several times since the start of the year. In Australia, the RBA have now taken a hawkish stance, with a cumulative 0.75 percent points in hikes in the last two meeting. Several more rate rises are anticipated this year, with the cash rate expected to reach 2 percent by end of 2022.
Climate change moving up the agenda after Federal election
Climate change was a key issue in the recent Federal election, with the incoming government committing to reduce carbon emissions by 43 percent relative to 2005 levels by 2030. While the incoming government anticipates that this will create 604,000 jobs and generate $52 billion in private investment, a more pressing immediate concern is balancing the need to reduce fiscal stimulus (given the current position of the economy) against spending commitments from the election, including aged care and enhancing the childcare subsidy. The new government will need to tread carefully to avoid further overheating the economy.
Full details on the Australian outlook can be found in KPMG's Economic Outlook: Q2 2022.
