Delta variant forces Australia into new lockdowns
- The Delta variant still has Australia in its grip with New South Wales entering the fifth week of lockdowns
- The Australian economy will be impacted through lower household consumption as a result of lockdown restrictions
- However, the negative economic consequences will be less severe than last year because the population is able to learn from past experiences
- While inflation reached a high point of 3.8% this is seen as temporary by the central bank
- According to the RBA, wage growth should be above 3% for inflation to be structurally within the 2-3% target range
- The RBA does not expect this scenario to materialize before 2024, although some economic conditions are in place for higher wage growth to occur
New lockdowns will drag on economy in third quarter
The Delta variant of the Covid-19 virus has Australia firmly in its grip (Figure 1). Several Australian states have been in and out of lockdowns since the beginning of May. Sydney and the state of New South Wales have the most to endure, and are now entering the fifth week of lockdowns. So what will be the economic impact of current lockdowns?
We know that government-imposed lockdowns induce collateral damage, both social and economic. From an economic perspective, this led to a contraction of 2.4% of the Australian economy in 2020. Which could have been much worse if the government had not stepped in, as we showed in an earlier publication. An effective way of assessing the potential impact of new lockdown measures is to look at mobility indicators, as presented in Figure 2. The logic behind this approach is that consumption makes up a large share of the total economy. Figure 2 shows that activity levels (Australia total) are close to the levels of Q3 last year. The combination of people’s fear of becoming infected and the restrictions of government-imposed lockdowns limited consumer spending, and thus consumption, in Q3. Consumers might be able to shift part of their spending toward goods, as seen in earlier lockdowns, in which case the main impact will be felt in service-related sectors. Another limitation on consumer spending is the potential drop in income as a result of reduced working hours, caused by lower demand for goods and services. Previously this was covered by the Jobkeeper payments. This program will not be re-introduced, but the government will pay employees on the basis of lost hours of work through the Covid-19 disaster payment program. This will help to keep consumption levels somewhat elevated.
Overall, we do not think the economic impact will be as severe as last year’s. The experience in other countries is that the population is able to learn from previous lockdowns, limiting the economic impact in case of a second or third wave of the virus. Furthermore, economic activity and output is likely to bounce back quickly when the economy opens up, as has happened before in Australia. But the final outcome remains very much dependent on the length and intensity of lockdowns going forward.
There is a more fundamental question looming on the horizon: how realistic is it to completely exterminate the virus domestically and continue to live in isolation? Especially as the virus has the ability to mutate in more transmissible variants and can continue to spread in many countries globally due to alternative government strategies/ inabilities in containing the virus. At the same time domestic lockdowns continue to impact business, which drags on the economy and wage subsidy schemes continue to impact the government budget. It seems Australia is approaching an important crossroad, and being an island seems both a blessing and a curse.
RBA accommodative in absence of desired wage growth
On July 7, the RBA took its much-anticipated monetary policy decision. The RBA decided to not roll over the maturity of the 3yr bond yield target and thus retain the April 2024 bond as target bond with a yield target of 10 basis points. Furthermore, they decided to slightly taper the purchase of government bonds from AUSD 5 billion a week down to AUSD 4 billion a week until at least November 2021. They will then assess the asset purchasing program in the light of the economic outlook at that time. This grants the RBA some flexibility to tailor the asset purchasing program according to the future economic situation. In addition, the RBA decided to “maintain the cash rate target at 10 basis points and interest rate on Exchange Settlement balances on zero per cent”.
In isolation, these decisions could be defined as “tightening” monetary policy, given that the bond maturity has not been rolled over to the next maturity and that the amount of asset purchases slightly decreased. However, if we put the decision into context, we see that the RBA is still ultra-accommodative. Firstly, many economic indicators are far more positive than anticipated. For example, the Q1 economic growth of 1.8% q/q on the back of higher-than-expected investments, recent tightening of the labor market and the surging housing market. Secondly, by comparison, other central banks have tightened monetary policy as a reaction to similar positive economic developments. For example, the RBNZ has halted additional asset purchases since July 23. Thirdly, inflation reached a high point of 3.8%, but the trimmed mean is “only” 1.6%, which is a less alarming number. Moreover, this peak was expected, due to the low base of last year and accelerated demand as result of the economic recovery.The RBA sees this rise in inflation as temporary. Nonetheless, real wage growth is negative with such inflation numbers, which makes the situation increasingly complex. Negative wage growth affects the purchasing power of workers, leading to lower consumer demand and limiting economic growth. Furthermore, negative real wage growth has the potential to increase inequality. So what can we expect from the RBA?
Since the RBA sees this peak inflation as temporary, they are focusing on more structural factors for inflation. It seems that we were rightfully looking at the developments in the labor market in our last monthly. In his recent speech RBA Governor Lowe mentions: “For inflation to be sustainably in the 2 to 3 per cent range, it is likely that wage growth will need to exceed 3 per cent “. Currently this is about 1.5%, which is materially lower, and there are several reasons why the RBA does not expect this to rise quickly. For now, the RBA does not expect this scenario to occur before 2024. Obviously, the current lockdowns cause a step back on the path toward full employment and potential wage growth. But the labor market has proven to be resilient over the past months. Taken in combination with high economic growth and closed borders, we could see wage growth picking up sooner rather than later. And with regard to that last point: Governor Lowe mentioned that wages cannot go up go as easily with high levels of migrant workers. With some sectors dependent on migrant workers and new federal elections coming up within a year, this could well be an issue for debate. All in all, these will be key developments to monitor in the months ahead.