RaboResearch - Economic Research

Australia: Economic update


  • The Australian economy is set to contract in Q3, followed by a modest rebound in Q4
  • States prepare to lift lockdowns as they approach vaccination rate threshold levels of 70%-80%
  • The government might be overplaying their hand with the sudden stop in income support in order to force states to comply with the national plan for opening up
  • The RBA continues to maintain its highly supportive monetary conditions
  • Recent developments in the Chinese property market can negatively affect Australia’s exports, driven by a drop in demand for iron ore
  • The increase in energy prices will benefit Australian gas exporters but will simultaneously increase input costs for producers
  • This might trickle down the supply chain, raising prices of goods, especially in combination with already elevated freight costs against the backdrop of supply chain issues
  • Australia announced the AUKUS deal, upsetting France in the process by cancelling their bilateral AUD 90bn submarine contract
  • Australia also announced an ambitious agenda, together with the ‘Quad’ (Australia, Japan, India, and the US) to “promote the free, open, rules-based order” in the Indo-Pacific region
  • Further deterioration of relations with their largest trade partner China are therefore in the cards, increasing the odds of negative economic consequences

Economic Outlook

After Covid-19 knocked down the Australian economy for the second straight year during winter, it is again scrambling to get back on its feet. Most recent GDP figures do not include the economic slowdown yet, but due to the fierce lockdowns through July, August and September, we have pencilled in an economic contraction in quarter-on-quarter terms in Q3. This is followed by a modest rebound in Q4 as we expect some of the effects of the lockdown to carry over into Q4 (see Table 1). Overall, we still expect strong YOY growth of the Australian economy of 4%, mainly on the back of strong recovery of private consumption and investments. Although one should take into account that the high growth is partly due to the low base of 2020, it still means that at the end of the year economic output in 2021 is higher than pre-Covid.

In 2022, we expect the economy to continue to grow. However, due to the complex and unique nature of recent developments, risks are skewed to the downside. Covid-19 continues to challenge policymakers, while simultaneously prices continue to climb as a result of logistical challenges and complex geopolitical dialogues. In the remainder of this publication, we highlight recent domestic developments, such as vaccination progress and lockdowns as well as international developments, such as the “unstable” Chinese property sector and several geopolitical announcements. The aim is to provide guidance on how these events may affect the Australian economy.

Table 1: Table economic outlook (YOY growth)
Table 1: Table economic outlook (YOY growth)Source: RaboResearch

Domestic Developments

Inverse Relation Between Vaccinations and Lockdowns

Australia was able to hold off strict lockdowns during summer, while the Northern Hemisphere faced many restrictions through their winter. Currently, this situation is the opposite, as many restrictions disappear in Europe and US, while parts of Australia are still facing strict lockdowns as a result of relatively high numbers of new Covid-19 cases (see Figure 1). The situation and restrictions differ from state to state. Initially, New South Wales (NSW) had the highest number of new daily cases but currently Victoria is surpassing the number of daily cases in NSW. Economic consequences as a result of the fierce lockdowns in these states are significant, for their combined GDP represents more than 55% of Australia’s total GDP. Continued lockdowns will remain a drag on the economy as ongoing restrictions to travel within Australia will hamper economic activity. At the same time, private consumption will take a hit as people are unable to spend their money, particularly on services. Furthermore, the recovery of the service export sector, for example through the arrival of international students, and tourism income, are further delayed.

Figure 1: High number of cases in largest states
Figure 1: High number of cases in largest statesSource: Australia department of health, Macrobond
Figure 2: Vaccination progress
Figure 2: Vaccination progressSource: Our world in data, ABS, RaboResearch calculations

The restrictions going forward are very much tied to the vaccination rate according to the National plan to transition Australia’s National Covid-19 Response. Important thresholds are the 70% fully vaccinated rate and 80% fully vaccinated rate, because these are tied to the level of restrictions. According to the national plan, they start to lower restrictions at 70%, and minimise restrictions at 80%. Figure 2 shows the actual vaccination rates and pace of vaccinations going forward, based on latest weekly new vaccinations. If Australia is able to continue vaccinating at the current pace, 80% of the total population will be fully vaccinated by mid-November. At that point, almost all restrictions should be lifted according to the National Plan. However, there is discussion among states, which indicate that they might still use lockdowns if the number of new cases rises within the border of their state. Although the largest states (NSW, Victoria) seem aligned with the national plan, the government deems it necessary to incentivise states through rigorous means.

Labour Market Resilience Overestimated?

In order to incentivise states to commit themselves to the National plan, disaster payments from the government to the state will be stopped once vaccination levels reach 80%. According to treasurer Frydenberg: “The temporary COVID-19 Disaster Payment has supported around 2m Australians with over AUD 9bn in payments made since it was announced in June this year.” This is quite significant as it equals approximately 1.8% of last quarter’s GDP. Cutting the support to workers who lost hours of work might threaten a smooth economic recovery because this would mean a drop in income in the transition period after lifting restrictions, especially as we have argued before that supporting household income effectively prevents larger contractions in GDP. Abruptly stopping the income support can be a risk for a smooth recovery. People might not immediately find a job as restrictions ease, which, at least temporarily, decreases household income, which in turn leads to lower consumption, which can be a drag on the pace of the economic recovery.

Figure 3: Labour market loosens…
Figure 3: Labour market loosens…Source: ABS, RaboResearch
Figure 4: … as lockdowns take their toll
Figure 4: … as lockdowns take their tollSource: ABS, ANZ, RaboResearch

What is even more worrisome, from an economic standpoint, is that the pullback of support is preceding any rebound in employment figures. The recently published declining unemployment figures are misleading. Looking underneath the surface, we see that the decline in unemployment can be explained by a lower workforce participation rather than that more people are working, as can be seen in Figure 3. In addition, productivity decreased due to an increase in underemployment (see Figure 3) and a decrease in hours worked of -5.6% since May (see Figure 4). Of course, the labour market has been more resilient than expected since the recovery in the beginning of this year, even in the absence of Jobkeeper. But don’t forget that the stop of Jobkeeper in April was preceded by six sequential month-on-month increases in the participation rate, hours worked and job vacancies, following the lift of restrictions in September 2020. In that light, there might be a risk of a policy mistake in the making when stopping support after three sequential decreases in participation rates, underemployment and job vacancies.

Monetary Policy: Pedal to the Metal

During the September board meeting, the board of the Reserve Bank of Australia (RBA) extended the date for asset purchases of AUD 4bn a week from November 2021 to at least February 2022. Part of the explanation by the RBA to extend the date for asset purchases is the economic slowdown that resulted from new lockdowns. During this week’s October meeting they reaffirmed this decision. Furthermore, the RBA expects a quick economic rebound as soon as lockdown restrictions are lifted, although they foresee some uncertainty causing a slightly less steep rebound than experienced earlier in the year.

The current Cash rate of 0.1% is still a record low, and we expect it to stay at this level for the foreseeable future. The RBA has clearly been pointing at the developments in the labor market. In his latest speech, Governor Lowe mentions: “The Board is committed to maintaining highly supportive monetary conditions to achieve a return to full employment in Australia and inflation consistent with the target”. As we already argue above in our short labor market analysis, we expect that the economic setback and negative impact on the labor market will further delay tightening of the labor market. Let alone that any labor scarcity would result in a (significant) rise in wages. This is important because in the view of the RBA, wage growth has to be “materially” higher than its current level (1.7% YOY) for inflation to be sustainably within the 2%-3% target band. According to the Bank’s central scenario, this is not likely until 2024.

In the meantime house prices are going through the roof. However, it seems that the RBA gives priority to focus on their inflation target and related labor market developments in its monetary policy decisions. As described in the first two of its three mandates, they focus on:  1) the stability of the currency of Australia 2) the maintenance of full employment in Australia 3) the economic prosperity and welfare of the people of Australia. One could argue that the third mandate could be in jeopardy as high house prices threaten financial stability through high household indebtedness. The RBA recognises the risks of excessive borrowing as a result of low interest rates in its latest financial stability review. Nevertheless, the RBA probably won’t be considering an increase in interest rates to keep these under control. In case of any action on this front we first expect macro-prudential measures (MPP) to be announced. Such measures are more targeted at the housing market and are less likely to take the wind out of the sails of the economy. One of the first of such measures is announced last Wednesday by the banking regulator APRA. They increased the minimum interest rate buffer for banks assessment of the serviceability of loans. This limits the borrowing capacity for new borrowers. Moreover, it might not be limited to this action as stated in the financial stability review: “Over time, if the extent of systemic risk changes, then the MPP settings may need to be adjusted, as has frequently been the case internationally.”

International Developments

Besides the economic distortions on the domestic podium, there is a lot happening on the international stage as well. What are the latest developments and how can they impact Australia’s economy?

“Grande” Difficulties in Chinese Property Market

During the financial crisis of 2008-2009, we experienced what the bankruptcy of a single company, Lehman Brothers, could trigger in the global economy. Fast forward to the 20th of September when markets were shocked by the announcement of the liquidity crunch of the Chinese property developer Evergrande, the second-biggest property developer in China, with liabilities over USD 300bn dollar, similar to 20% of Australia’s GDP. markets were nervous that this could be China’s “Lehman brothers moment”. China’s policymakers probably won’t let this single company crisis turn into a systemic collapse. Nonetheless, there could be negative economic consequences for Australia. China’s growth has been one of the drivers of Australia’s pre-Covid streak of 30 years without recession, and China is, by far, Australia’s largest export partner, accounting for almost 40% of Australian export. So how could this event have a knock-on effect on Australia’s growth?

The problems faced by Evergrande are only a symbol for the larger problems faced by the Chinese property market, which accounts for almost 30% of China’s GDP. Construction of property has been a major driver of Chinese economic growth over the past decades and a decline, let alone a collapse, of this industry would surely lead to lower demand from China. More specifically, products used in construction, such as iron ore, will take a blow. Australia as a large iron ore exporter, would suffer from lower iron ore prices in several ways. Firstly, Figure 5 shows that the iron ore has been increasing its share of Australia’s total export value, accounting for over 45% of total export value in Q2 this year. This can be partly explained by the increase in demand from China and the high iron ore prices of the last year. So, a significant drop in iron ore prices or international demand in iron ore will have negative consequences for Australian GDP as this translates to lower export value. Figure 6 highlights the relation between the iron ore price and the current account. Our calculations indicate that we can expect the drop in iron ore prices to shave 1.65ppts off the current account in Q3. Secondly, government income will take a battering due to lower tax income. Obviously, this is not warmly welcomed in a time were the government has spent over AUD 291bn on households and companies to battle the Covid-19 pandemic.

Figure 5: Iron ore’s large share of Australian exports
Figure 5: Iron ore’s large share of Australian exportsSource: TradeMap, RaboResearch
Figure 6: Impact on current account?
Figure 6: Impact on current account?Source: Macrobond, ABS

Nevertheless, not all commodity prices face the headwinds that are currently experienced in the iron ore market. The rise in prices of other commodities, such as natural gas (see Figure 6; part of mineral fuels) could counterbalance some of the government tax income generated by commodity exports.

Gas prices through the roof

As said, not all prices are falling as hard as iron ore. On the contrary, energy prices, as well as cargo prices, have been surging globally over the past months (see Figure 8). Australia, as a large gas and coal exporter, can benefit from the higher prices of coal and gas, while higher transport costs will probably have a less positive effect on the Australian economy. Furthermore, both factors could raise the risk of a prolonged period of higher inflation. Until now, higher inflation has been mainly classified as “transitory” by central banks. However, recent developments suggest inflation might be more sticky than initially anticipated.

During the Covid-19 pandemic, people shifted part of their consumption from services to goods, as they were simply unable to direct their spending towards services like restaurants and hotels. This has led to a global surge in demand for goods, also leading to record high imports in Australia this year (see Figure 7), even though most restrictions were already lifted a year ago.

Figure 7: Record imports wash on shore...
Figure 7: Record imports wash on shore...Source: ABS
Figure 8: Gas prices through the roof globally
Figure 8: Gas prices through the roof globallySource: Bloomberg, Rabobank

Central banks and governments think supply chain issues are largely the result of Covid-19, and inflation will fall when supply chain issues are gradually resolved. But although Covid-19 probably played a large role in catalysing supply chain issues, shipping market dynamics might cause supply chain issues to persist much longer. As we describe in this publication, supply chain problems therefore might be here to stay. The risk here is that the supply shock continues to keep prices of goods elevated for a prolonged period and thus raises inflation expectations for some time to come. Box 1 provides a higher inflation scenario, including its potential impact on economic growth for Australia. 

Gas prices have also exploded in past weeks and months, as Europe and China are facing energy shortages heading into winter, with the risk of serious impact on their economy. Of course, Australia is the odd one out here, approaching summer instead of winter like China and Europe. This suggests that the impact on electricity bills in Australia, as a result of high gas prices, will likely be (more) muted. Moreover, Australia’s LNG exporters can benefit from the current high demand for gas. Furthermore, we expect LNG demand growth in Asia to continue to be substantial in the years ahead, supporting gas prices into the future.

On the flipside, probably not everyone can benefit from these higher prices as gas isn’t solely used for electricity production. There is a wide range of sectors that will suffer higher input costs like producers and offtakers of by-products, such as fertilisers and ethanol. These higher input costs for producers may ripple through the supply chain, eventually leading to higher prices for consumers in Australia as well.

Box 1: Higher inflation scenario

Figure 9: Higher prices, lower growth
Figure 9: Higher prices, lower growthSource: RaboResearch, NiGem

At the moment of writing it’s hard to determine the exact impact of the aforementioned developments on prices, as there are so many factors at play. However, as we expect the risk to be to the upside, we have done an exercise to determine the effect on economic growth in case we add 1ppts higher inflation for 2022 to our base case. Figure 9 illustrates that 1ppts higher inflation generally has a negative effect on economic growth. Mainly due to lower consumption and lower investments. The result is an approximately 0.4ppts lower GDP in 2022.

Shaken, Not Stirred

After several delays, we were happy to welcome a new James Bond movie to our lives. However, some of the news in recent weeks covering international relations feels like a real life Anglo-Saxon spy plot.

First, there was the announcement of Australia, the UK and US that they signed a trilateral security deal partnership in which they note: “guided by our enduring ideals and shared commitment to the international rules-based order, we resolve to deepen diplomatic, security, and defense cooperation in the Indo-Pacific region, including by working with partners, to meet the challenges of the twenty-first century.” The Indo-Pacific region is increasingly in the spotlight due to its strategic importance. Many of the trade routes toward Europe and US flow through the region. Therefore, the security of these trade routes is of importance so as to ensure the safe flow of commodities, materials, and goods towards the west.

However, it is mainly the first initiative of the partnership: “shared ambition to support Australia in acquiring nuclear-powered submarines for the Royal Australian Navy” that sent shivers through the spines of the diplomatic world. This ambition simultaneously denounced a AUD 90bn deal with France. Obviously, this was very ill-received by France, especially since France was informed only just before the official announcement. The fury of France means economic consequences will be broader than just financial since France has recalled their ambassadors from Washington and Canberra, and EU-AU trade talks are stalled for the moment. Hopefully, this action will not scar the overall diplomatic credibility of Australia. But it’s not hard to imagine difficulties gaining trust of (European) allies going forward. Nevertheless, Australia can move forward with its renewed partnership with the US and UK within the new security deal, which is one of the most significant since WW2.

Apart from diplomatic opportunity costs, the financial cost of purchasing nuclear-powered submarines will probably be much higher for the Australian government as it not only encompasses building the actual submarines but also all other supporting technology involved to be able to get the submarines into operation. The total costs are unclear because the deal came without exact disclosure of the costs, although the countries admit that it will be more costly than the deal with France. So even if we take the most conservative number of AUD 90bn, which were the costs of the deal with France, it would increase the current government budget deficit with AUD 9bn a year for the next ten years. This increases the government budget deficit (as % of GDP[1]) with almost 0.5ppts every year until 2031. This increases pressure on an already depressed government budget.

AUKUS was not the only major announcement on the geopolitical front. Australia, together with India, Japan and the US also announced to recommit to their partnership called the “Quad” after their first in-person meeting on the 24th of September. They note: “Together, we recommit to promoting the free, open, rules-based order, rooted in international law and undaunted by coercion, to bolster security and prosperity in the Indo-Pacific and beyond.” Sounds familiar? However, this partnership is more focussed on deepening the ties with the Indo-Pacific region diplomatically and economically, rather than militarily. The ambitious agenda of initiatives includes: “increasing production and access to safe and effective vaccines; promoting high-standards infrastructure; combatting the climate crisis; partnering on emerging technologies, space, and cybersecurity; and cultivating next-generation talent in all of our countries.”

Figure 10*: Breaking up?
Figure 10*: Breaking up?Source: Trademap *Foreign trade data from Q2 2021

In the meantime, one might wonder how Australia’s largest trade partner, China, is looking at these developments (see Figure 10). China in itself is not explicitly mentioned in any of the formal announcements by AUKUS or the Quad. Yet, it seems quite clear that the recent moves are part of a strategy to counterbalance increasing Chinese influence in the Asia-Pacific region. Furthermore, Australia is clearly tightening relations with like-minded economies in an effort to increase its economic resilience. Australian-Chinese relations had already worsened last year, with China banning Australian products like coal, barley, lobster and wine. The recent moves by the Australian government have led to a furtherer deterioration of the bilateral relation. This could carry over into economic consequences through further reductions in China’s imports from Australia, and banning more Australian products. But Australia also has large supply chain dependency on China, with large dependencies on crucial imports used for industry inputs like semi-conductors, computers and fertilisers. At the moment of writing, the ramifications of the two geopolitical ‘deals’ are still very unclear, but it’s an important topic to continue to follow as the effects have the potential to ripple through the Australian economy. After all, it feels like a messy divorce in the making, following a fruitful 30 years affair.


Summing things up, there are some bumps ahead on the road back to full economic recovery for Australia. Domestically, there is light at the end of the tunnel with regard to the economic impact of the Covid-19 pandemic. Vaccination rates continue to climb after a very slow start. This raises the opportunity to open borders and enjoy life without government-imposed restrictions. This bodes well for the economy going forward. However, policymakers are taking a risk by reducing disaster payments at this delicate moment in the recovery. This increases the chance of a slower bounce back of the labor market. Internationally, Australia, as a commodity-rich economy, is in a position to benefit from the large global shifts that seem to be at hand. However, being positioned in the increasingly competitive Asia-pacific, Australia has to walk a tightrope between existing economic ties with China and increasing geostrategic ties to the west.

[1] Based on 2020 GDP


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