The Forward View – Australia: March 2021

GDP fully recovered by Q1, but spare capacity remains.

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Overview

  • The economy continues to recover at a rapid pace. The Q4 national accounts showed GDP rising by 3.1% in December to be 1.1% below its pre-COVID level in Q4 2019. This result was again driven by a pick-up in household services consumption, though dwelling and business investment also rose.
  • More recently, the NAB business survey and internal transactions data also point to ongoing strength in the economy for both business and the consumer.
  • The better-than-expected outcome for GDP and ongoing strength in our higher frequency indicators, is consistent with the labour market recovering much more quickly than initially expected – with unemployment falling to 6.4% in January.
  • Incorporating this stronger starting point into NAB’s forecasts, we now see year-average growth of 4.6% in 2021 and 2.5% in 2022. GDP now reaches its pre-COVID level of activity in Q1 2021. For our labour market forecasts, we have tweaked the outlook and now see unemployment falling to 5.8% by end 2021 and 5.3% by end 2022.
  • While the recovery to date has unfolded much more quickly than expected, it is important to remember that 1) it has been uneven and 2) that despite recovering to pre-COVID levels by mid-2021, there remains a high degree of spare capacity in the economy.
  • We estimate that the output gap – the point at which the economy reaches full capacity – could be closed as soon as early as end-2022. However, our forecasts also point to growth slowing to around trend rate at this point, suggesting that it will take longer for capacity and inflation pressures to build. Also, there are likely to be notable lags between activity and the labour market, and then from the labour market to inflation.
  • For policy makers, this suggests any tightening in policy will not be warranted for some time, which is in line with the RBA’s own outlook. We continue to expect the cash rate to remain unchanged until 2024 and now expect a full $100bn extension of QE beyond the second round. That said, we continue to expect the RBA will announce that YCC will not be extended past the April 2024 bond, with the RBA no longer able to credibly commit to rates staying at 0.1% beyond this point.
  • There are a number of risks around our forecasts. The most immediate is the completion of the JobKeeper wage subsidy program and its impact on the labour market. Further out, the underlying weakness of the private sector is a risk given its notable weakness prior to the pandemic. On the upside, tax cuts and the boom in housing market activity may provide more support than we expect.

For further details, please see The Forward View Australia – March 2021