OECD Economic Outlook, Volume 2022 Issue 2

Australia

Real GDP is projected to grow by 4% in 2022, 1.9% in 2023 and 1.6% in 2024. Elevated inflation is eroding households’ purchasing power and has prompted the Reserve Bank of Australia to raise interest rates at a rapid pace. As growth slows, the tightness in the labour market is expected to subside. Inflationary pressures will diminish as the labour market cools and supply chain bottlenecks ease. A stronger than expected decline in house prices is a key risk to the growth outlook.

Further monetary policy tightening will be necessary to bring inflation down to the 2-3% target range. Any further fiscal support in response to cost-of-living pressures should be targeted and temporary and maintain incentives for energy savings. Reducing greenhouse gas emissions remains a top priority and will require further action, including investment in renewables and in the transmission network, regulatory changes, structural reforms and higher carbon pricing.

Inflationary pressures are rising due to global factors and a tight labour market

The recovery from the pandemic continued in the second quarter of 2022, with growth driven by strong domestic and export demand. High-frequency indicators suggest that household consumption has slowed somewhat in recent months. The labour market has tightened considerably, with the unemployment rate remaining at 3.5% in September, a historically low level. Labour shortages are rife, with employment and participation rates near all-time highs, in part due to a fall in immigration since the beginning of the pandemic. As a result, wage growth picked up significantly in the third quarter of 2022, with yearly growth in the Wage Price Index rising to 3.1%.

Australia

1. The Index of Commodity Prices measures the prices of 22 major commodities exported by Australia, including rural commodities, base metals, bulk commodities and other resources. The index is shown in terms of Special Drawing Rights (SDR), which is less affected by exchange rate movements.

2. All persons aged 15 years and over.

Source: Reserve Bank of Australia; and Australian Bureau of Statistics.

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Australia: Demand, output and prices

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Russia’s war of aggression against Ukraine has had little direct impact on the Australia economy given the country’s limited direct economic links with the most affected countries. However, both the war and the recent stringent lockdowns in China have exacerbated supply-chain issues, particularly in the shipping industry. High global energy prices have also resulted in a rise in inflation and declining consumer sentiment. Consumer price inflation rose to 7.3% year-on-year in the third quarter of 2022, and there is evidence that price pressures are becoming more broad-based. Even so, inflation expectations remain at moderate levels. Higher commodity prices have boosted Australia’s terms of trade, and strong global demand for commodities have supported exports, with Australian liquefied natural gas and coal exporters reporting a strong rise in 2022.

Macroeconomic policy is becoming more restrictive

The Reserve Bank of Australia has tightened monetary policy in response to rising inflation, raising its cash rate from 0.1% to 2.85% in the past six months. Accordingly, financial conditions have become more restrictive, with rising corporate bond yields and mortgage interest rates. Further increases in the cash rate will be necessary to bring inflation back to the target range of 2-3%, with the projections assuming that the cash rate will peak at 3.6% in the first quarter of 2023 and remain there until well into 2024. In March, the government provided cost-of-living support to low- and middle-income earners and other vulnerable parts of the population, amounting to more than 0.2% of GDP in tax offsets and direct payments. The fuel excise duty was also halved until September 2022 in response to rising fuel prices. The federal deficit is projected to gradually fall as fiscal support measures introduced during the pandemic and in response to severe flooding earlier in the year are unwound. Public investment, however, is expected to increase due to a large pipeline of public engineering work, including the infrastructure projects announced in the October Budget.

Economic growth will slow after a rapid recovery

Economic growth is projected to slow after the strong recovery from the pandemic, with real GDP growth reaching 1.9% in 2023 and 1.6% in 2024, after 4% in 2022. Tighter financial conditions and elevated inflation will weigh on consumption and investment. Dwelling investment is also projected to slow over the projection period in response to declining house prices. With a very tight labour market, wage growth is expected to pick up further in the near term, but it will ease as unemployment edges up in the second half of 2023. Inflation will moderate, aided by lower commodity prices than in 2022, easing supply disruptions and slowing wage growth later in 2023. Risks to economic growth are tilted to the downside. More persistent price pressures could cause a stronger decline in real incomes and more aggressive policy tightening by the central bank. Falling house prices may also further weaken residential construction and household spending.

Reducing emissions from greenhouse gases remains a priority

Any further support to households and businesses in response to cost-of-living pressures should be targeted, temporary, and delivered in a way that does not distort price signals. The government has committed to net zero emissions by 2050 and recently raised its greenhouse gas emissions reduction target for 2030 to a 43% cut in emissions from 2005 levels. Measures to reduce the country’s reliance on fossil fuels will be important to achieve these targets. These include greater investment in renewables and in the transmission network, regulatory changes, structural reforms and carbon pricing. As proposed by the government, reconsidering the design of the safeguard mechanism, which limits the net emissions of Australia’s largest greenhouse gas emitters, will be an important step towards achieving emissions targets.