Key insights from the week that was.
Australia received a run of robust data this week as global markets remained focused on the terrible developments in Ukraine and their global repercussions.
The prime data release for Australia in the past 7 days was the Q4 GDP report. A strong 3.4% gain was recorded for activity in the three months to December, leaving annual growth at 4.2%. The primary driver of this gain was a resurgent consumer in NSW and Victoria, consumption rising 11% and 7.5% in the two states as delta restrictions were removed for a 6.3% national gain.
Restrictions and supply shortages weighed on housing investment in the quarter, though it still ended 2021 5.3%yr higher. A similar narrative applies for business investment (-0.3%; +5.4%yr); the outlook for this sector is also healthy, with Australian businesses positive on the domestic outlook and cognisant of limited existing excess capacity. For 2022, the still-elevated savings rate and strong labour market are big positives for consumption and investment alike, particularly facing into a monetary tightening cycle.
On monetary policy, this week’s RBA meeting communications highlighted the underlying strength of the Australian economy, but also the immense uncertainty facing the world owing to Russia’s invasion of Ukraine. Specifically, the broadening of the discussion around wages recognises the limitations of the headline Wage Price Index and the greater momentum being shown in other measures of labour costs that incorporate bonuses and promotion-related pay rises.
On Ukraine, the Governor stated that “the war in the Ukraine is a major new source of uncertainty” and “how long it takes to resolve the disruptions to supply chains is an important source of uncertainty regarding the inflation outlook, as are developments in global energy markets.” Chief Economist Bill Evans subsequently investigated these themes in depth in a video update.
Of the other Australian data out this week, the Balance of Payments (BOP) release was most notable. With respect to trade, in Q4 2021, Australia experienced its 11th consecutive quarterly surplus; while smaller than Q3, it was still sizeable at 2.3% of GDP. Commodity prices are behind this trend, the past 3 years seeing a 17% increase in export earnings on the back of a 30% gain in prices.
Of course, the other half of the BOP release is detail on Australia’s financial position, another big positive for our nation. Direct investment in Australia has rallied strongly from the early days of the pandemic, with annualised inflows from foreign investors in the second half of 2021 back above the average of the 5 years prior to the pandemic – a period of strength. Australia’s proximity to Asia and the opportunities created by global recovery bodes well for a continuation of this trend.
The other major positive for Australia’s long-term health is that Australian investors continue to invest offshore in equity investments, at pace. Our workforce’s commitment to building wealth through superannuation and the sector’s global investment mandate is key here, but the momentum in investment signals households are investing offshore in excess of super. Combined with the savings held domestically at banks, this wealth bolsters the prospects for future consumption.
The strength of commodity prices, opportunities in Asia and investment inflows into Australia are all constructive for the Australian dollar. Notably, despite a further escalation of tensions in Ukraine and consequent uncertainty over the economic outlook for Europe and inflation globally, the Australian dollar appreciated over the past week from around USD0.7180 as our Weekly went to press on Westpac IQ to around USD0.7320 currently.
While we still see a setback for the Australian dollar as the FOMC tightens policy ahead of the RBA in coming months, a return to USD0.73 is expected by year end and a push up to USD0.78 is forecast by end-2023. Arguably, recent developments for commodities and the desire of authorities to promote robust activity point to upside risks for our currency over the forecast period.
Then to developments in the US. Speaking before House and Senate Committees this week, FOMC Chair Powell made clear that the FOMC would continue to carefully assess the implications of Russia’s invasion of Ukraine but believe the strength of the US economy and inflation risks warrant commencing policy tightening at their March meeting.
A 25bp rate hike is expected at that meeting, and the Committee is also set to give guidance on the speed and timing of balance sheet reduction. We expect the latter to begin in Q2, around the time of the second and third rate hikes for this cycle (May and June). Thereafter, the combined effect of these two forms of policy tightening on financial conditions and a rapid reduction in inflation and related risks will see rate hikes move to a quarterly schedule until a fed funds rate peak of 1.875% in June 2023. A positive spread between fed funds and the US 10-year is expected to remain in place throughout the forecast period, with US growth at or above trend and inflation converging to target.
President Biden’s State of the Union address and subsequent sanctions against Russia’s oligarchs continued to build pressure on Russia this week. However, it is the sanctions on the Russian central bank combined with the removal of some Russian banks from SWIFT that has done the most damage to their economy. The impact of these policies has been further accentuated by Western banks and corporates imposing their own restrictions/ bans on Russian entities.
In short, Russia’s central bank has lost access to most of its foreign reserves as these are invested/ held outside their borders and can therefore be withheld by their counterparties. Another large portion of their reserves are physical gold in Russia. While under their full control, these reserves also have little use unless a foreigner is willing to purchase or lease the asset – an unlikely outcome in the current circumstances. Russia’s central bank has therefore had to rely on capital controls and closing the stock market to limit the Ruble’s decline, further destabilising confidence.
Russia’s private sector therefore increasingly finds itself without access to foreign currency and global banks to finance trade. Shipping is also becoming more and more difficult given issues with insurance and trade finance. Russia’s access to foreign income is narrowing to the proceeds they receive from energy sales to Europe and elsewhere, which are exempt from the sanctions.
These developments are incredibly destabilising for Russia’s economy and can only be endured for a short period before considerable hardship is placed on ordinary Russian businesses and households. While a full ban of energy imports from Russia is highly unlikely given its significant share of global supply, there are growing calls from politicians in several nations, including the US, to cut Russia’s income by banning imports. Canada, which imports only a very small amount, has already banned crude oil imports. The global community continues to hope that a negotiated resolution to this conflict can be encouraged by their actions.
