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Rising inflation and potential slowdown bring uncertainty for business

RBA Governor Phillip Lowe has strongly signalled that another out-sized increase in the cash rate is on the cards at tomorrow’s meeting. With all the data suggesting the economy is still running hot – retail turnover was up over 10 percent y/y in May – a second 0.5 percentage point increase in the cash rate seems likely.

Rising inflation and potential slowdown bring uncertainty for business
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This would take the cumulative increase in the cash rate over the last three months to 1.25 percent, and given it takes time for the impact of higher rates to flow through the economy it’s likely that the pace of increases will ease from August onwards. Further increases from 1.35 percent are a near-certainty, but the RBA will need to closely monitor the transmission through the economy to calibrate a soft landing.

Around the world, interest rate rises are flowing thick and fast as central banks grapple with rising inflation. The US Federal Reserve raised its target by 0.75 percentage points in June and the European Central Bank is gearing up for its first raise in 11 years this month.

As we enter the second half of the year, KPMG now forecasts in our Quarterly Economic Outlook domestic inflation to average 6.4 percent over 2022. Global supply shocks and strong domestic demand are creating significant cost pressures that are increasingly being passed to consumers.

Given this backdrop, we predict 3.6 percent GDP growth year on year – down from 4.8 percent in 2021. At this stage we do not expect Australia to fall into recession, but we do see growth momentum softening through the rest of 2022 and into 2023. This is not unexpected, as the post-lockdown rebound could not last forever.

Budget constraints at state, territory and federal level will put a fiscal drag on demand, as the need for repair work grows and spending programs are cut to ease inflationary pressure.

We also expect exports to lag behind imports into 2023 (resulting in net exports putting a drag on GDP), with the rise in commodity prices yet to produce increased investment from the mining sector – likely because they have decided the current shocks are temporary in nature.

Meanwhile, service exports to overseas students and tourists are recovering, but the challenging global environment means we don’t expect inflows to return to their pre-COVID trend.

Right now, the labour market shows little sign of cooling with participation sitting at a high of 66.7 percent. The lack of capacity in the market is driving wages growth, but in general we expect wages to lag behind inflation; the Fair Work Commission’s 5.2 percent increase of the national minimum wage is likely to be at the top end of pay rises this year.

The acceleration in wages growth has led to warnings of a possible wage-price spiral from some groups, which would cause widespread damage to the economy. However, we see this as unlikely, given the RBA is now raising the cash rate rapidly, to cool domestic momentum and keep inflation expectations in check.

Indeed, with growth momentum set to moderate in the face of global headwinds and lower levels of government spending, we expect the pace of interest rate rises to ease sharply over 2023 (and potentially pause) to prevent overreaching.

On a brighter note, the focus on climate in the election and the new government’s pledge to reduce emissions in 2030 by at least 43 percent of 2005 levels may create new opportunities for business and investment. Government estimates suggest that around 604,000 jobs could be created in this space, while private investment is forecast to reach $52 billion.

While this is undoubtedly positive for the future of the economy, the transition will also create challenges, with a need to retrain the workforce and mobilise the necessary capital for investment.

Overall, it is clear the upcoming quarters will place considerable strain on businesses and households, with global headwinds unlikely to dissipate any time soon. Careful economic management will be key for the Federal government as they seek to guide Australia back on a path of growth and stability in the long-term.

Productivity, as ever, will be crucial and presents the strongest base for any reform agenda that governments may wish to pursue.

Shared from KPMG

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