Economic growth slowed by inflation and monetary tightening
In 2022, Australian economic activity continued to benefit from strong post-pandemic recovery and favourable terms of trade amid high global commodity prices. Labour market tensions reflect the strength of the economic rebound and the unemployment rate is at a 50-year low. The unemployment rate fell to 3.4% of the labour force in November 2022, leaving the economy facing significant labour and skills shortages. However, wage growth has remained moderate (3.1% year-on-year in Q3 2022), thereby limiting the risks of a wage-price spiral.
While the job market will remain tight in 2023 (average unemployment rate at 4% of the labour force), Australian economic growth is expected to slow. Its main driver, private consumption (53% of GDP), will be dented by the durably high level of inflation, which is causing a decline in real disposable household income, as well as by a sharp increase in mortgage rates. While Australian households have one of the highest levels of debt to disposable income among developed economies (192%), some households may face pressure from rising debt service costs. The Reserve Bank of Australia (RBA) estimates that debt service could rise to 9.25% of household disposable income by the end of 2023, up from 7% in 2021. While higher mortgage rates will impact consumption, they are not expected to pose a risk to financial stability due to prudent lending standards and high bank and household reserves. Like consumption, inflation and monetary tightening will dampen private investment. Public investment should remain relatively resilient, driven by government support for green energy initiatives and transport infrastructure development. Last, net exports will contribute positively to GDP growth. Despite the slowdown in export growth caused by the gloomy economic outlook in Western trading partners and the weakness in China's real estate sector that may weigh on iron ore prices, net exports will be supported by China's reopening and a lower import bill.
Despite persistently high energy costs and a strong labour market, inflation will fall in 2023 after being held back by lower global oil prices and weaker domestic demand. High inflation already prompted the RBA to add 300 basis points to the Official Cash Rate (OCR) over the course of 2022, bringing it to 3.6% in March 2023.
Fiscal consolidation and a comfortable external position
In the 2021-2022 fiscal year, Australia embarked on a path of fiscal consolidation and significantly reduced its government deficit, benefiting from the withdrawal of post-pandemic stimulus measures and windfall revenues related to the strength of the economy. However, the end of the tax revenue "overperformance" slowed the pace of fiscal consolidation in the 2022-2023 fiscal year and the modified federal budget that was presented in October 2022 indicated a stable federal deficit of around 1.5% of GDP. This will ultimately depend on commodity export price trends and the extent to which funds are allocated to cost of living relief and climate change measures, which were two election promises of the recently elected Labour government. While rising debt servicing is expected to push up spending in the 2023-2024 financial year, tax reforms, in particular the downward adjustment of the income tax cut due to come into effect in July 2024, will partly offset this. This gradual fiscal consolidation is therefore expected to stabilise the government debt ratio over the medium term. In addition, the share of Australian public debt held by non-residents fell to 45% at the end of the second quarter of 2022 and has been falling since 2020.
Australia's current account has turned positive since 2019, driven by an expanding trade surplus and fuelled by strong growth in commodity exports. Australia's current account surplus will narrow but subsist in 2023, on back of durably strong iron, coal and liquefied natural gas exports. The comfortable trade surplus (4.2% of GDP) will offset growth in the services deficit (0.9% of GDP) and the primary income deficit (2.8% of GDP), linked respectively to the end of travel restrictions and increased overseas dividend payments by mining companies. As Australia seeks to reduce its dependence on China by diversifying the source of its foreign direct investment and free trade agreements, China’s resolve to stabilise relations with certain Western powers will lead it to partially reverse punitive trade measures imposed on Australian coal and agricultural products in 2020.
Political stability and the quest for independence from China
The May 2022 federal elections saw the centre-left Labour Party return to power after nine years in opposition, gaining a slim majority in the House of Representatives (the lower house of Parliament). The party won 77 out of 151 seats (up from 68 in the previous federal election in 2019), leaving 58 seats with the centre-right Liberal-National coalition previously in power. The weak opposition and basic support from smaller parties and independents, particularly in the Senate where Labour does not have a majority, will facilitate the party's policy-making. The government will focus on extending social welfare programmes, implementing climate change mitigation policies, addressing the issues of establishing an Australian Republic and including the Indigenous Voice to Parliament by referendum.
Externally, Australia will reinforce ties with the United States and the United Kingdom through their tripartite AUKUS military alliance, which was unveiled on 15 September 2021. The security agreement aims to counter Chinese expansionism in the Indo-Pacific region and build on the informal military and diplomatic cooperation between the US, India, Japan and Australia (in QUAD), and add to Australia's deepening commitments to its Pacific island neighbours. The agreement reflects its concern to curb growth of China’s influence in the region and could strain relations with China in the future.