Maidan Uprising Kiev Ukraine
Australia looks relatively well-placed to cope with what has now become a major global supply shock, as the hit to the economy from higher petrol prices and lower sentiment will be offset by elevated commodity prices, stronger terms of trade and hence a boost to national income and federal government revenues. But the price shock does complicate matters for the central bank, with the RBA conceding this week that inflation will now be higher this year, which in turn makes a near-term increase in the cash rate appear more plausible than Martin Place had previously indicated. At the same time, this week brought some early indications that the crisis in Europe, along with the higher fuel prices that it is contributing to, is taking a toll on Australian consumer confidence. This week’s data on business confidence predates events in the Ukraine but indicates that pre-conflict, business confidence and conditions were both strengthening in February as the Omicron wave showed signs of easing.
Australia is also having to manage the impact of severe floods in Queensland and New South Wales. These will likely have caused well over a billion dollars’ worth of damages, will further add to price pressures in the economy, and should also serve as a potent reminder of warnings that climate change implies a greater frequency, greater intensity and greater cost of extreme weather events – and therefore more future pressures on the budget and more disruption to the supply side of the economy.
This week also brought data on job ads, weekly payroll jobs, the labour account, inflation expectations, industrial disputes and consumer spending.
There was no weekly note last week, but if you’d like to catch up on the Q4:2021 GDP release, you can find our updated GDP chart pack here which reviews the December quarter’s consumer-powered recovery.
This week’s linkage is dominated by the Ukraine war and includes pieces and podcasts on estimating the costs of the war, the role played by sanctions, the end of the oligarch era, crypto in a time of war, grading prediction markets and possible implications for the green energy transition.
I’ll be doing a webinar on Australia’s Budget 2022 on 31 March. You can register for the Budget update here.
Finally, many thanks to those readers (and podcast listeners!) who said hello at the AGS in Melbourne last week. It was great to get your feedback in person.
Listen and subscribe to our podcast: Apple Podcasts | Google Podcasts | Spotify
The war in Ukraine is inflicting significant damage on the global economy
The war in Ukraine has produced a marked increase in geopolitical risk that has already made its mark on global commodity and financial markets and has led to a rise in economic and financial uncertainty.
Early IMF assessments of the economic impact of the war begin by acknowledging the central factor of this uncertainty, emphasising that it is still too early to determine the full implications for the global economy. But the Fund’s early take is to consider the joint impact of both the conflict and the sanctions that the west has imposed on Russia in response, and to highlight three major transmission channels from the conflict to the global economy: commodity prices, migration and confidence. To those three channels we should probably add trade links and supply chains and global financial markets.
To date, most attention has focused on the commodity price channel, where there has been a sharp increase in the price of oil:
The increase in European gas prices has been even more dramatic:
And thermal coal prices are also up. For net energy importers, this delivers a painful stagflationary shock, in that it drives up prices and therefore inflationary pressures at the same time as depressing economic activity. How big a shock will depend on the magnitude and duration of the price increases, which in turn will be a function of the duration and extent of the conflict and of the sanctions it has triggered. Note that the history of sanctions also suggests that in some cases (involving say investment decisions made by private firms) it is easier to turn sanctions on than to turn them off again.
The Ukraine war is also adding further pressure to already-high global food prices, both directly (Ukraine and Russia are major wheat exporters and there are worries about disruptions to supply through the Black Sea region) and indirectly (for example, via fears of disruption to the supply of fertilisers). Global food prices rose to a new record high in February this year, propelled by large increases in vegetable oil and dairy prices (including a jump in international sunflower oil prices which again reflected concerns over disruptions to the Black Sea region) as well as by higher grain prices. Past experience – think, for example of the 2007-08 global food price shock – warns that higher food prices can have significant, adverse consequences for social and political stability in parts of the world economy:
Higher commodity prices, rising inflation expectations, lower growth forecasts, and the fallout from the deployment of extensive sanctions along with higher levels of uncertainty generally have all combined to roil financial markets, with an increase in measures of market volatility and a tightening of global financial conditions:
Add in the pressure to neighbouring countries from refugee flows, yet more disruption to already-stretched global supply chains and to international transport networks, and it is clear that the war has already imposed some major downside risks to the global economic outlook at a point when the endgame still remains highly uncertain.
The Australian economy is relatively insulated
While the global nature of the economic and financial shocks triggered by the Ukraine war mean that Australia is certainly not immune from these developments, it is also the case that we are relatively insulated from many of the immediate adverse economic consequences.
In part, that reflects Australia’s distance from and limited direct exposure to the region. As of 2019-20, Russia only accounted for about 0.1 per cent of Australian merchandise trade (pdf) and a similarly modest share of our trade in services. Our share of trade with Ukraine (pdf) was even lower. Investment ties with both countries are also minor: Australian foreign investment in Russia in 2020 accounted for less than 0.1 per cent of Australia’s total stock of overseas investment, for example, while Russia’s share of all foreign investment in Australia in the same year was even lower.
Our relative resilience to the Ukraine war shock also reflects the fact that as a commodity exporter, Australia stands to benefit from many of the increases in global commodity prices triggered by the conflict. In particular, and in contrast to Europe’s status as a net energy importer, Australia’s status as a net energy exporter puts it in a quite different position. More generally, higher prices for gas and coal as well as for food and some metals will all boost Australian export prices, lift our terms of trade and raise national income (and thereby also the federal government’s tax take). That’s not to say that there will be no economic pain: households will be hit with higher petrol prices which will push up living costs and businesses will likewise face higher transport costs. But there will be large and important offsetting factors at work.
There are implications for the RBA and monetary policy
The Ukraine conflict will also have implications for Australian macro policy. Last week’s statement accompanying the RBA’s 1 March 2022 monetary policy meeting provided the central bank’s initial take on the potential consequences. It noted that ‘the war in Ukraine is a major new source of uncertainty,’ that the conflict had produced further increases in commodity prices, that the ‘CPI inflation will rate will spike higher…due to the higher petrol prices resulting from global developments’ and that there ‘are uncertainties about how persistent the pick-up in inflation will be given recent developments in global energy markets and ongoing supply-side problems.’
This week saw Governor Lowe provide further detail on the RBA’s views in the form of a speech on recent economic developments, noting that:
- The war in Ukraine is ‘a major new risk to the global economy.’ He conceded that it was ‘difficult to know what the full implications are’ but added that at present ‘the main economic effects stem largely from higher commodity prices.’
- There were also implications for the RBA’s assessment of the duration of global supply-side disruptions: ‘Prior to the war in Ukraine, there was some evidence that the supply-side issues in the global economy were gradually being resolved…But, now, the war in Ukraine and the sanctions against Russia have created a new supply shock that is pushing prices up, especially for commodities. This new supply shock will extend the period of inflation being above central banks' targets.’
- A key potential consequence of higher-for-longer inflation is that it ‘runs the risk that the low-inflation psychology that has characterised many advanced economies over the past two decades starts to shift. If so, the higher inflation would be more persistent and broad-based, and require a larger monetary policy response.’ The possibility of such a shift in inflation psychology ‘is a critical issue.’
That significantly complicates the RBA’s outlook for monetary policy. In the discussion following his speech, the governor acknowledged that the ‘risks to inflation have certainly moved to the upside and headline inflation is going to be higher…it’ll have a number four in front some time this year.’
However, the likelihood of higher rate of headline inflation is not the only factor in play. During his speech, Governor Lowe again emphasised the importance of the evolution of domestic labour costs. Here, he reminded his audience that the latest data (December’s Wage Price Index (WPI) release) showed wage growth remaining modest, with a 2.3 per cent annual increase in the headline WPI and a 2.8 per cent rise in a broader measure that includes bonuses. The national accounts measure of average hourly earnings did rise a bit faster than this (at 3.3 per cent) but Lowe’s overall take was that ‘most working Australians are still experiencing base wage increases of no more than two-point-something per cent.’ Granted, the RBA’s central forecast is for the pace of wage growth to accelerate in line with a tightening labour market, but the central bank also thinks that the pick-up will be gradual. At the same time, Lowe also accepted that there were large uncertainties around this forecast, ‘partly because we have no contemporary experience of a national unemployment rate below four per cent’ and partly because of the risk that, if current high rates of inflation were to be sustained, workers might start to demand higher wages in compensation.
Lowe’s summary of the policy implications was that given the nature of this uncertain environment, and given that the starting points for wage growth and underlying inflation in Australia were not particularly troubling, the RBA could ‘take the time to assess the incoming information and review how the uncertainties are resolved.’ He also argued that while there were risks to inflation for waiting too long to move on monetary policy, there were also risks in moving too early and forgoing the opportunity to achieve a decades-low unemployment rate.
But how does that shifting calculus of risks influence the likely future path of the cash rate? According to the governor, recent developments mean that ‘it is plausible that the cash rate will be increased later this year.’
Global risks will also impact consumer and business confidence
As well as acting on the economy through commodity prices and the RBA’s policy choices, the conflict will also influence consumer and business confidence, although it will be only one of several factors in play. In fact, this week’s consumer sentiment numbers suggest that there have already been some negative consequences, although it is difficult to disentangle those from the impacts of the Queensland and New South Wales floods and from higher inflationary concerns. In the case of business confidence, meanwhile, the latest NAB numbers largely predate the war, although they do show a recovery in both confidence and business conditions last month.
The Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) fell 4.2 per cent to an index level of 96.6 in March, taking the index below neutral – and indicating that pessimists outnumber optimists – for the first time since September 2020.
Westpac said that the survey underpinning this month’s results was conducted in the week of 28 February to 4 March, which encompassed most of the response to the Queensland and Northern New South Wales floods (but was before this week’s floods in the Sydney region). Respondents would also have had the war in Ukraine and ongoing fears around inflation and interest rates on their minds, meaning that a drop in sentiment this month was not unexpected, although the size of decline was still significant.
The week’s other read on how households are feeling – the ANZ-Roy Morgan Consumer Confidence index – actually rose 0.9 per cent last week to an index reading of 100.1. That’s (just) above neutral but still some distance below the series average of 112.4. Note, however, that the index had already fallen over each of the previous two weeks, with the 2.6 per cent drop during the last week of February capturing the impact of the Queensland floods and rising COVID cases in Western Australia as well as some of the early impact of events in Ukraine.
In that context, Roy Morgan reported that almost two-thirds of the interviews underpinning the index for the week ending 27/28 February were conducted prior to the Russian invasion of Ukraine. It’s noteworthy that for those interviews conducted from February 21-23, consumer confidence was 100.8, while for the smaller number of interviews conducted from February 24-27, the confidence index had dropped to 97.1.
Rounding up this week’s data on confidence, the NAB monthly business survey reported that both business conditions and business confidence had improved in February 2022, likely reflecting the waning of the Omicron wave. Business conditions rose seven points in February to +9 index points, which is back above the series’ long-run average, and reflected improvements across the employment, trading conditions and profitability subcomponents.
At the same time, business confidence rose eight points last month to +13 index points. That increase in expectations about the future was also reflected in improvements in other forward-looking indicators: forward orders strengthened, capital expenditure increased, and capacity utilisation edged up.
However, according to NAB ‘the survey for the month was largely completed before the invasion of Ukraine.’ That means we will have to wait for the March 2022 survey results in order to gauge the size of any impact of the conflict on Australian business confidence.
Finally, one last point on the NAB survey: on cost pressures, it reported no change in the (relatively high) rate of increase of labour costs from last month, a slight drop in the rate of growth of final product prices and a larger drop in the rate of growth of input prices, albeit to a still-rapid pace.
What else happened on the Australian data front this week?
ANZ Job Ads
ANZ Australian Job Ads surged 8.4 per cent over the month in February (seasonally adjusted) to 228,170. Job ads are now 46.3 per cent above their January 2020 (pre-COVID) level and 1.8 per cent above their pre-COVID peak, suggesting further scope for labour market gains. That’s also consistent with the high vacancy rate reported in the latest labour account data below.
The ABS said that between the weeks ending 29 January 2022 and 12 February 2022, the number of payroll jobs rose 0.8 per cent after having increased by two per cent over the previous fortnight, to be up 2.8 per cent over the past month. Total wages paid were up 2.7 per cent over the most recent fortnight of data compared to a rise of one per cent over the previous two weeks.
The Labour Account
According to the ABS, the Labour Account for the December quarter 2021 showed total jobs increasing by 3.7 per cent (529,900), with filled jobs up 3.4 per cent (472,300) to 14.5 million. Hours worked in the economy rose 4.3 per cent, the number of employed people increased by 3.3 per cent to 13.6 million and the number of unemployed fell 51,900 to 569, 100.
At the same time, the share of vacant jobs rose to 2.7 per cent from the 2.4 per cent recorded in the September quarter 2021. That marks the highest vacancy rate in three decades of Labour Account data and is significantly above the pre-pandemic rate of 1.6 per cent.
Finally, the ABS also reported a jump in the rate of multiple job holding to 6.4 per cent, another series record.
Consumer inflation expectations
The Melbourne Institute Survey of Consumer inflationary and Wage Expectations showed the rate of underlying inflation (the trimmed mean) expected by households rose by 0.3 percentage points in March this year, to 4.9 per cent.
Related, the ANZ-Roy Morgan measure of weekly inflation expectations fell by 0.1 percentage point last week but remains elevated at 5.2 per cent.
The ABS said that in the December quarter 2021 there were 55 industrial disputes which together involved 57,200 employees and saw 68,500 working days lost.
Household spending intentions
The CommBank Household Spending Intentions (HSI) Index rose 1.8 per cent over the month in February 2022 to be up 5.5 per cent over the year, with an index reading of 107.3. The index was lifted by a post-lockdown increase in transport spending intentions (driven by higher fuel prices and increased spending on taxes, parking, car washes, freight and trucking services, although commuter transport spending remained relatively weak) and a rise in home buying and intentions as well as rises in household services and health and fitness.
Other things to note . . .