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The economy: Why it’s a good news story

Composite image of map of Australia filled with money and a city skyline to symbolise the economy..
Rising interest rates and record inflation won't have a lasting impact on the economy. (Source: Getty)

It’s time for a stock take on the economy. So much has happened in recent months that there is broad confusion about the state of play?

Just how good, or bad, are things right now?

Strong? Weak? Recession? Inflationary boom? Are there any workers left in Australia?

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From my discussions and work with business, there are two key themes that dominate their assessment.

First, the near-impossible task of finding suitable labour without having to resort to pay levels that would see some of them struggle to make a profit.

And, second - and related to the first in many ways - a general surge in operating costs linked to the 30-year-high inflation rate.

Even though they are vital issues, in broad terms, the economy is doing reasonably well.

While growth is slowing - as it must if inflation is ever to return to the RBA’s target - business investment plans are strong, order books and sales are solid, the economy is running at full employment, exports are booming and household spending remains firm - albeit with some downside risks as cost-of-living pressures eat away at incomes and the interest-rate-hiking cycle redirects some funds from consumption spending to debt servicing.

There is also plenty of evidence that the supply chain problems that dogged the economy over the past year are slowly but very surely getting resolved.

Freight shipping costs are falling, as are the prices of semiconductor computer chips.

Oil prices are sharply lower as are timber prices and a series of other important commodities that feed into production costs and consumer prices.

Silhouettes of onshore oil and gas wells in the field outdoors against blue cloudy sky.
Oil prices have retreated from recent highs. (Source: Getty)

Car manufacturers are churning out new vehicles at a near-record pace, which will ease some of the delivery bottlenecks that have been evident for the past year.

These factors will see inflation decelerate over the year ahead.

For the household sector - that’s you and me - things are generally good, even if there remains a sharp level of inequality in the distribution of wealth and cost-of-living pressures, the latter being driven by the high rate of inflation.

At one level, it is clearly better to have these cost-of-living pressures with unemployment at 3.4 per cent and wages growth of 3.0 per cent as it is now, rather than what we had pre-COVID when unemployment was hovering around 5 per cent and wages growth was stuck around 2-2.5 per cent.

The good news is that inflation is set to fall through the course of the next six to 18 months.

This will help businesses and consumers alike in their expense management, but it also means we are getting close to the peak of the interest-rate-hiking cycle. That peak is increasingly looking like it will be reached late this year or the first part of 2023.

While the RBA still needs to deliver a few more interest rate hikes - around 100 basis points to come - the hiking cycle is nearer the end than the beginning. Note that 175 basis points have been delivered in the current cycle since May.

The fall in house prices remains a hot topic but it looks set to fizzle into a relatively minor issue.

Buyers are factoring a few more rate hikes and because of the super strength in the labour market and the appeal to property investors from the boom in rents and the tight rental market, house prices – Australia wide - are likely to stabilise in the first half of 2023 after dropping by around 7 per cent through to early 2023.

Auction clearance rates are already starting to lift from the slump evident earlier this year.

This should help support consumer confidence. The wealth effect, in turn, will ensure consumer spending remains resilient over the medium term.

Inflation remains the main spanner in the works for the economy.

It is likely to rise a little more in the next few months before dropping sharply through 2023, with the commodity price cycle, slower economy and resolution of supply chain issues driving it lower almost as quickly as it rose from the low point in early 2021.

The end point is that the economy is in good shape.

Growth is decent but it is slowing, which is indeed the focus of policy makers as they strive to contain inflation. This is a good news story.

The peak cost pressures for business and consumers from the inflation surge is poised to top out and reverse.

And the labour market is so strong that, effectively, everyone who wants a job has a job, which is something not seen in half a century. As a result, household incomes are strong.

Get set for a few more interest rate hikes before the peak is reached, immigration will rise as the Government addresses the labour shortages, and the Budget in October will start the long process of budget repair.

No economy is ever perfect but, in Australia now, the outlook remains promising and that is good news.

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