While there are downside risks to our cautiously optimistic outlook for 2022, any near-term pullback in markets is likely to signal a healthy correction from what are already ‘frothy’ global share markets. If conditions are attractive it may even provide the opportunity to increase risk assets further.
Home grown recovery
In Australia, the vaccine-led recovery, removal of border restrictions (both domestic and international) and a combination of high levels of household savings and pent-up demand provide a strong backdrop for the domestic economy to solidify its rebound in 2022. As a result, ANZ Private expects GDP to grow 5.1 per cent over the year in what would be the strongest annual domestic growth since the late-1980s.
Inflation continues to rise but is lagging other major economies. Here, the Reserve Bank of Australia (RBA) continues to articulate a patient approach, waiting for inflation to lift sustainably to the middle of the 2-3 per cent target band before hiking rates. Conversely, the market continues to challenge such rhetoric. Wages growth remains critical. Higher prices due to supply-side disruptions are unlikely to lead to sustained inflation pressure if real wages are falling. Things are looking up on the wages front though. After rising again during the Delta lockdowns, unemployment is expected to trend downward once again — reaching 4 per cent by the end of 2022. Underemployment is also expected to fall and this should place upward pressure on wages growth. Annual wages growth is expected to reach just above 3 per cent by the end of 2022.
Despite this, the pick-up is likely to be slower than in other countries like the US and therefore the impact of wages growth on inflation should be delayed. In 2022, global supply cost pressures are expected to moderate somewhat as supply chains adjust and spending switches from goods to services. This should ease Australia’s tradables inflation, offsetting the impact of rising wages growth, leaving inflation a touch below 2.5 per cent by the end of 2022.
ANZ Private’s wages outlook suggests inflation will return to 2.5 per cent by the first quarter of 2023 and rise further that year. This will satisfy the RBA that inflation is sustainably at the mid-point of its target band and so should trigger the first rate increase in the first half of 2023. ANZ Private thinks the RBA will increase the cash rate to 0.25 per cent initially and then follow with a further 75 basis points of rate hikes by year-end.
This doesn’t mean policy is on hold. The end of the term-funding facility and 3-year yield target have contributed to a tightening in financial conditions and subsequent sharp rise in fixed mortgage rates. The termination of the RBA’s bond purchase program (QE) — potentially as early as February this year — will further heighten market expectations the RBA will hike sooner than expected.
Risks currently appear tilted towards an earlier rate cycle. Downside risks centre primarily on the pandemic and specifically whether further outbreaks and more hostile variants could lead to prolonged lockdowns. Upside risks include the potential for spending to outpace already strong forecasts and the risk labour market tightening or wages growth acceleration occurs faster and earlier than expected.
Markets are currently backing these upside risks to prevail with almost 100 basis points of cash rate tightening priced in over the next year. Here, there is a clear mismatch with the RBA’s view the conditions for tightening will not be met until the end of 2023. Australia is not alone, with the US and others facing a similar dynamic. Like 2021, this stand-off between central banks and markets should remain a dominant theme in the year ahead.
Lakshman Anantakrishnan is Head of Investment Strategy, Private Banking & Advice at ANZ
Click here to read the full 2022 Outlook report