Quarterly Economic Update, Q4 2021: The consumer is the cornerstone of recovery

From the Chief Economist

The economy has yet again shown its resilience, and it’s the consumer that is cornerstone of the economic recovery. After the delta lockdowns, economic activity bounced-back – expanding 3.4 per cent and 4.2 per cent through the year. But when we look under the hood, the growth all came from household spending and stock accumulation. That’s not to say that investment, construction, trade and government spending are no longer supporting the economy – it reflects the lumpy nature of their recovery track.

In fact, the outlook for private investment is strong, and the pipeline of residential work yet to be done is at a record high. The fundamentals for business investment are as strong as they have been in years - business confidence, non-mining company profits, credit growth and capex plans are all strong.

The economy has again started a new year with a range of challenges. At the same time, Australian businesses are worried about how to attract the workforce they need and whether that means a higher wage bill; how to manage disrupted supply chains and rising input costs; and how forward orders and margins will be impacted by rising inflation and interest rates. In essence, these are all questions we ask when the economy is strong.

The baton of growth is being taken up by the private sector, supported by strong balance sheets across households and businesses. Economic activity has taken a hit in the March quarter from omicron, floods and international geopolitical events – but the underpinnings are strong, and we expect the jobs-rich recovery to continue. The unemployment rate looks set to fall to fifty-year lows and we have a shot at experiencing full employment.

That said, inflation is clearly on the rise – and the National Accounts provided further evidence of this. Domestic prices (as measured by final demand implicit price deflator) rose by 1.1 per cent – the fastest quarterly rate since 2008. These pressures were very evident for residential construction, where costs rose by the fastest quarterly rate since the introduction of the GST – up 3.2 per cent in the quarter, and 8.2 per cent over the year. Inflation is also being imported. Import prices rose 7.8 per cent (in chain price terms), the fastest rate since the GFC.

How households react to rising inflation and interest rates will be critical to the role of the consumer as the economic engine. There’s no doubt that the household sector is cashed-up and keen to spend. The household saving rate fell to 13.6 per cent from 19.8 per cent, as disposable income fell and spending rose. Looking ahead, how far consumers are willing to tap those savings is critical and will depend on confidence. A strong labour market and high job security should provide some confidence against some of the other factors on consumers’ minds.

With the Reserve Bank this week shifting its focus to broader measures of labour costs, the income side of the National Accounts deserves greater attention. Compensation of employees rose by 2.0 per cent, but in hourly terms fell by 3.2 per cent, as the easing of lockdowns saw mostly lower paid jobs returning to work. These are murky waters for the RBA – with COVID-19 impacted data on one hand and a barrage of anecdotes about rising wages on the other. We continue to see the RBA as being patient, waiting for the data to provide greater clarity. There’s a lot of debate about the timing of the first rate hike in this cycle, but the real issue for households and businesses is where interest rates peak.