Economic and financial market update: inflation and pandemics


The recent news flow highlights the difficulty in predicting the economic and financial market outlook. There was the release of the CPI figure. The timing of the data is well known and economists have tried-and tested models to predict the likely outcome. But at the same time there has been news of the spread of a new strain of flu, an event and outcome that is far more difficult to forecast.


Coronavirus:  Clear short term economic impact, less likely long-term impact

Flus are around every year, and some years are worse than others. A new virus always gets plenty of attention, probably because there is always some uncertainty about how deadly it will become.


Financial markets have reacted with initial concern about the coronavirus outbreak, and there is no doubt that the short-term economic impact of the virus is negative. It will have significant economic implications, including:


- A large reduction of tourism and retail spending both in China and globally

- Lower Chinese production

- Significantly weaker economic growth in China this quarter


The global economic impact of the virus could be high, because the consumer is a bigger part of the Chinese economy and the Chinese economy is a bigger part of the global economy. But we can be confident that the Chinese Government will do whatever it takes to ensure there are no sustained economic implications.


Many countries (including Australia) will feel the economic pain of less Chinese spending, but it’s likely that the effect will be short term and modest (0.1-0.2%). However, the impact of the virus on data will make it harder to get a reading on the underlying economy.


Inflation:  Not going lower but not heading higher

The Q4 data indicated that headline inflation picked up by around half percentage point from the start of 2019. The movement in the RBA measure of underlying inflation has been less impressive, remaining at around 1.5% over 2019. The flat lining of the underlying measure is consistent with an economy growing both below trend and with excess capacity (i.e., the unemployment rate is too high).


The economic data released over the past couple of months suggests that the economy picked up a little in the second half of last year. Better signs for the global economy are also developing. Inflation looks to have bottomed, and financial markets are pricing in another quarter percentage point rate reduction. The RBA has made it pretty clear that it is not averse to further rate cuts. But they will likely be happy to sit on their hands for the next couple of months to see whether the economic pickup is sustainable.

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