Economic update: The covid story is not finished

Updated: Feb 21

At the time of writing, it is not clear what the implications of the Omicron virus will be. The worst-case scenario is that the virus turn out to be both more deadly than previous versions and immune to current vaccines. This would result in sustained border closures and potentially the re-imposition of more stringent restrictions.

The ongoing issue is how Governments’, consumers’ and firms react to the news of the emergence of a new virus strains or rising case numbers. Given what we have been through over the past couple of years it is understandable that Governments and consumers’ are currently reacting with caution. In time society will get more comfortable that the health system will be able to minimise (but not eliminate) the risk of COVID. The economy has already gone some way to adapting to COVID waves (each successive wave has had a diminishing effect on the economy). But the virus is still leaving economic scars.

The economy has got smaller

The Q3 2021 GDP numbers is one of the vivid scars. The Q3 GDP growth of -1.9% was worse than any single quarterly decline during the 1990s recession. But it was half as bad as the -4% that some forecasters were expecting afew weeks back. The main driver of the big drop was the Sydney, Melbourne and Canberra lockdowns. With those lockdowns now at an end a substantial bounce in economic growth is likely in the December quarter (according to Bloomberg the consensus expects 1.8% growth in Q4).

Following the Q3 decline the Australian economy was again smaller at the end of September than it was at the end of 2019. That will be short-lived following the expected big rise in the December quarter. But the economy will 3 Bank of Queensland Limited ABN 32 009 656 740 (BOQ). still be smaller than it was in June 2020. And it will still be over 1% below where the economy would have been if it had of been growing at the same rate it was pre-COVID.

Private-sector incomes have got bigger

Typically declines in GDP would be a cause of major angst. It has not been on this occasion as the Government has been very successful in buffering household and incomes from the fallout of the pandemic. So successful was the Government programs that the trend in household disposable incomes actually rose after COVID.

The impact of COVID can be more clearly seen on quarterly household spending that was over 3% below December 2019 levels at the end of September 2021. Some of that weak spending would be down to consumer caution. But government income support and the underlying strength of the jobs market would have moderated any reduction in household willingness to spend. The bigger issue has been the ability to spend, with consumers in some cities stuck at home, borders closed and some businesses shut.

The impact of COVID on spending in the economy has been mixed

COVID has impacted not only how much consumers spend but also where they have been spending. Spending on goods is comfortably above its pre-COVID trend. COVID though has severely impacted spending on services. After all, goods can be delivered to your front door but a service must typically be provided by someone in-person (although that is starting to change with developments such as Telehealth). Both federal and state government consumption spending has played an important role in stabilising the economy.

COVID has had a differential impact between industries since the end of 2019. Many farmers have had a good time reflecting high commodity prices and favourable weather. The increase in demand for goods has helped the trucking, retail and wholesale sectors. Increased demand for testing has boosted the health industry (although lockdowns can impact elective surgery and dentists). Ongoing growth in NDIS has underpinned the social-services sector. Very low interest rates have boosted activity in finance, while increased spending on digitisation has increased demand for IT workers (there has also been strong demand for accountant and lawyers).

But the airline industry has done it very tough. Less people are catching a train or bus to work (although freight trains have been busy). Mining has been mixed (partly reflecting weather). The Recreation and Accommodation and Food Service sectors have been hard hit by the lockdowns.

Where does that leave us

The maintenance of strong income growth has allowed for strong spending on the stuff that households and firms could buy (cars, equipment) and rising saving because there was a lot of stuff they couldn’t buy (services). This created a demand-supply mismatch as lockdowns and other restrictions meant that production of goods was unable to keep up with demand. This will change as factories everywhere again get back to full capacity (that already is happening) and more spending switches back to services and away from goods.

A lot of attention on the demand-supply mismatch has been on the supply problems. But with a high level of saving and very tight labour markets it is likely that demand will remain strong. Stronger investment will boost capacity in the economy to meet some of this higher demand. Both the Federal Government and the RBA have begun dialling back fiscal and monetary support to the economy. We can expect the debate on how much generosity is necessary to continue through next year.

Original post by Bank of Queensland