What the current COVID wave means for the economy

All about COVID

The appearance of another COVID wave over recent weeks has been disappointing, but not surprising. At some stage, much of the rest of the world has had difficulty with the latest COVID mutation. It was only a matter of time before we were confronted with that problem.

It is widely agreed that widespread vaccination is the way to return life back to 'normal'. But even here there is disagreement. The appropriate vaccination target has not yet been agreed. A target of 80% of the adult population (62% of the total population) has been widely discussed. But we don't know for sure what proportion is necessary to stop the virus spreading.

The economy will take a big short-term hit

The latest lockdown will have a significant impact upon economic growth. The economy was absolutely booming entering the third quarter. But the extent and degree of the Sydney lockdown (and that of other states) means GDP growth will slow sharply.

The experience of the past year has shown that the economy bounces back quickly once the lockdowns finish and people regain confidence to resume their 'normal' lives. The degree of Government income support is more difficult to assess this time compared to what was provided by JobKeeper. But the momentum of the economy is stronger than it was going into COVID. So a very strong GDP number (1.7%) is the most likely outcome for Q4. This assumes that we don't get another COVID wave later in the year. Hopefully, the increasing vaccination rates should reduce the chance of that happening.

Long-term issue - National saving

Until the recent outbreak, the consensus view was that the domestic economy was very strong. The main downside risk was the re-appearance of COVID. But the upside economic risk often cited (including by me) was the potential for the 'mountain of saving' that was built up last year to be spent once the economy fully re-opened. Last year the national saving ratio (the combined saving of households, firms and governments relative to national income) hit its highest level in over 30 years.

Government saving - the buffer

Different sectors save at different rates. The Government saving performance over recent years has mainly been the mirror image of what has happened in the private sector. Last year, the massive increase in private-sector saving was matched by a massive fall in government saving as policies were put in place to absorb the blow to household disposable incomes from COVID. This is how Government budgets' should operate. Fiscal policy acts as an offset to developments in the private sector to reduce the fallout in the economy.

Household saving - the only way is down

Last year, household saving exploded. Despite Australia experiencing the most serious peacetime recession since the Great Depression, household disposable incomes rose, underpinned by a range of government programs (notably JobKeeper). Lockdowns meant that households had less ability to spend (no travel).

In addition to changes in the level of saving, there will also likely be changes to the composition of saving. A lot of the extra saving of last year went into deposits. Partly that was households wanting a ready source of liquid funds. But also, consumers put money into offset accounts to repay debt. The desire for liquidity saw a substantial slowing of inflows into Super (as well as the Government allowing people to take money out of Super to provide cashflow support).

Corporate saving - less to build more

Over the next couple of years, a decline in business saving is likely. Businesses are very confident about the profit outlook (at least until the recent lockdowns). But competition for labour and materials will mean that cost growth will be higher. They will (and) are able to pass some (but not all) of those costs onto their customers. And Governments' are unlikely to provide the same income support through tax and rent deferrals. Dividends will rise.

In the short term, renewed lockdowns may see household and business saving rise. But once the economy re-opens, consumer and business spending will rise and saving decline. From a national standpoint, this will be partially offset by a rise in government saving. The overall aggregate number will be determined by movements in the terms of trade.