Australia Macro Outlook: Tighter Times

Australian equities have performed well in 2022 relative to peers - a trend that Morgan Stanley analysts believe should hold. The nuance is a more challenged domestic outlook as financial conditions tighten, and inflationary pressures persist. 

Economic conditions remain strong in Australia and the Morgan Stanley Research team expects this momentum to sustain in the near term. They expect a strong spending pulse as election-related fiscal stimulus boosts incomes, the savings rate declines from 14% to 7% and unemployment hits 50-year lows. However, cost of living headwinds and a more uncertain external environment sees them trim their 2022 GDP forecast from 4.5% to 4.2%, above trend but below consensus expectations (see exhibit 1).

Exhibit 1: Morgan Stanley Forecast for 2022 is below consensus and the RBA

An important change to Morgan Stanley’s outlook has been incorporating the stronger inflation pulse that has emerged. Our analysts expect inflation to peak at 6.1% in the third quarter, lower and later than most other developed market economies. This is driven by lower energy costs, more inertial wage setting and some Government subsidies. They also expect a shift in drivers as inflation falls, towards rents and market services inflation given a further rise in wage growth.

House price growth has slowed significantly year-to-date, and our analysts expect national prices to decline over the second half of 2022 and throughout 2023 as rate increases challenge mortgage serviceability. Whilst they don't expect significant mortgage stress given the strong labour market, they project this will slow economic growth, through wealth effects, lower turnover-related spending and an eventual decline in the construction pulse. 

With the economy expected to slow through 2023, the labour market momentum is also projected to turn, particularly given continued increases in immigration – with 2023 marking a return to pre-Covid settings (resulting in around 250,000 in net migration). As such, our analysts expect the unemployment rate to trough in early 2023 before rising gradually to end the year at a still-tight 3.9%.

The RBA has accelerated its tightening significantly. The near-term hiking path will be determined by the data flow relative to RBA forecasts, which our analysts see evolving broadly in line with RBA expectations. After putting through an initial rate hike in May, our team expect a follow-up 25bp rate hikes in June and July, with a 40bp hike in August on the back of updated inflation data and forecasts. Follow-up hikes in November and December would see a cash rate of 1.75% by year-end. The path for next year will be much more dependent on the economy's endogenous response to rate hikes, and our expectation for house price declines and rising unemployment means we see these slowing significantly – with the cash rate at 2.25% by year end (see exhibit 2).

Exhibit 2: Morgan Stanley analysts expect the RBA will hike to 2.25%

In the bear case, the RBA responds more aggressively to stronger inflation outcomes from continued global supply disruptions and hikes rates to 2.5% by the end of the year. This sees a sharp slowing in economic activity through 2023, which alongside the much weaker external environment shifts the RBA towards cutting rates. In the bull case, the economy is resilient to tighter financial conditions with consumers drawing more heavily on improved balance sheets. This sees the RBA hike in a more gradual but sustained manner, reaching a cash rate of 3% by the end of next year.

To read the full Morgan Stanley Research report on the 2022 Mid-Year Outlook, speak to your Morgan Stanley financial adviser or representative. Plus, more Ideas from Morgan Stanley's thought leaders.