Economic overview: June quarter 2021

Matthew Howden

• Global economic growth assumptions have been revised upwards for 2021 and 2022.
• Revisions have been driven by better-than-expected progress in containing COVID-19, allowing some economies to reopen sooner.
• The Australian dollar is assumed to appreciate to US78 cents in 2021–22, driven by high prices for bulk commodities.

Growth outlook continues to improve

The outlook for the global economy has improved since the March edition of Agricultural commodities, improving the demand prospects for Australia's agricultural exports. Global growth has been revised upwards by 0.7% in 2021 and 0.3% in 2022. In 2021 global economic growth is expected to recover strongly to be 6%, following a contraction of 3.3% in 2020. In 2022 growth is forecast to remain strong at 4.4%. The key downside risk remains the spread of the COVID-19 virus. Severe outbreaks, such as the one currently underway in India, are likely to slow but not reverse global economic recovery.

The outlook for growth has improved in most countries, with some notable exceptions such as India. Successful containment measures and progress in vaccine rollouts are assumed to support growth in advanced economies. Very large fiscal stimulus packages, such as those announced by the United States, are also assumed to accelerate economic recovery. Stronger growth in advanced economies will strengthen demand for exports from emerging and developing economies, stimulating growth in export-oriented economies.

The reopening of economies over 2021 and 2022 is assumed to support demand for Australia's agricultural exports. A resumption of activity in the food services sector will support demand for Australian beef, lamb, seafood and wine. Demand for apparel will also increase due to more people returning to their workplaces following the removal of social distancing and other health measures.

Recovery will be uneven

Despite improvements to the outlook since March, the recovery is still predicted to be uneven across economic regions and sectors. Access to vaccines and capacity to provide fiscal support varies across economies. Vaccination programs are underway in most advanced economies, but other economies have limited access to vaccines. Emerging and developing economies driven by manufacturing and exports, such as China and Vietnam, are recovering faster than those reliant on services, such as Thailand. Economic activity in emerging and developing economies reliant on travel is likely to remain subdued until widespread vaccination allows travel to recommence.

Incomes in most of Australia's agricultural export markets are estimated to recover to above pre-COVID-19 levels over the short term to 2022, but they will remain lower than pre-pandemic projections. Lower incomes have so far not resulted in marked reductions in demand for most of Australia's agricultural exports.

Commodity prices rising as growth prospects improve

Commodity prices increased strongly during the second half of 2020 and into 2021. Prices for bulk commodities – including iron ore – increased, reflecting higher demand as economies exited lockdowns. China's elevated demand for iron ore and reduced supply from Brazil has driven prices to record highs.

Lifting of lockdown measures and increases in travel have contributed to increased aggregate demand, driving energy prices higher during the second half of 2020 and into 2021. Oil supply has also been reduced by agreements between the Organisation of Petroleum Exporting Countries. Energy prices are assumed to remain around current levels for the remainder of 2021 and into 2022.

Agricultural commodity prices have also increased, mainly reflecting unfavourable seasonal conditions in the northern hemisphere and recovering demand for livestock feed in China.

Significant risks to economic outlook remain

There are upside and downside risks to the global economic outlook. On the upside, fiscal stimulus packages, such as those announced by the United States, may cause growth to accelerate faster than assumed. The sheer size of these stimulus packages is enough to drive stronger global growth. Further improvements to the prospects for economic growth could trigger increased optimism in markets, leading to increased consumption. Economic growth could also be supported by an acceleration in household consumption resulting from households drawing down on precautionary savings accumulated during the lockdown phase of the pandemic.

Ongoing and renewed COVID-19 containment measures are a major downside risk. Favourable growth prospects among major export markets, such as in emerging Asia, are tempered by the risk of recurring COVID-19 outbreaks. Progress has been made in vaccine rollouts in some countries, but concerns regarding the safety of vaccines have slowed efforts elsewhere. Recent outbreaks in India, and to a lesser extent Indonesia, the Philippines and Thailand, pose significant risks to recovery in South-East Asia.

As a major vaccine manufacturer, India intended to distribute some of its supply globally as part of the COVAX program. However, the crisis in India means vaccines are likely to be redirected away from other emerging and developing countries for use in India, delaying vaccine rollouts in other economies. These other countries currently have limited vaccine access so outbreaks will delay their economic recovery, reducing demand for some of Australia's agricultural products.

Australian economy to expand in 2021–22

In 2020–21 the Australian economy is assumed to have grown by 1.3% after contracting by 0.2% in 2019–20. In 2021–22 the economy is assumed to recover strongly to grow by 4.3%.

Australia's economic recovery in 2021–22 is assumed to be driven by increased household consumption as COVID-19 containment measures continue to be removed and business and consumer confidence grows. During 2020–21 households increased precautionary saving in response to uncertainty surrounding COVID-19 lockdowns. This created a significant pool of savings that will be partially drawn on to fund higher consumption as confidence returns. Growth will also be driven by increased public and private investment.

Australian exchange rate to appreciate in 2021–22

The value of the Australian dollar is assumed to appreciate in 2021–22 to average US78 cents over the year. This is an upward revision of US3 cents on the exchange rate assumption from the March edition of Agricultural commodities. This has primarily been driven by sustained higher iron ore prices than previously assumed.

The appreciation of the Australian dollar has coincided with a weakening of the US dollar relative to other currencies. The US trade weighted index has fallen in line with declining global uncertainty. This has encouraged investors to move away from safe-haven investments in the United States and seek out higher returns elsewhere, including in Australia. The additional impetus from iron ore prices means that the Australian dollar has appreciated relative to the currencies of key trading partners, reducing the competitiveness of Australia's exports in these markets.

Risks to the outlook for the exchange rate are tilted to the upside and contingent on the trajectory of iron ore prices. It is currently assumed that iron ore prices will fall over 2021–22 but will remain higher than previously expected. Prices will gradually fall as supply is restored following weather-related disruptions in Brazil and as Chinese demand moderates. Continued high prices for iron ore from either sustained high demand from China or further disruptions to Brazilian supply are likely to result in the Australian dollar appreciating further. A higher exchange rate would further reduce the competitiveness of Australian agricultural exports in international markets.

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