Rates, growth and China: what will cause economic headwinds in 2023 | Australian economy

A safe prediction to make for 2023 – or any year – is that many forecasts will be wrong, not least in the world of economics and financial markets. As Daniel Kahneman, a Nobel-winning economist notes in his book, Thinking, Fast and Slow, “[e]verything makes sense in hindsight … The illusion that what we understand the past fosters overconfidence in our ability to predict the future.”

Year ends (plus a lull in market-moving economic news in western economies, at least) present an ineluctable opportunity to highlight the ill forecasts of the 12 months previous and attempt to extract lessons for the year to come.

Examples of late include a Bloomberg piece on the “brutal reckoning” for Wall Street’s “top stars” in misreading the inflation risks. The Economist, meanwhile, dubs 2022 a “brutal year of inflation” that may leave us worried about unemployment in a year’s time as the impact of higher official interest rates dent demand everywhere.

Here, though, are some of the safer bets to make for 2023.

China’s Covid contortions will be a key focus

China, the world’s second-biggest economy behind the US, has been the main growth dynamo this century. It is easily Australia’s biggest market, taking about a third of exports and accounting for as much as the next five largest combined.

Even before China’s “screeching U-turn” to abandon its zero-Covid policy, the Reserve Bank of Australia had identified growth in the Middle Kingdom as one of its three key outlook uncertainties. (The other two were the persistence of high inflation and the fate of consumer confidence amid soaring interest rates.)

One senior RBA official told Guardian Australia exiting tight pandemic controls would cause China “significant economic disruptions”. One question is how China’s teetering property market will fare. Another is whether newfound freedoms would prompt a spending splurge, given China’s patchier income support during lockdowns.

Beijing is broadly tipped to resort to its standard approach of rekindling growth by spending big on construction. That tactic has supported prices for Australia’s biggest single export – iron ore – in the past and investors are betting it will do so again.

Longer-term predictions are, of course, more fraught with risk. Roland Rajah and Alyssa Leng at the Lowy Institute warned in March China’s future is less rosy than many predict, regardless of short-term contortions over Covid.

Key drags are China’s ageing and shrinking population, a gradual reduction of already poor productivity levels (compared with other east Asian economies at similar wealth levels) and diminishing returns from its pour-concrete-and-build-things economic model.

“This deep slowdown in China’s economy is kind of happening largely one way or another. All the risks are really to the downside,” Rajah said. “We still see a highly significant slowdown in the coming years and decades.”

Australia’s interest rates have further to rise

None predicted the RBA would lift its key interest a record eight consecutive months, starting in May. That’s mostly because of Russia’s surprise invasion of Ukraine in February.

Russia’s exports of oil and gas were disrupted by the subsequent sanctions and the two warring states alone account for about 12% of calories traded worldwide.

Inflation had been expected to be “transitory, short and sharp” because of the supply chain dislocations and economies juiced-up to power through the pandemic, said Catherine Birch, a senior ANZ economist. The war has meant central banks’ insurance against recessions was extended too long and they “left it for too long” to hike interest rates to blunt the price spikes.

ANZ and Westpac both expect the RBA to lift its cash rate from 3.1% now to a peak of 3.85% in 2023. The CBA and NAB, the other two big banks, predict the central bank will be done at 3.35% and 3.6%, respectively. Investors were lately tipping a top rate of 4%.

Each rate rise of 25 basis points adds about $75 to monthly repayments on a typical 25-year, $500,000 mortgage, according to RateCity. The 300bp increase since May has added about $834.

Many of those on fixed interest rates are yet to feel the impact. But as Sally Tindall, the head of research at RateCity, noted earlier this month that about one in three outstanding home loans are on fixed terms and about two-thirds of these are due to expire by the end of 2023. For such borrowers, higher rates are unavoidable.

Economic growth will slow

Higher borrowing costs aimed at sapping demand from households and businesses alike mean major economies are likely to slow if not contract in 2023.

Australia’s GDP expansion will halve from about 3% in 2022 to 1.5% in both 2023 and 2024, the RBA foretells. The direction of travel is widely agreed by economists if not the precise pace.

Even if a rising population will mean per-capita GDP growth may end up close to zero or even feel recessionary, the abundance of jobs in Australia amid half-century lows in unemployment is one cause for optimism.

“The strong labour market underpins our view of the relative resilience of the Australian economy in 2023,” Birch said.

The RBA tips the jobless rate to remain at about 3.5%, or close to current levels, until mid-2023. By the end of 2024, it may still be about 4.25%, a level any treasurer since the early 1970s would have happily accepted.

Insolvencies will rise

Rising interest rates expose companies (and households) who have borrowed too much, so an increase in insolvencies appears to be another given in 2023.

In fact, the end of the Covid-imposed moratorium on such foreclosures means there’s already a bit of corporate cleansing to make up, said Kristen Beadle, a manager of public practice at CPA Australia and a former registered liquidator.

The collapse of the Clough Group earlier this month, with its potential knock-on effects for projects such as Snowy Hydro’s giant pumped hydro project, was just the latest hit for the construction industry. Rising raw material costs and labour shortages have battered that sector particularly hard, Beadle said.

“Pain points” are also showing up in industries such as hospitality, she said. Ongoing working-from-home habits have reduced foot traffic in the heart of major cities. Melbourne, for one, is designed around people coming into the CBD, so the downturn has been “really quite bad” for restaurants and cafes.

The interest rate “cliff” of expiring fixed rates will also affect business. One major bank told Beadle recently as many as 70% of its customers would go from a fixed to floating rate early next year, lifting repayment rates from 1.5%-1.9% to 5%-7%.

“In times like this, the directors or the business owner will actually stop paying themselves so they no longer get a wage,” Beadle said. “That really exposes them personally because they’re not able to maintain their debt levels.”

Energy prices will rise

Leaving aside petrol and diesel prices that gyrate with global fluctuations, prices of gas and electricity will rise further in 2023.

That’s despite the highly unusual intervention in energy markets in December by the Albanese government to put a 12-month cap on gas at $12/gigajoule and $125/tonne for black coal. The federal government will also pay consumers subsidies worth $1.5bn.

Treasury estimates power prices in the 2023-24 fiscal year will still rise 23%, a steep increase but better than the 36% its modelling suggests would have been the case without the foray into markets that some derived as Soviet-lite or even Armageddon.

Recent falls in wholesale power and gas prices will eventually chip away at retail prices but that’s assuming they are sustained.

Extreme weather, made worse by climate change, can be expected to test our energy and other key networks as it has increasingly done so in recent years. Should El Niño form in the Pacific after three La Niña years – an event models show is possible – we might face some sizeable energy and other challenges by this time in 2023.