Change of Pace

7 mins reading

Despite the surging economy and strong labour market, forecasted interest rate hikes are expected to slow GDP growth and soften the housing market.


THE CONFLICT BETWEEN Russia and Ukraine has sent shock waves across the world, increasing economic uncertainty at all levels. One hopes the tragic event does not lead to a long and protracted war, but even a short one will have significant ramifications- especially for energy-dependent economies such as Europe and Japan. Russia’s economy is also expected to shrink by more than 5% in 2022.

In the event that hostilities are limited, the effect on direct trade between Australia and Russia is likely to be minimal: we export a total of about $1 billion per annum in goods and services to Russia and import virtually nothing from them. Any economic fallout in Australia will be indirect, mostly affecting oil and gas prices, leading to lower business and consumer confidence and a decrease in equity wealth. Even then, the impact is expected to be reasonably small.

The price of Australian gas in particular is likely to rise, and export volume may increase as Europe seeks to shore up its supplies. As Ukraine is a major supplier of wheat, the price of that commodity is also set to increase. Oil price hikes are forecasted to negatively affect wider consumption, with some models predicting a 0.2% decrease in consumption growth over 12 to 18 months (or 0.1% from GDP) if the price of oil goes up by 10 cents per litre. Another negative is the decrease in wealth due to lower equity markets, having about a third of the impact of changing house prices.

In short, global growth will be slower as higher commodity prices, sanction-related disruptions and uncertainty about the war and commodity prices all bite. At NAB, we recently lowered our global GDP forecast for 2022 from 4.2% to about 3.7% or lower. Most central banks will be inclined to monitor developments and gauge their impact before raising interest rates aggressively. In countries such as the United States, United Kingdom and New Zealand, where the central banks are behind the curve, the process of interest rate normalisation will probably happen at a slower rate.

Closer to home, the Australian economy rallied last year, with GDP up 3.4% in late 2021, and around 4.2% over the course of the year. Thus, by the end of 2021 losses from the Delta lockdowns had been more than recovered, and the unemployment rate remained at around the low 4% mark.


Clearly, Omicron hurt activity in January, but our internal data and the NAB Business Survey point to a very strong bounce back in February, with all key measures of activity confidence and forward orders now above long-run levels. The data suggests that consumer spend (as measured by electronic transactions across the NAB network) fully recovered from the January dip, and by late February had returned to mid-December levels (seasonally adjusted), while hospitality was at levels not seen since June 2021, before the Delta outbreak.

Our internal data on employment and NAB customers receiving JobSeeker payments suggests a strong labour market performance in February. Indeed, our February Business Survey saw a very large jump in employment from an index of -1 to +9, where the long­run average is about +2. Those levels are consistent with a national unemployment rate of about 4%.

The other big issue is supply disruptions, which have triggered a hike in purchase costs and, increasingly, retail prices. Measures of these variables reached near record highs in the January Business Survey, causing some issues for builders with fixed-price contracts. Against that, labour costs are more subdued.

Turning to forecasts, it seems likely that Omicron and recent floods will result in a modest start to activity in the first quarter, with GDP growth possibly as low as 0.5%. We expect to see a strong rebound in the rest of the year, bringing growth to about 3.5% in the year to December 2022, or an average growth rate of about 4%. In the face of higher interest rates, we predict growth will slow to about 2.1 % in the year to December 2023. That profile, together with the current strong starting point, could see the unemployment rate dip below 4% soon, reaching about 3.5% by mid-2022 and likely to remain at that level during 2023.

In these circumstances, we will continue to see elevated readings in underlying inflation (reaching about 3.6% by the third quarter of 2022 – exceeding the Reserve Bank of Australia’s ongoing 2 to 3% target) and even higher headline inflation. Core inflation in 2023 is expected to remain at about 3%, while the headline rate will slow as supply-chain pressures ease and commodity prices decrease. That inflation outlook combined with low unemployment should see wages increase to almost 3% by late 2022 and stay there.

These numbers have clear ramifications for the RBA. We predict the RBA will start increasing rates moderately from around August this year, although it could happen anytime from August to November if the RBA needs more data on the impact of elevated geopolitical risks and if it wants to run the economy hot.

Any interest rate increases set by the RBA are expected to be moderate. For example, the RBA could bring the cash rate to 0.25% in August (it’s currently 0.1 %), with additional 0.25% increases in September and November. We expect to see two to three hikes a year till mid-2023, when the cash rate will reach about 2%, meaning the proportion of household spending on mortgages would return to a level seen in previous cycles.

With a federal election on the horizon, the coming months promise to be politically charged. Whoever wins, it’s unlikely to have a big impact on Australia’s economic outlook, although some industries may be more affected than others.

Looking at property, we are already seeing slower house price growth in Sydney and Melbourne, less so in Brisbane and Adelaide. We expect this sluggish trend to continue throughout the year.

The NAB Residential Property Survey for the fourth quarter of 2021 also showed that house price increases are starting to level. The outlook for rents, however, improved and lifted in all states except Queensland and Tasmania.

Property professionals singled out high construction costs as the biggest constraint on new housing development in the fourth quarter, more so than in the previous quarter. For buyers, lack of stock and prices were the biggest impediments to purchasing established houses, with credit access and rising interest rates also becoming problematic, particularly in NSW and Victoria.

Going forward, we suspect affordability concerns and rising rates will be key drivers of dwindling house prices. Homeowners are increasingly switching to loans with standard variable rates, due to the knock-on effects of interest rate hikes in the US and the UK on fixed-rate loans available in Australia. We expect that trend to continue in 2022.

We believe house prices will soften further in the second half of this year, then drop about 10% during 2023. This fall, although considerable, comes off the back of a 22% increase in prices in 2021. On the plus side, we don’t foresee a fundamental mismatch between supply and demand in the coming months, and low unemployment rates will help boost affordability.

Homeowners with variable loans are, on average, more than 3.5 years paid in advance, hence we don’t expect to see any system­wide issues related to household balance sheets. Homeowners already need to prove to banks that they can afford an interest rate buffer of 3% more than what they’re currently paying. We suspect the RBA will be cautious in adjusting rates, carefully assessing consumers’ response before issuing further hikes.

The information contained in this article is gathered from multiple sources believed to be reliable as of the end of March 2022 and is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, property, financial and taxation advice before acting on any information in this article. ©2022 National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686