Higher rates and Ukraine war force downgrade to Australian economy

Treasurer Jim Chalmers’ hopes of quickly repairing the federal budget face fresh headwinds with warnings the global economy has stalled and will struggle to recover next year due to the war in Ukraine and rising interest rates.

As one of the world’s largest ratings agencies said it expected a sharp slowdown in Australian economic growth, the Organisation for Economic Co-operation and Development downgraded its forecasts for the local and global economies amid growing fears central banks will drive the world into recession as they fight to tame inflationary pressures.

Consumer spending is expected to slow due to higher interest rates. The OECD believes the Australian economy will expand by just 2 per cent next year.Credit: Luis Ascui

The OECD believes the Australian economy will expand by 4.1 per cent this calendar year, down 0.1 percentage point on its June forecasts, with growth to drop to just 2 per cent in 2023. That is half a percentage point lower than it predicted almost four months ago.

While the economy is slowing, the organisation expects inflation to quicken. It has sharply revised up its forecasts for inflation in Australia, tipping it to average 6.1 per cent this year and then 4.4 per cent in 2023.

The OECD said central banks would have to continue lifting interest rates to bring inflation under control, noting countries including Australia – where it projects the cash rate will reach 3.6 per cent by next year – would be hit over the coming months.

“One key factor slowing global growth is the ongoing generalised tightening of monetary policy in most major economies in response to the greater than expected overshoot of inflation targets over the past year,” it said.

“Japan, Korea and Australia have somewhat stronger growth momentum currently than Europe and the United States, but that is projected to wane over the coming quarters, in part due to softer external demand.”

Globally, the OECD is now forecasting economic growth to be just 2.2 per cent in 2023, a 0.6 percentage point cut on its June predictions. Through 2021, the global economy expanded by 5.8 per cent.

Chalmers will release his re-do budget on October 25. An update on key forecasts delivered in late July showed the government expected inflation to be slightly lower than the OECD’s predictions and around the same for GDP.

Chalmers said the OECD report highlighted the world’s growing economic risks.

“These challenges are intensifying, not dissipating, and Australia is not spared from this darker and more dangerous global outlook,” he said.

The OECD’s forecasts are similar to those from ratings agency S&P Global, which on Monday slashed its expectations for key countries across the Asia-Pacific region.

It is tipping the Australian economy to expand by 1.8 per cent next year, a full percentage point lower than it had forecast in June. It is also expecting GDP to lift by 2 per cent in 2024, a 0.7 percentage point cut from its previous forecasts.

S&P also downgraded forecast growth for major trading partners including China, Japan, South Korea, Malaysia and New Zealand.

Inflation, and dealing with it, was the key reason for its more pessimistic view of the regional economy.

It is forecasting inflation in Australia to average 6.5 per cent this year, 5.7 per cent in 2023 and 3.4 per cent in 2024. At 3.4 per cent, inflation would still be above the Reserve Bank’s 2 to 3 per cent inflation target.

It expects higher inflation to force the RBA to take the official cash rate to 3.1 per cent by the end of this year, where it would remain until 2024.

S&P Asia-Pacific chief economist Louis Kuijs said higher interest rates would affect housing markets, particularly in Australia.

“The effects will be greatest where housing debt is the highest and where a large share of it is on variable terms,” he said.

“We believe that residential markets in Australia, New Zealand, and South Korea are the most
vulnerable to rising interest rates. In these markets, house prices are declining and housing activity
has slowed.”

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