Australia’s economy will not recover to pre-COVID levels until 2022, a leading economist says.

In an online address delivered as part of the Housing Industry Association’s Housing 100 event last Thursday, Westpac Chief Economist Bill Evans said Australia’s GDP would take time to return to pre-COVID levels.

According to Evans, the economy will lose about 3.5 percent of its value over calendar 2020 after a 7 percent fall in first half of the year will be followed by a recovery in the second half.

Add in a modest 2.5 percent expansion next year and Evans says the economy will be one percent smaller at the end of 2021 compared with its level at the start of 2020.

Unemployment, meanwhile, will remain above 7.0 percent until 2022, with any return to the 4.5 percent level seen prior to COVID being ‘many many years away’.

In his presentation, Evans said questions surround the Commonwealth strategy in its upcoming budget.

He says the priority will be to restart the economy – a task he says will be manageable for government finances on account of relatively low levels of debt and a cash rate which will remain at unprecedented low levels for many years.

As things stand, Evans says a budget deficit of $85 billion in 2019/20 will blow out to about $230 billion in 2020/21.

Whilst this latter number exceeds current government estimates for 2020/21 of $185 billion, Evans says the government’s numbers do not account for new spending which is likely in the budget and likely understates expenditure which will be needed on JobKeeper and JobSeeker in the December quarter.

Commonwealth debt, he said, will rise from around 19 percent of GDP in 2019 to around 43 percent of GDP by 2022.

Whilst this number looks high, he says Australia remains well positioned compared with countries elsewhere who are dealing with debt/GDP ratios of more than 100 percent.

Moreover, in the context of a three-year bond rate which is likely to drop to 0.1 percent and remain at unprecedented low levels for some time (see below), Evans says the burden on debt will be manageable.

In terms of stimulus, Evans says several themes are likely.

With JobKeeper phasing out in March, the focus will shift away from supporting business to retain existing workers and toward encouraging new job creation. This may include subsidies for hiring new workers along with the extension of the instant asset write-off scheme to include larger companies and to cover assets of a greater monetary value.

Also likely is the bringing forward of personal income tax cuts which are currently scheduled to commence in July 2022.

These include an increase in the thresholds above which marginal tax rates increase from 19 percent to 32.5 percent and from 32.5 percent to 37 percent from $37,000 to $45,000 and from $90,000 to $120,000 respectively.

Such cuts may be brought forward to commence in July 2021 or – hopefully, in Evans’ view – to January 2021.

Whilst he would personally like marginal rates to be cut to as low as 30 percent for all taxable income within the bracket of $45,000 to $180,000, Evans says this may be a bridge to far for the government.

Despite this stimulus, Evans says challenges for the economy remain.

Over the short term, one issue involves a fiscal cliff which will occur amid government estimates that the volume of money to be pumped into the economy through schemes such as JobSeeker and JobKeeper will taper off from $60 billion in the June quarter and $105 billion in the September quarter to around $25 billion in the December quarter.

This, Evans says, will be manageable.

For one thing, he says the number of people remaining on JobKeeper after September – and thus the number of people whom the subsidy will support into the December quarter – is likely to exceed these estimates.

Further, much of the existing money which has been paid out through these schemes remains in the system and is yet to be spent on consumption as consumers and businesses have used subsidies to improve their balance sheet and financial position. In coming quarters, part of this could be spent and released into the economy.

A longer-term challenge will be higher unemployment.

Following previous recessions in the early 1980s and 1990s, Evans says unemployment took eight to fifteen years to return to pre-recession levels.

Twelve years on from the GFC, unemployment remains still above pre-GFC levels.

Following COVID, Evans says unemployment will remain at above seven percent until at least 2022 and will not return to pre-COVID levels (around 4.5 percent) for ‘many many years’.

Mostly because of this, he expects unprecedented low levels of interest rates to remain for some time.

In what he believes will be a ‘Team Australia’ moment, he expects the Reserve Bank of Australia to cut interest rates to ten basis points (0.1 percent) when the Board meets on the same day that the Commonwealth Budget is set to be handed down.

With the RBA targeting a return to previous levels of unemployment as its trigger point for higher rates, Evans says rates are likely to remain at those unprecedented lows for some time.

Those low interest rates are part of what Evans says will – after some delay – drive a resurgence in house prices from during 2022/23 (see separate article).

Overall, from April this year until June next year, Evans expects that house prices will decline by five percent – 2.7 percent of which has already occurred.

In the immediate term, he sees further modest falls along with a ‘hump’, which the market will need to manage in dealing with $180 billion of deferred mortgages which banks are holding.

Beyond that, however, he expects house price growth of 15 percent in 2022/23 as the lower rates and a less restrictive approach toward lending on account of a desire to reboot the economy make home borrowing ‘very attractive’.

Finally, Evans the Australian dollar to perform strongly against the US dollar over the next eighteen months amid a much stronger profile of economic growth in China – Australia’s largest export destination – compared with the US.

Currently sitting at around 70 US cents (after hitting a low point of around 60 US cents in March), Evans expects the dollar to be at around 80 US cents by December next year.

He points out that the dollar is trading below the bottom of Westpac’s ‘fair value’ range as determined by its modelling based on commodity prices, interest rates and the risk environment.

As for the trade dispute with China, Evans says around $100 billion of our $150 billion in exports relates to iron ore, gold and base metals and appears to be relatively safe.

The other $50 billion, however, is more vulnerable as coal can be sourced from elsewhere (and China produces around 90 percent of its own coal) tourism will be off the cards for twelve months, service exports in education remain at risk despite efforts to enable students to return and agricultural exports such as wine and barley are vulnerable to trade tensions.

Evan’s comments come as most forecasters say the pathway to economic recovery in Australia will be slow.

Last month, the RBA forecast that Gross Domestic Product in Australia would not return to pre-COVID levels until at least 2022.

Whilst a recovery in activity was expected throughout the remainder of this year and into next year, the RBA said this recovery would be ‘slow and uneven’ and that the GDP will take several years to return to its trend path prior to virus outbreak.