China, Australia
Our economic and market outlook at midyear 2023
June 26, 2023
China’s and Australia’s economies are in some ways on opposite trajectories. Monetary policy rates continue to climb in Australia amid sticky inflation. A recent interest rate reduction in China, meanwhile, is unlikely to stoke demand. One attribute they’ll likely share: a slowdown in growth for the rest of the year.
China's gradual economic healing
Read video transcript
Qian Wang: The story of Asia-Pacific economies in 2023 has been one of “less”: less tight labor markets and less inflationary pressure than in other regions, which has allowed central banks in this region to be less aggressive in hiking interest rates. As a result, Australia and Japan face a lower chance of recession than in other developed markets.
China’s economy heavily influences this region. We’ve seen a rapid recovery after China’s breakneck reopening from the pandemic late last year. Especially, we see the recovery is particularly strong in the service sector. However, we don’t believe China can maintain its better-than-expected first-quarter pace of growth.
Pent-up demand will eventually fade, and it will take time for a more broad-based healing of private-sector balance sheets and confidence, which has been damaged by three years of COVID and policy uncertainties.
As a result, we expect the pace of China’s recovery to slow quite notably in the near term but pick up again later this year with continued improvement in the labor market, income growth, and some additional policy support.
We believe that China’s economy will grow in 2023 by more than the government’s target of “around 5%,” largely because of a low base in 2022.
At the start of the year, we had foreseen GDP growth of around 4.5%, with the risk to the upside. Now, our forecast is higher, but the risk has shifted to the downside.
Intensifying external headwinds, a structural housing downturn, and weak household fundamentals and business confidence will continue to weigh on our outlook. With some success already being made toward meeting its growth target, which in our view is a bit conservative, policy support for China’s economy could fall short of expectations.
Now, China’s economy’s rebound reduces the chance of global recession. After all, China is already 20% of the global GDP. But the global spillover benefit will be more muted given the services-led nature of the recovery.
Some Asian neighbors could benefit from a rebound in Chinese tourism, but China’s recovery is unlikely to boost up goods or commodities demand to the extent that we have seen in the past.
The implications for global inflation are rather mixed. Stronger China services demand would be inflationary. But China’s economic normalization stands to reduce the risk of global supply chain disruption, and this will continue to help stabilize global goods inflation.
China
Our outlook for year-end 2023
5.5%–6%
Economic growth,
year-over-year
Although we see China’s economy as likely to grow by more than we anticipated at the start of the year, the bulk of those gains have already occurred. The pent-up demand unleashed in the first quarter after the removal of COVID-19 restrictions has yielded to a broad-based weakening. Full-year growth above a conservative government target is likely, but three years of policy uncertainty will weigh on confidence.
1%
Core inflation, year-over-year
Lower energy and pork prices have contributed to a series of weak inflation prints. Alongside slowing growth, that has led us to nearly halve our inflation forecast from the start of the year. A rebound later this year is likely as credit demand strengthens and food and energy prices stabilize.
2.45%–2.55%
Monetary policy rate
A recent People’s Bank of China cut to 2.65% for the key 1-year medium-term lending facility should have little tangible economic effect. We believe an additional 10 to 20 basis points of cuts are likely. But China’s challenge is a lack of demand for money, not a lack of supply. The likelihood of aggressive fiscal stimulus is low because of an increasing local government debt burden.
4.7%
Unemployment rate
The labor market has improved steadily since China’s post-pandemic reopening, with the headline unemployment rate declining to 5.2%. However, youth unemployment has climbed to a record high, posing a downside risk to growth.
What I’m watching
China’s limited global spillover effects
“In past economic recoveries, China’s appetite for commodities and other goods benefited its trade partners. Now, as its economy bounces back from COVID-19-related downturns, China is less likely to support global growth. That’s because its current recovery has been led by the services sector, and services exports account for much less of its trading partners’ gross domestic product than goods exports.”
Grant Feng,
Vanguard Senior Economist
Notes: This chart is based on 2019 gross domestic product because the COVID-19 pandemic skews more recent available data.
Source: Vanguard calculations, using China's General Administration of Customs data via CEIC.
Australia
Our outlook for year-end 2023
1%–1.5%
Economic growth,
year-over-year
Our growth forecast is little changed from the start of the year. But tepid first-quarter growth and our expectation for subdued consumption in the coming quarters skew risks to the downside. Our proprietary leading indicators model suggests growth will fall below trend. We place a 40% probability on recession in the next 12 months—below that of many developed markets but still significant.
4.5%
Headline inflation, year-over-year
Despite some mixed signals recently, we believe inflation has peaked; our forecast remains where it was at the start of the year. Still, recent higher-than-expected readings suggest higher interest rates will be required to dampen demand. We foresee inflation falling to the high end of the central bank’s 2%-3% target range only in late 2024 or 2025.
4.6%
Monetary policy rate
A historically aggressive effort to slow the Australian economy—and thereby quell inflation—almost certainly will continue. The Reserve Bank of Australia (RBA) raised its cash rate target a dozen times between May 2022 and June 2023. We foresee two more rate hikes, taking the rate target to 4.6% by year-end, higher by 25 basis points than our view at the start of the year amid signs of sticky inflation.
4%
Unemployment rate
An unemployment rate that has flirted with near- 50-year lows is likely to rise in the second half of the year and further—to 4.75%—in 2024 as financial conditions tighten. The RBA will be attuned to unit labor costs, which have risen as productivity growth has been subdued. An increase in productivity will be required for wage growth to remain consistent with the RBA’s inflation target.
What I’m watching
A measure of inflation's stickiness
“Inflation that is broad-based, affecting a wide range of goods and services, is likely to remain stickier than inflation confined to a small proportion of items. The proportion of goods and services whose prices have risen by more than 5% has started to drop back after reaching more than 30-year highs at the end of 2022. We’ll want to see that proportion continue to fall.”
Alexis Gray,
Vanguard Senior Economist
Notes: Data points are quarterly.
Source: Vanguard calculations, using Australian Bureau of Statistics data through the first quarter of 2023.
The outlook for emerging markets
We expect emerging Asia to boast sharply higher growth than the rest of the world’s emerging markets. We foresee growth of 5.25% this year, cooling somewhat to 5% in 2024. The outlook is based on China’s strong first-quarter growth and resilient activity globally.
Compared with emerging markets globally, emerging Asia faces tame inflation of less than 2% in 2023, meaning central banks don’t need to restrict activity to constrain prices.
Notes: All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future results.
A closer look
10-year asset-class returns
Our 10-year annualized return forecasts are modestly lower since the start of the year for most developed markets.
Inflation and portfolios
Even in the unlikely event of long-term elevated inflation, a 60/40 portfolio could serve investors well.