Amidst the Ukraine-Russia war, questions have been raised as to how the conflict will impact Australia. Specifically, we need to assess how the crisis will impact Australia’s inflation levels and external stability - two objectives that are becoming increasingly difficult to achieve. As observed in a previous article, burgeoning inflation has raised questions regarding the RBA’s response to price stability concerns in Australia. And whilst external stability has remained strong in the last two years, the Ukraine-Russia crisis has greatly decreased investor sentiment worldwide and created uncertainty surrounding Australia’s external balance. This week’s article will assess the extent to which the crisis will impact Australia and the two aforementioned economic objectives.
Australia’s inflation problem and how the crisis has aggravated it
Since 2014, Australia’s annual CPI movement (%) has remained below-target, reaching a low of 1.0% in June 2016. Despite setting a target of 2-3% inflation in 1993, sluggish global growth prior to COVID-19 and the push towards a services-dominated labour force limited inflationary pressures nationwide. However, in recent times, Australia’s quarterly YoY inflation figure of 3.5% is a sharp increase from prior trends, beating the expected 3.2% for Q4-21. As mentioned in previous article(s), positive consumer sentiment, lower savings and higher spending amidst the economic rebound from COVID-19 has led to high, demand-driven inflationary expectations.
However, cost-push inflation is becoming increasingly concerning amidst the Ukraine-Russia crisis. Low investor confidence, alongside the sanctions placed on Russia have certainly aggravated the global supply chain crisis and inflation issues. Whilst Australia does not directly import crude oil or petrol from Russia, there is a clear contagion effect spreading in Europe that is likely to spread to Australia. Since Russia provided 30% of Europe’s crude oil and 40% of its natural gas imports, European nations are now suffering from a depleted pool of gas and other fuels.
With this in mind, these shortages will likely increase the competitiveness of the fuels market, crowding out nations like Australia. As argued by the ABC, fuel is a major component in everything we consume, from production to transport. Thus, the supply chain issues in Europe are likely to increase cost-push inflationary pressures in Australia, as firms pass on higher input costs onto consumers. This has led economists to believe that petrol prices will soon average $2.10 a litre or above. FuelPrice Australia currently measures the average price of 98 Octane to be $2.08 across four state capital cities, including Sydney.
This isn’t necessarily a bad thing. As argued by Radobank economist Wouter van Eijkelenburg, the prices of key Australian commodities are likely to increase as demand redirects towards Australia and away from Russia amidst uncertainty. As evidenced by the RBA’s Index of Commodity Prices, commodity prices have risen from 65 index points in 2015 to 150 in 2022, which will likely increase further as the crisis continues. Yet, van Eijkeleburg believes that the higher input prices that hit global and local producers will translate to higher inflation levels for consumers, deteriorating consumer purchasing power and real income.
External stability or external instability? How the crisis will impact Australia’s external balance
As mentioned earlier, the direct impacts of the crisis on Australia’s trade balance will be minimal. Russia accounts for 0.1% of Australia’s total merchandise trade, ranking only 42nd on the national list of trading partners. However, it is the indirect impacts of the crisis that are likely to impact Australia’s trade balance. In the past two years, Australia’s trade balance has shifted from 3% of nominal GDP to 7% of nominal GDP at the end of 2021. This has been driven by a surprise surge in rural exports, which grew from 10b to 15b between 2016 and 2021, as well as continued demand for resource and LNG exports since 2018.
This ABC article notes that Russia has long been a competitor with Australia, exporting similar goods, such as food, energy and minerals. As such, the conflict favours Australia’s trade balance as nations become reluctant to trade with Russia, redirecting export demand to Australia. This has contributed to the improved terms of trade as export prices soar, which has shifted from a low of 79 in 2016 to 122 in 2022. The ongoing crisis should benefit Australia’s external balance, with the upward positive trend in the BOGS indicating a positive forecast, shifting from 8.2b in December 2021 to 12.8b in January 2022.
Given that it has only been two weeks since the beginning of the crisis, it is difficult to assess the impact of the crisis on investor sentiment and net investment into Australia. However, with Phillip Lowe holding interest rates at 0.10% amidst the uncertainty, interest rate hikes are looking unlikely in the near future, which may deter investors waiting for a more-positive interest rate differential.