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Economics | January 1, 2021

Year in Review. Year in Preview The Past Year: 2020 In the March quarter 2020 the Australian economy entered recession for the first time in 28 years – impacted by

the COVID-19 coronavirus as well as drought, bushfires and storms. In the June quarter, the economy contracted by 7 per cent – the biggest fall in activity since the end of World War

II. The Australian economy contracted by 0.3 per cent in 2019/20. But the recovery is underway with the economy growing by 3.3 per cent in the September quarter – the biggest lift

since March 1976. The Australian economy is recovering due to our relative success in supressing the COVID-19 virus as well as the

speed and size of economic stimulus and support supplied by all levels of government and the Reserve Bank. The cash rate ended 2020 at a record low 0.1 per cent; the Aussie dollar ended the year at US77 cents;

unemployment stands at 6.8 per cent; annual inflation is 0.7 per cent; the S&P/All Ordinaries ended 2020 at 6,851 points, up 0.7 per cent on the year; and the S&P/ASX 200 index ended the year at 6,587 points, down 1.5 per cent for the year. Total returns on shares (includes dividends) rose 3.6 per cent in 2020.

The Year Ahead: 2021 As we enter 2021, it is clear that COVID-19 still dominates the landscape. The bad news is that Europe and the

US are experiencing second and third waves of the virus, driving case numbers to record highs and necessitating fresh lockdowns. The good news is that effective vaccines are starting to be distributed across the globe.

The economic outlook will clearly be dictated by the virus and how quickly the vaccines can stem case numbers and allow economies to start repairing.

After contracting an estimated 2.5 per cent in 2020, the global economy is tipped to rebound by 5.1 per cent in 2021. On the same basis, the Australian economy is tipped to grow by 4.9 per cent in 2021 after contracting 2.8 per cent in calendar 2020.

The Reserve Bank Governor has committed to leave the cash rate at 0.1 per cent (or even lower?) for three years. Bond purchases are being employed with the hope of reducing longer-term yields.

Underlying inflation is expected to broadly hold near 1-1.5 per cent over 2021. Unemployment is the focal point of all monetary and fiscal policy actions. Commonwealth Bank Group economists

expect that the jobless rate has already peaked at 7.5 per cent. The unemployment rate is expected to ease to 5.75 per cent by the end of 2021 and ease further to 5.0 per cent by the end of 2022.

ECONOMIC ACTIVITY FORECASTS

2022202120203.45.1-2.5World1.62.2-3.3US (Dec qtr vs Dec qtr)2.82.4-7.3Eurozone0.91.9-5.9Japan (fiscal year)5.69.11.8China3.84.9-2.8Australia

Source: CBA, CommSec

January 1, 2021 2

Economic Insights: Year in Review. Year in Preview

Interest rates The cash rate was reduced from 0.75 per cent to 0.10 per cent in 2020 with 25 basis point rate cuts delivered on

March 3 and March 19 and a further rate cut of 15 basis points on November 3. On March 19 the Reserve Bank (RBA) introduced a target rate for 3-year Australian Government bonds of around

0.25 percent. It reduced the target rate to 0.10 per cent on November 3. On March 19 the RBA introduced a term funding facility for the banking system. On September 1 the Reserve

Bank decided to increase the size of the Term Funding Facility and make the facility available for longer. On March 19 the RBA said Exchange Settlement balances at the Reserve Bank will be remunerated at 10 basis

points. On November 3 the RBA announced: a reduction in the interest rate on new drawings under the Term Funding Facility to 0.1 per cent a reduction in the interest rate on Exchange Settlement balances to zero and the purchase of $100 billion of government bonds of maturities (also known as Quantitative Easing) of

around 5 to 10 years over the next six months. The market-determined 90-day bank bill rate fell from highs near 0.92 per cent in January to record lows of 0.01

per cent and yields ended 2020 at the lows. Yields on the long bond – 10-year government bond – fell from highs of 1.37 per cent in January to lows of 0.62 per cent on March 9; lifted to highs near 1.50 per cent on March 19; and ended the year near 0.97 per cent.

January 1, 2021 3

Economic Insights: Year in Review. Year in Preview

Exchange rates The Aussie dollar rose by 9.9 per cent against the greenback over 2020. The Aussie started the year around

US70 cents and ended the year near US77 cents. The Aussie hit highs (32-month highs) of US77.08 cents on the last day of December, while the low (17½-year low) of US55.06 cents was set in on March 19. The 22 cent range for the Aussie over the year was the biggest in 11 years.

The Aussie gradually trended higher since mid-October against a weaker greenback. Reduced interest rate differentials, a rapid rise in iron ore prices and improved risk sentiment combined to push the Aussie up 40 per cent from the March low.

Over 2020 the Aussie lifted against pound sterling (+4.8 per cent); the Japanese yen (+3.1 per cent); the NZ dollar (+2.7 per cent); and Chinese yuan (+1.3 per cent). The Aussie fell against the Swiss Franc (-0.8 per cent) and Euro (-0.7 per cent).

January 1, 2021 4

Economic Insights: Year in Review. Year in Preview

Sharemarkets At the start of 2020, the Australian All Ordinaries index stood at 6802.4 with the ASX 200 at 6684.1. The All

Ordinaries ended 2020 at 6850.6, up 0.7 per cent. The ASX 200 ended the year at 6587.1, down 1.5 per cent. Focussing on the ASX 200, the index hit record highs (together with the All Ords) on February 20 at 7162.5

points. The ASX 200 then fell 37.5 per cent over the next 22 days before lifting 21 per cent over the next 16 days. Movements of other key markets over 2020: US Dow Jones (+7.2 per cent); US S&P500 (+16.3 per cent); US

Nasdaq (+43.6 per cent); Japan Nikkei (+16 per cent); UK FTSE (-14.3 per cent); German Dax (+3.5 per cent). The world index (MSCI) excluding Australia in US dollar terms rose 14 per cent in 2020 to record highs. The MSCI

Australia index in US dollar terms rose 6.9 per cent and ended 2020 just off record highs set on December 18. US sharemarket indexes set fresh record highs late in December 2020 with the Dow Jones and S&P 500 at highs on December 31.

January 1, 2021 5

Economic Insights: Year in Review. Year in Preview

Australia sharemarket sectors & asset returns Australia’s relatively small Information Technology sector out-performed in 2020. The Information Technology

sector rose by 56.3 per cent over 2020, ahead of Materials (+13.4 per cent) and the Consumer Discretionary sector (+8.6 per cent).

At the other end of the scale, Energy fell by 29.9 per cent, from Utilities (-21.5 per cent) and Industrials (-14.1 per cent).

Of the size groupings, the MidCap50 (+14.5 per cent) out-performed the Small Ordinaries (+6.6 per cent). The S&P/ASX20 ended lower by 1.5 per cent and the S&P/ASX50 ended lower by 4.9 per cent.

Total returns on Australian shares (All Ords Accumulation index) lifted 3.6 per cent over 2020. The cash rate ended 2020 at 0.1 per cent while bond returns (Bloomberg AusBond Govt 0+ Yr index) were up 4.5 per cent. And residential property (CoreLogic Home Value index) returned 6.6 per cent in the year to November.

January 1, 2021 6

Economic Insights: Year in Review. Year in Preview

Commodity prices The CommSec daily commodity index lifted 42 per cent in 2020 in US dollar terms. Over the same period the

Aussie dollar rose by almost 10 per cent. The Reserve Bank commodity index in US dollar terms (using spot prices for bulk commodities) was up 6.9 per

cent in the 11 months to November. Prices for iron ore, coal and natural gas have since lifted sharply in December.

In contrast, the CRB futures commodity index fell by 9.7 per cent over 2020. One of the stand-out gains from an Australian perspective has been natural gas (up 145.1 per cent), followed by

iron ore (up 73.1 per cent); copper (up 26 per cent); gold (up 24.7 per cent); coking coal (up 24.4 per cent) and thermal coal (up 19.3 per cent). Also of note: rice (up 18.9 per cent); zinc (up 19.7 per cent); nickel (up 18.7 per cent); cotton (up 6.7 per cent); sugar (up 15.4 per cent); wheat (up 14.6 per cent); aluminium (up 10.8 per cent); and lead (up 3.3 per cent).

At the other end of the scale, wool fell by 25.7 per cent; followed by barley (down 23 per cent); oil (down 20.5 per cent); and beef (down 19.4 per cent).

January 1, 2021 7

Economic Insights: Year in Review. Year in Preview

ECONOMIC FORECASTSCalendar yearsFinancial years

2022202120202022202120203.84.9-2.84.50.1-0.2Economic Growth (GDP, %)1.20.91.31.10.91.3Underlying inflation* (annual %)5.36.26.55.66.85.6Unemployment rate % (avg.)

Mar-22Dec-21Sep-21Jun-21Mar-210.10%0.10%0.10%0.10%0.10%Cash rate7,2507,2007,0506,9006,750Sharemarket (ASX200)US78cUS78cUS77cUS76cUS75cAustralian dollar

Source: CBA, CommSec*Trimmed mean

Outlook 2021 The 2020 calendar year was a year of unprecedented challenges. The last time there was a pandemic of global

significance was just over a century ago. And unfortunately our ancestors didn’t leave us with a playbook – each country and region have had to make their own choices about the ‘right’ way to respond.

While there were some hiccups with virus case numbers in Australia, we exited 2020 as a nation with plenty of optimism. A monthly consumer sentiment index is at decade highs while business confidence is at 31-month highs.

The success in suppressing the virus has enabled our states and territories to largely ‘re-open’ their economies. Governments, the Reserve Bank, commercial banks and regulators have provided all the necessary support and stimulus to ensure that as many businesses as possible stay in business and workers hold onto jobs. Borrowing costs for businesses, households and governments are at ‘rock bottom’.

The additional boost to confidence and future prospects comes from the vaccines that are already being roll-out across the UK, mainland Europe and the US.

Stimulus measures will need to stay in place through the first quarter of 2021. The hard decisions lie ahead about the phasing out of fiscal measures like JobKeeper and JobSeeker. If you remove the support too quickly, you risk a loss of economic momentum. But leave the support in place for too long and businesses and consumers lose the desire to take charge of their own destinies.

Overall we expect the Australian to rebound by 4.9 per cent in 2021 after contracting 2.8 per cent in 2020. Risks to the forecasts include ‘second’ or ‘third’ waves of virus cases; setbacks with vaccines; policy mistakes on the removal of support measures; and extended delays in the re-opening of foreign borders.

We believe that the jobless rate peaked at 7.5 per cent. The jobless rate could fall to the 5.75-6.00 per cent region by end year.

But make no mistake the job market will dominate attention over 2021. No longer is the Reserve Bank directed solely by inflation but by reducing unemployment – an “important national priority”.

January 1, 2021 8

Economic Insights: Year in Review. Year in Preview

The Reserve Bank is committed to leave the cash rate at 0.10 per cent through to late 2023. The big question is what happens if unemployment surprises on the downside and inflation surprises on the upside over 2021.

Home prices could grow by 3-5 per cent in 2021. Low interest rates and government grants will support buying and building of homes. But demand for homes will be constrained by the absence of foreign migrants. Should the property market show signs of overheating the banking regulator APRA may act through macro prudential policies.

We expect the Australian sharemarket to return to record highs by the end of the year. An earlier return to highs is possible given the fast progress with vaccine approval and distribution in many countries. Also other advanced economies are expected to follow China’s lead with infrastructure-led growth, supporting Australia’s mining and energy sectors.

While the relative outperformance of the Aussie sharemarket may continue over the summer months, the ASX 200 is ‘expensive’ valuation-wise and is less cyclical in composition relative to offshore peers.

The global economy is expected to lift 5.1 per cent in 2021, further underpinning demand for metals and ores and driving the Aussie dollar higher.

The Aussie dollar is expected to rise further over 2021 to reach US78 cents by the December quarter. A stronger Aussie could see the Reserve Bank extend its bond purchasing program with the Board reluctant to cut the cash rate further or introduce negative interest policy.

Craig James, Chief Economist, CommSec Twitter: @CommSec Ryan Felsman, Senior Economist, CommSec Twitter: @CommSec