Investors appear to have convinced themselves that the worst of the war-induced energy crisis is largely over, based on some recent records notched up on global markets.
The world’s two biggest sharemarkets – those in the US and Japan – both hit all-time highs last week, while Australia’s market wasn’t too far off its previous peak, either.
Of course, there is still volatility day-to-day, but the overwhelming sense lately has been that equity investors are in an optimistic mood.
So, does that mean the most unpleasant economic effects of Donald Trump’s military foray are also behind us? Unfortunately, it’s not that simple.
Don’t let recent sharemarket bullishness mislead you: there’s still some way to go before the energy crisis is finished. Even if Trump is able to strike a lasting peace deal – a big if – we won’t know the full impact of the war on our actual economy (as opposed to the sharemarket) for quite some time.
It’s almost become a cliche for business types to bemoan the uncertain outlook but lately they have been right. No doubt Treasurer Jim Chalmers will reiterate such warnings about the uncertain economic times in which we are in his budget speech this week.
Three of the country’s biggest banks also warned of a highly uncertain future in their recent profit results, highlighting the risk that economic conditions could possibly get worse in the future. Our biggest financial institutions often have a “glass half full” view of the economy as it’s not in their interest to talk things down. Why are they so cautious when sharemarkets have generally been more upbeat?
Part of the answer is that sharemarket investors are taking a view on the future and the prospect of peace, whereas banks need to be prudent and prepare for the risk their loans aren’t repaid. But a bigger factor is that economic shocks don’t just have one easily measurable effect on the economy; they have all sorts of ripple effects that won’t be visible for months.
Independent economist Saul Eslake explains that for every conceivable economic shock there are “first-round” effects, followed by “second-round”-and-later effects, as millions of people and firms change their behaviour.
The first-round effects in this oil shock were simple enough. The cost of petrol soared, which meant many of us had to spend more on fuel. Some businesses, such as airlines, ride-share firms and supermarkets, raised some prices in response to higher fuel costs, and other businesses will no doubt join them. It’s been predicted the cost of building materials will also get pushed up, for example.
What’s less simple, however, is how consumers and businesses might change their behaviour in response to those higher prices.
Will consumers spend less on other things because petrol is costing them more? Could affected businesses not just raise prices but start cutting back on the shifts they give staff? Or, in extreme cases, might some firms even go to the wall?
There are no simple answers to any of these questions but a lot will depend on how long the shock lasts.
If fuel costs quickly return to more or less where they were before the war, you wouldn’t expect major behavioural changes from firms or households. But if the price shock is prolonged, people and firms will need to make changes.
Economists say that, so far, there’s only been a modest response from consumers to the petrol price shock. Banks that monitor our spending debit and credit cards have detected a small squeeze on non-fuel spending but it is far from dramatic.
But if fuel costs remain high, and other goods also rise in price, the pullback by consumers would get more pronounced. And some believe we’re getting close to the point where more people might decide to cut back more their spending.
ANZ Bank’s group chief economist Richard Yetsenga says it looks as though during March, consumers in many economies chose to run down their savings to cover the higher fuel costs. He says if fuel costs remain high in May we might see more “decisions to cut expenditure elsewhere because of the cost of energy”.
In a scenario where consumer spending weakened a lot, it would start to become a bigger economic problem because this would hit businesses that depend on our expenditure. Firms might then need to respond by cutting costs, such as giving their staff fewer hours, or even cutting jobs, thereby turning a price shock into an employment shock.
Thankfully that hasn’t happened, it’s only a scenario. Australia is also more fortunate than other, less wealthy countries, where energy costs inflict a bigger hit on household budgets.
But the important point is that all of this can take months to play out. That’s why we don’t know yet if the energy shock will trigger a serious economic downturn, or not.
One thing we do know, however, is that the longer there are blockages in the global supply of oil out of the Middle East, the higher the risk of a significant slump.
Economic shocks don’t just have one easily measurable effect on the economy; they have all sorts of ripple effects that won’t be visible for months.
A key reason financial markets have been fairly optimistic lately is because they are betting that the war will end soon enough, allowing flows to resume through the Strait of Hormuz. They may well be right, which would be a welcome reprieve for the world economy.
But if they’re wrong, and the strait remains closed for much longer, things could well deteriorate.
ANZ, for example, is forecasting that we’re in the peak phase of the oil shock and that energy prices will come down later in the year. This view is based on transits resuming through the Strait of Hormuz. But what if the strait remained effectively blocked for another month? Yetsenga says that would be a “significant problem”.
“I hope we’ve seen the worst of it but the oil is still not flowing through the Strait of Hormuz, and so that’s unquestionably the elephant in the room,” he says. “I think we can say with confidence, if the oil doesn’t flow, the economic impacts will get worse.”
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Clancy Yeates is deputy business editor. He has covered banking and financial services, and was previously national business correspondent in the Canberra bureau.Connect via X or email.
