Australia faces economic setback as fresh outbreaks shut down Melbourne

By Swati Pandey

SYDNEY (Reuters) - A hard lockdown in Australia's second-largest city will likely erase nearly A$5 billion of economic output over six weeks, slowing a broader national recovery and forcing the government to expand its already massive debt-funded stimulus.

Australia has been among the most successful countries in curbing the spread of the coronavirus but the lockdown in the state of Victoria and its capital Melbourne has hurt hopes of a faster and sharper economic recovery.

"Our initial sense is that the re-opening reversal stemming from the lockdown will see the economy surrender some - but not all - of the better than expected trajectory," Deutsche Bank economist Phil Odanaghoe wrote in a note.

Crucially, the shutdown will close cross-border trade and movement between Victoria and New South Wales, which collectively account for more than half of Australia's economy and population.

The two states, which are separated by the Murray River and its lucrative farming districts, had previously remained open to each other even as other states closed their domestic borders.

In 2019, the air passenger route between the state capitals of Sydney and Melbourne was the second-busiest in the world, according to industry analytics group OAG.

Westpac downgraded its forecasts for growth in Australia's A$2 trillion economy to 4.2% contraction in 2020 from 4% previously.

Westpac chief economist Bill Evans said "the events in Melbourne highlight the risks to this scenario around the containment of the virus; other shutdowns; and the inevitable savage loss in confidence were that to occur."

To be sure, other states and territories are sticking to their planned re-openings, with Queensland, South Australia, Tasmania and the Northern Territory set to re-open their borders this month to each other and to New South Wales, the country's largest state economy.

That would be positive for domestic tourism, retail spending and business supply chain management.

Still, the Melbourne lockdown means Prime Minister Scott Morrison's conservative government could face a larger stimulus bill.

Morrison has repeatedly said the temporary measures that is set to cost his government about A$160 billion (£88.38 billion), or 8% of GDP, will end in September.

However, he now faces increasing pressure to extend this support, which includes household income relief and provisions for workers to unlock some of their pension funds.

Citi economist Josh Williamson expects demand for these programmes to increase.

The government will publish a "mini-budget statement" on July 23, providing some clarity on what measures would continue and in what form.

Policymakers are also bracing for a hit to confidence in other parts of the country from the Melbourne lockdown.

"Outside of the localised economic impact, the Melbourne lockdown could hit consumer and business confidence outside of Victoria," Williamson said.

"Any dent to confidence is a risk for the pace at which the hard data returns to normal and is worth watching."

(Reporting by Swati Pandey; Editing by Sam Holmes)