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The clouds continue to clear

Business Outlook September 2017

23 October 2017: The world is taking a bunch of threats in its stride, including renewed protectionism, pressures on the Eurozone, North Korea’s accelerating missile program, Chinese debt, global housing prices, late night tweets and the release of Taylor Swift’s latest album. And the big picture remains robust, with global growth in both 2017 and 2018 looking like the best since 2012. The joy is widely spread: China, Europe and Japan are all outperforming expectations, although the US and the UK have disappointed earlier hopes for the pace of their growth. Yet the better news on global growth owes more to cheap money and great underlying momentum in emerging Asia than it does to courageous politicians and a related boost to investment in infrastructure and education, topped up with a dash of pro-competitive market reforms. Growth has mostly been debt-financed. And while it’s been fun, the glory days can’t last forever. But they’ll last for at least a little longer: although interest rates will eventually rise around the world, global inflation remains as weak as a cup of boarding house tea.

The clouds around Australia’s economy are clearing. China began to slow six years ago, sending a fast shockwave though national income as commodity prices fell, and a slow shockwave through production growth (mine approvals came to a halt a long time ago, but it wasn’t until this year that the already approved projects were completed). Yet those two big negatives are now mostly in the rear view mirror. As always, there are new risks: part of today’s good news is thanks to renewed stimulus that has been boosting Chinese construction activity, and that is likely to ease back. And we used lower interest rates to ward off the risks of recent years, thereby pumping up housing prices to silly levels. Yet the most likely path for Australia doesn’t see a triggering of those new risks (China and/or housing). Rather, it sees both national income and national production growth gradually return to a steadier path – boosting wage growth as they do so, albeit slowly so.

None of the three big drivers of inflation risk – a strong economy giving businesses pricing power, or wage growth outstripping productivity growth, or rising import prices from a falling $A – currently point to anything like a surge in pricing pressures. At best they spell out a very slow burn in which pressures will lift over the next couple of years. But that lift will be from “not much happening” to “little happening”. That’s why the Australian inflationary outlook is pretty boring. No, inflation won’t stay as low as it is today. Equally, however, it won’t bounce back off the canvas any time soon.

Global growth has the best breadth of anything you’ve seen since Clive Palmer started his diet, yet world inflation remains strikingly sleepy. That “risk on” environment says the US Fed will stay rather more sidelined than was expected in early 2017, and it says the same of the Reserve Bank too. That leaves risky assets looking better than they have in a while, making sharemarkets happy and housing prices delirious. Much now depends on Chinese growth and US inflation. Assuming the former eases back while the latter is slow to climb, the outlook may see cash rates on hold until well into 2018 (before starting a slow march back to 3 to 3.5% by 2021), and the $A also holding up until early 2018 (before starting a slow slide closer to US 70 cents).

Australia’s current account deficit recently dropped to the lowest as a share of national income than seen for decades. But the best is already past, with the current account worsening through 2017 to date. Despite a huge lift in export earnings from gas, both farm and service exports may lose some of their shine. And, further out in time, once global and local interest rates do eventually climb from their current record lows, that will come as a rising cost to our heavily indebted nation.

Australian job growth is a thing of beauty. And it looks set to stay beautiful for a while longer, as good global growth lifts the demand for both labour and capital, thereby boosting the outlook for both jobs and business investment. Looking longer term, and like many of our trading partners (such as Hong Kong, Korea, Taiwan, Singapore, Thailand and China), Australia will age relatively rapidly. However, provided we continue to welcome migrants to our shores, our growth and living standards will take a rather smaller hit than is expected in many of our major trading partners.

Better global growth (China cheer in particular) has finally flowed through to the national tax take. Official expectations are being bettered as profits boost company tax, jobs lift personal tax, spending boosts the GST, and house prices sprinkle fairy dust on stamp duties. New taxes on banks plus a bigger Medicare levy add to that, extending a long running revenue recovery since it troughed as a share of national income back in 2011. Yet not all of the recent buoyancy may last, and some savings on spending owe more to slower-than-budgeted rollouts than they do to sustainable savings.

The tussle at the top – industry growth rates

Mining aside (and that sector’s strength reflects decisions taken long before the globe’s foreign policy began being conducted over Twitter), Australia’s industry growth landscape is very much a service sector story. Mining’s output surge of the moment won’t last much beyond the next two years – essentially the period in which huge gas projects ramp up to their nameplate capacity.

Thereafter that should leave health care as the nation’s fastest growing industry as:

  • Demographics have their wicked way with the aches and pains of our ageing population
  • The National Disability Insurance Scheme starts to really hit its straps.

At the same time the global easing of inflationary risks (and the related delay in the expected timing of interest rate rises) has been good news for a range of service sectors. It has:

  • Yet again extended the growth runway for the finance sector
  • Allowed some extra wriggle room to business services (by extending the period in which M&A transactions will earn top dollar)
  • Reduced the risk for wholesalers and retailers that sagging housing prices could pose problems before improving wage growth provided a rising tide for the sector.

Yet interest rate rises are being delayed rather than denied and, regardless, gravity may peg growth in property services back to earth. At the same time the earlier boost from a lower $A is starting to be less of a driver for tourism and for the number of foreign students coming to our shores).

Finally, the farm sector looks unlikely to come near last year’s record crop, while manufacturing is feeling the slings and arrows of closures among car makers.

The states: It’s just a jump to the south and east

A healthy world economy is providing a happy backdrop for Australia’s states. On the one hand China’s never-say-die construction sector has showered blessings on Western Australia, Queensland and the Northern Territory, while fading inflation risks in the US and around the globe have added another six months or so to the outlook for Australian interest rates to stay near record lows, thereby showering blessings on the botoxed real estate markets of NSW, Victoria and the ACT. Even Tasmania and South Australia are doing better than perhaps many realise, meaning most of Australia is sharing in the solid growth and improving prospects of the moment.

NSW

The sparkling stupidity of its house price gains means NSW has borrowed growth from the future. But interest rates seem set to stay low for longer, putting off the day of reckoning when today’s artificial support for retail and home building finally fades, compounded by easing population gains.

Victoria

We’re huge supporters of migration, whose sound economics is too often dismissed. But Victoria certainly has heaps of it, both from abroad and from the rest of Oz. Population growth is half as fast again as the national average, and it’s boosting pretty much all activity indicators in the State.

Queensland

Good news is building in Queensland. The big fall in project construction has now stopped, Sydney housing prices are sending refugees north of the Tweed, gas output is set to soar, and numbers of students and tourists flocking here haven’t (or haven’t yet) taken damage from the frisky $A.

South Australia

South Australia is facing challenges on a few fronts, as manufacturing jobs are shed at the same time as power pricing and reliability are on the front page. Keep an eye on the risk that combo could spook business, keeping job growth modest and reinforcing weakness in population gains.

Western Australia

Half the national rate…that’s the pace of growth in Western Australia for population and retail turnover, while small business confidence is also half the national level. Better global growth means recovery is brewing in the West, but it remains too early to declare that it has arrived.

Tasmania

Tasmania’s economy has been putting in a solid performance in recent years – not flashy, but solid. In fact the last four years have seen relatively steady growth, avoiding some of the cycles that have promised much but then disappointed in times past. That’s unusual, and it’s welcome.

Northern Territory

Stuck in a lull between construction finishing and exports lifting at Ichthys, the Northern Territory economy is wallowing. And although the global economy has lifted, the next big project hasn’t yet materialised, suggesting growth won’t go back to galloping for a while yet.

ACT

The inability of the Senate to tie its own shoelaces remains excellent news for the ACT economy, keeping Federal cutback negatives at bay while allowing low interest rates – which look set to stay low for a while longer – to help keep the home fires burning in the capital’s large mortgage belt.

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