The house price fall we had to have
Business Outlook Q3 2018
23 October 2018: Despite worsening trade wars, global growth remains great: although tariffs do hurt growth, they don’t hurt it by all that much. But the geographic base of growth continues to narrow, growing more dependent on the US. That poses two problems. First, synchronised strength tends to be more durable, so the fading synchronicity of the moment is – by definition – riskier than had growth been more widespread. The base is narrowing because Europe and Japan have lost some momentum in their growth. And while China’s growth remains magnificent, it too is slowing. The second problem is that the spurt in US growth is mostly due to the juice coming from the large business and personal tax cuts enacted in late 2017. Those cuts are mostly a one-off prop to growth. The upshot is that, while global growth is excellent now and should remain above trend in 2019, it looks like heading back down the slippery slope come 2020.
Despite the house price fall we had to have, Australia’s growth has continued to accelerate, and our ongoing strength is forecast to be good enough – at a smidge above trend both this year and next – to keep job gains solid and unemployment edging down. And, with inflation gradually on the rise, that mix should see the recovery in wages continue, albeit at snail’s pace. But that will be a Faustian bargain. Alongside a lift in wage growth there’ll be a matching lift in interest rates, with the latter acting as an anchor on consumer spending – and hence on the wider economy – in the next couple of years. So although Australian economic growth will be solid, it won’t be quite as good as global growth, with the current drought adding to the short term headwinds in play.
The job market is tightening, wage growth is edging up, and the Australian dollar is edging down. Is that combination enough to snap a decade long downswing in the pace of inflation? Well, yes and no. Inflation – like wage growth – actually bottomed in 2016, and it has been making glacial gains ever since. And we do forecast those gains to continue. But they’ll remain relatively glacial. Neither the world nor Australia will see a rapid rebound in price pressures. It’ll be slow and steady.
It’s on in financial markets. Or at least it’s on in the US, where cheap money is no longer as cheap as it was – and the markets are expecting that trend to continue, thereby putting more faith in the views and the trajectory of the US Federal Reserve than has been true for many years. The trend is far from universal. Japan and the Eurozone, for example, look likely to keep money as cheap as they can. And China is pushing out stimulus in the face of US trade wars. But the US dominates global financial markets, and some of the higher costs of recent times have already shown up here as out-of-cycle rate hikes by the banks. That is showing up as pain in a range of markets, including share markets. By late 2019 the Reserve Bank may also be raising rates, as better news on wage gains will encourage the RBA to take steps to ensure inflation doesn’t get too much of a hurry up. Meanwhile the huge US tax cut continues to propel the greenback up. That’s hurting the Aussie dollar a little, but it is hurting emerging market currencies rather more.
The Donald says “trade wars are good, and easy to win”. We doubt that, though the impact of a trade war is likely to be far more muted than much media reporting would suggest. Setting aside all the noise, the backdrop for Australia’s balance of payments isn’t that bad. There will be some pressure on the current account deficit in the next few years as commodity prices soften and interest rates lift here and around the world, but the impact isn’t expected to be all that dramatic.
Growth has been showing up in more jobs rather than in higher wages. And there’s some strength left in that split: although business surveys are pointing to a degree of continuing moderation in the magnificence of job gains over the next year, our assessment is that strength in jobs will ebb slowly rather than fast. If you want to keep a close eye on that, then you’ll need to keep a close eye on wages – the better the news on wages, the worse the news on jobs. However, as we see the wage acceleration as being glacial, we expect deceleration in job gains to be pretty slow too.
The economy is continuing to power a very welcome surge towards surplus. Yet while economic winds have been favourable, policy trends are threatening turbulence. The nation’s three biggest governments – the Feds, plus NSW and Victoria – all head to the polls by mid-2019. That suggests the political equation of the next year will be unfortunate, as both sides weigh up whether they’ll get more votes out of a dollar of budget repair (at the federal level) or infrastructure spending (at the State level) versus a dollar of pork-barrelling in marginal electorates. Unfortunately for the longer term national interest, it may well be the pork-barrelling that wins that contest.
Looking across Australia’s industry landscape, mining output is soaring as the long-awaited surge in LNG export volumes is happening. But it’s health care that is likely to be the fastest growing sector in Australia between now and 2020, pipping the gains in mining. That’s because health care is riding not merely an ageing population and the rollout of the National Disability Insurance Scheme, but also the last hurrah of the stamp duty cycle, which seems set to underpin promises to boost health funding in the upcoming Victorian and NSW elections.
And other service sectors will also strut their stuff, with information services selling lots thanks to new technologies, and business services selling the implementation of those new technologies. Meantime the juggernaut that is the finance sector is taking some big hits amid a rising global cost of funding, over-stretched housing prices and fired-up regulators in the wake of the banking Royal Commission. Yet its growth is only projected to slow from ‘excellent’ to ‘above average’.
At the other end of the growth league ladder, manufacturers look set to struggle, though more due to rising energy costs than to the usual culprit of currency-induced chaos.
And whereas farmers can expect to bounce back from this year’s drought, that bounce will be moderated by the slow speed of the rebuild in livestock herd numbers. Finally, and despite a current rash of investment in renewables, the utilities will also be at the slow end of the scale. Partly that’s the indirect impact of rising energy costs on this sector’s big industrial customers, but partly it’s because Canberra’s inability to craft policy compromises broadly acceptable to both sides of politics means future investments in electricity generation may be few and far between.
Population and gas exports the two key growth drivers to watch for the States
The fastest growing States and Territories in the nation this financial year are those with the fastest growing populations – Victoria and the ACT. Similarly, the slowest growing economies are seen in the Northern Territory and Tasmania, two relative laggards in terms of their ‘people power’ (though Tassie has been doing better on that front). Yet population isn’t the only game in town, with lifting LNG exports set to make some magic happen for growth in both the Top End and in Queensland by next financial year. And exports may also be the key reason why Western Australia will finally be able to surpass the growth in fast-flying South Australia in a year or so.
NSW remains a top notch performer despite slipping house prices and drought stricken farmers. Infrastructure and consumer spending underpin current strength, but a peak is nigh in infrastructure, while sky high mortgages and weakening population gains pose problems for further out in time.
Victoria is surfing a triple treat of growth drivers – interest rates, exchange rates and ‘people power’ – with infrastructure spending also playing a handy supporting role. But political pressures on Australia’s migration levels are intensifying, and housing markets deserves a close watch.
Queensland continues its road to recovery. High coal prices, more tourists and government social spending are all providing temporary boosts to the economy. The lift in population flows from south of the Tweed is also good news, including via helping the housing market recovery.
So much for the naysayers. South Australia weathered the closure of its car assembly plants in fine style. Elevated construction activity is boosting the economy, as is an influx of students from overseas. However, the ongoing exodus of the State’s youth remains a drag on future growth.
Western Australia continues to strengthen, but its recovery is patchy rather than full-throated. Rising LNG exports will see the recovery continue, though the ‘feel-good’ factor from that will be a bit limited, with the domestic economy still somewhat sluggish outside taxpayer-funded sectors.
Positive global and local conditions have given Tassie its best run of performance in years. The lower $A has boosted farm and tourism exports, while improving population growth (aided by those crazy house prices seen on the mainland) have reinvigorated the State’s housing markets.
The Northern Territory economy remains short on growth drivers for the near term. While gas exports are skyrocketing from the completed Ichthys plant, the on-shore effect of that is less. With construction activity in the doldrums, so too is population growth in the Top End.
The ACT economy remains a top performer as a combination of low interest rates, more foreign students, strong population growth and a better Federal Budget outlook combine to provide the right backdrop for continued economic expansion.