NSW Economic Outlook. Thursday, 17 October State Report NSW

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1 Thursday, 17 October 1 NSW Economic Outlook Summary NSW has recently been touted as one of the big winners from the shifting dynamics currently facing the Australian economy, and is set to outperform growth Australia-wide. The brighter assessment for NSW is welcome news, particularly since economic growth in NSW has lagged behind other States and territories over of most the past decade. NSW s more diversified economy will mean that the transition away from mining investment should be less difficult in comparison to other States. While slower mining investment will still affect NSW, lower interest rates are having a bigger positive impact given mortgages held by NSW households are larger than the national average. Despite outperforming final demand for Australia, growth in State final demand for NSW remains below its long-run average. Household caution along with concerns about the employment outlook is continuing to constrain consumer spending. Business investment has also weakened given the shrinking pipeline of mining projects, and the high Australian dollar is still having a dampening impact on growth. Sydney house prices are rising at a healthy clip and have outperformed the Australian capital city average. A housing shortage, still attractive rental yields for investors and better affordability should continue to drive further gains in house prices. We expect Sydney house prices to continue to outperform Australia s this year and next. Rising house prices should encourage a further pickup in residential construction, which has begun to improve after a long period of weakness. The healthy pipeline of road and rail projects will be another positive for the NSW growth outlook and will assist in filling the gap from weaker mining investment in the State. There are also signs of improvement in non-dwelling construction after lacklustre growth over the past few years. The recovering housing market and low interest rates should result in a pickup in NSW gross State product in 1-1. After estimated growth of.% in 1-1, we expect growth of.9% in 1-1, which would be the fastest growth in the State in six years. 1

2 Economic Growth NSW has recently been touted as one of the big winners from the shifting dynamics currently facing the Australian economy. The brighter assessment for NSW is welcome news, particularly since economic growth in NSW has lagged behind other States and territories over most the past decade. The State s underperformance is, in part, because the bulk of the boom in mining investment has been concentrated in other parts of the country, including WA, QLD and NT. However, now that mining investment is close to a peak, conditions have become increasingly more favourable for NSW relative to other States. While mining remains an important industry in NSW, the more diversified range of industries in the State should mean that the transition from mining investment will be less difficult. State final demand in NSW has been growing moderately, rising.% in the June quarter, and 1.% in the year to June quarter. This growth in State final demand outperformed final demand Australia wide, which grew just.% in the June quarter and.% in the year to the June quarter. One reason for the relative strength in the NSW economy is the larger benefit from lower interest rates, as household mortgages are on average higher. Given improved affordability and relatively favourable conditions for investors, house prices are rising at a healthy clip, particularly in Sydney. Recovering house prices should encourage a further pickup in residential construction, which has been sub-par for a long period of time. Additionally, the positive wealth effect should boost confidence among households. Percentage Shares of the Economy* Industries NSW Australia Financial and insurance services Manufacturing 9.. Professional, scientific and technical services. 7. Health care and social assistance 7..9 Construction..7 Transport, postal and warehousing..7 Wholesale trade..1 Public administration and safety..7 Education and training..9 Information media and telecommunications.9. Retail trade.7.1 Mining. 11. Administrative and support services..7 Accommodation and food services..7 Electricity, gas, water and waste services..7 Rental, hiring and real estate services.. Other services..1 Agriculture, forestry and fishing..7 Arts and recreation services * As % of GSP and GDP less ownership of dwellings Source: ABS, St.George

3 That being said, annual growth in NSW State final demand has remained below its long-run average of.9% for four consecutive quarters to the June quarter. The subdued labour market, the high Australian dollar and ongoing household caution which are evident in the broader Australian economy are also dampening growth in NSW, although to a lesser extent than in other States. We however, expect growth in NSW to pickup, as the impact of lower interest rates continues to take effect. The flow on impact from lower interest rates and rising house prices should in time, boost confidence and support household spending. Residential construction should also continue to lift. Additionally, a large pipeline of road and rail infrastructure spending in NSW should also be supportive of growth while mining investment is softening. State government infrastructure spending is expected to lift from $1.bn in 1-1 to $1.bn in 1-1. We estimate that the NSW economy grew by.% in 1-1 following.% growth in However, stronger investment on infrastructure, further recovery in dwelling investment and low interest rates should support a pickup in growth in 1-1. Our forecast for.9% growth in 1-1 is above NSW Treasury s forecast of.7% in 1-1. If NSW growth turns out as forecast in 1-1, it would be the fastest growth for the State in six years. (See page -9 for more detailed forecasts). Over the long-term, industries such as tourism, international education, wealth management, gas and agribusiness have been considered as areas of strong growth within the global economy. Many of these sectors have a presence in the NSW economy and NSW has the potential to take advantage of these key growth areas. % NSW State Final Demand Long-Run Average Annual % Change... Actual NSW Gross State Product (Year ending June, %) Forecasts Consumer Spending Consumer spending in NSW has grown modestly over the past few years, with annual growth over the past year below the long-run average. Household consumption softened considerably

4 over the second half of 1, reflecting lingering concerns by households over the economic outlook and job prospects. In the year to June 1, household consumption expenditure grew by.1%, the weakest annual growth in more than three years. 1 Value of Retail Sales (trend, annual % change) 1 Household Consumption (annual % change) Australia 9 9 National NSW NSW - Jan- Jan-7 Jan-1 Jan Although retail sales began 1 on a positive note, growth has since deteriorated, with consumers reluctant to spend on the traditional retail trade categories. In NSW, retail sales fell for three consecutive months from May through July, despite significant interest rate cuts by the RBA. Retail sales then bounced in August, rising.% in NSW, the largest increase since February this year. Despite the reprieve for retailers in August, retail sales are up just.1% for the year to August in NSW, well below the long term average of.% annual growth. Although we would expect lower interest rates to eventually impact consumers spending habits in NSW, further evidence of this will be needed, before the rebound in August retail sales can be considered a trend. While consumer spending has been slow to respond to interest rate cuts, a pickup in consumer confidence over the past year is an encouraging sign. The index for NSW has risen 7.% in the year to October, to a reading of 1.. It is now above 1, indicating that optimists outnumber pessimists. Households in NSW, however, are less optimistic than Australia-wide with the Australian index at 1. in October. We expect that rising share markets, a recovery in house prices and lower interest rates should underpin a pickup in consumer spending. However, high household debt levels and an uncertain outlook for the labour market will constrain growth in household consumption. Housing The residential housing market has improved this year driven by lower interest rates, rising population growth rates and attractive rental yields. With the highest house prices and largest mortgages of all capital cities, the NSW housing market has been the greatest beneficiary of lower interest rates. According to RP Data-Rismark, Sydney dwelling prices are up.% in the year to September,

5 which is a significant improvement on the.9% increase in the year to September 1 and are now up 1.% from their trough in May 1. House price data from the Australian Bureau of Statistics showed Sydney house prices are up.1% in the year to the June quarter, compared to a decline of.% in the year to December 11. Both the ABS and the RPData-Rismark measures indicate Sydney house prices have outperformed the national capital city average this year. Index 7 RP Data-Rismark Hedonic Dwelling Price Index % Source: REIA Vacancy Rates (June quarter 1) Sydney Australian Capital City 1 Jan- Jan-7 Jan-9 Jan-11 Jan-1 Syd Melb Bris Adel Per Hob Dar NSW has gone through a lengthy period of under-building resulting in a growing housing shortage. The housing shortage is providing a floor for house prices with the gap between supply and demand expected to widen further. Population growth slowed in NSW in 11, from a peak in -9, but growth has again picked up, with overseas migration gaining strongly in 1. The housing shortage, which exists nationally, is particularly acute in NSW. NSW accounted for almost 7% of the national housing shortage in 11 and 1, and is forecast to sit at just under k dwellings this year. This shortfall is also forecast to edge higher next year. The shortage of housing has contributed to low vacancy rates in Sydney. These stood at.1 % in the June quarter, the equal lowest vacancy rate of all the capital cities (along with Brisbane). Vacancy rates below % are indicative of tight rental markets and strong demand for rental accommodation. Sydney median weekly rents for bedroom houses in the year to the June quarter 1 were unchanged at $, while rents for bedroom other dwellings rose.% to $7 per week. The combination of falling house prices over 11 and the early part of 1 and rising rents indicate that rental yields have become quite attractive, particularly given interest rates have also fallen significantly. Investor demand in NSW has picked up strongly suggesting that investors have been encouraged by attractive rental yields, a low interest rate environment and stabilising house prices. Tight rental markets suggest that rents could also rise further. Rental yields, however, may fall as house prices are also increasing. This should still leave yields at relatively attractive levels given interest rates are low.

6 NSW Housing Finance (By value 1mma, $millions) No. of Building Approvals NSW (Thousands, Trend Data) Owner Occupier Long-run Average Investor Owner-occupier demand, however, has lagged behind investor demand. The slump in the owner-occupier market has been driven by a drop in first home buyers which have been impacted by policy changes. After 1 December 11, the exemption on stamp duty was abolished for purchases of established dwellings by first home buyers, while the $7 first home owner grant ended on September 1. This has driven down first home buyers in NSW as a percentage of all dwellings financed to 7.% in April to June 1, the lowest since at least 1991 (from earliest available data). In July 1, the proportion of first home buyers edged up to 7.7% of all housing finance, but remains at a very low level on a historical comparison. Given that the policy changes have probably resulted in a pull-forward effect and that housing affordability has improved, we expect that potential first home buyers will eventually return to the market. Index Housing Affordability Index Index First-Home Buyers (NSW, % of all dwellings financed) 7 7 New South Wales Australia Sydney 1 Source: HIA Sep-9 Sep-1 Sep-11 Sep-1 Sep-1 Jan- Jan- Jan- Jan- Jan-1 Jan-1 Jan-1

7 High rental yields and low interest rates should result in further gains in the NSW housing market. These factors taken with the growing shortage of housing should continue to see Sydney house prices outperform the Australian capital city average. That being said, residential building activity picked up towards the second half of 1 and has continued into 1, indicating that low interest rates and stabilising house prices have helped to spur life into residential construction. Investment in new dwellings in NSW rose a solid.% in the year to June 1. The recovery in house prices should also continue to induce a supply response and provide a boost to residential construction. Business Investment Business investment has begun to slow in NSW, as the pipeline of mining investment fades. In the June quarter, we estimate private business investment grew just.1% in NSW and declined.% in the year (abstracting from the one-off impact of the sale of NSW port assets in the quarter). Private capital expenditure has also weakened, falling 1.% in the year to the June quarter, the largest annual decline since the December quarter. Mining investment has been a large driver of business investment in NSW much like Australia wide and a decline in mining investment coming years will pose a challenge for NSW. That said, given mega-mining projects have been concentrated in WA, QLD and NT, the potential drop in mining investment and the detraction from growth should be less severe in NSW. Nonetheless, some major resource projects have been cancelled or delayed in NSW, including a $bn expansion plan on the Kooragang coal terminal and the extension to the Warkworth open cut coal mine in the Hunter Valley. Meanwhile, one of the State s largest resource projects the Cadia East gold mine near Orange worth $1.9bn has now completed. It is worth noting that there remain a number of potential mining projects in the pipeline. The Bureau of Resources and Energy Economics (BREE) has estimated that $.7bn worth of projects were at the committed stage. These are projects which have received final investment approval and are very likely to go ahead. The majority of projects are within the coal industry including coal mine projects or infrastructure to support coal transportation. Outside of mining investment, subdued levels of business confidence may have been keeping firms from committing to new investment spending. A recent lift in business confidence, post the Federal election, is encouraging. However, the high Australian dollar and ongoing uncertainty within the global economy could continue to keep business spending at bay. The major driver of investment in coming years will likely be driven by road and rail infrastructure. There are currently a number of projects underway including the $.1bn South West Rail link and the $1.7bn upgrade to the Hunter Express Way. The biggest project in the pipeline is the WestConnex to link Sydney s M and M motorways through to the Sydney CBD and Sydney Airport, estimated to be worth around $11 to $11. billion. Construction on the first stage of the project is due to commence in 1 with the final third stage due to finish in. Work is reported to have started on the $.bn North West rail link, while work on a tunnel linking the F and M Motorway worth $bn may well be ready to commence in 1. A $1.bn light rail system in Western Sydney is also a potential transport project in the pipeline. In the NSW State Budget, public infrastructure spending was estimated to lift from $1.bn in 1-1 to $1.bn in 1-1. Funding for many projects such as the WestConnex will be 7

8 sourced from a mixture of private sector capital, the Commonwealth Government as well as the State Government. There are also signs of improvement in non-residential (commercial) construction, after lacklustre growth over the past few years. The pipeline of projects is dominated by the $ billion Barangaroo project which will be ongoing till. Other large projects include the Southern Distribution Business Park in Goulburn and the development of the Royal North Shore Hospital. Commercial construction should continue to see gradual growth over the next few years given various projects in the pipeline led by projects in healthcare. The healthy pipeline of work suggests that investment activity should continue to grow moderately over the next few years, despite the current soft patch. $bn NSW Capital Expenditure (by asset) $bn 1 NSW Engineering Construction (qtr moving avg, $bn) 1 Work Yet to be Done Total Equipment Work Done Buildings Work Commenced Labour Market After adding a significant number of new jobs earlier this year, jobs growth in NSW has deteriorated in recent months. In the year to September, NSW has added just 1.k new jobs. This reflects the loss of 1.k jobs in NSW in the six months to September, indicating that the fortunes of the NSW labour market have reversed despite lower interest rates. NSW employment has declined in four out of the last five months. NSW has underperformed the national labour market, which has seen the addition of 9.k jobs in the year to September. Annual jobs growth in NSW has declined to.% in the year to September, compared to a recent peak of.% in the year to April. This compares to national jobs growth of.% in the year to September. The slowing in employment growth has seen the unemployment rate in NSW rise to.% in September from.% a year earlier. This is in line with the national average unemployment rate of.% in September. In the year to August 1, most jobs in NSW were added in public administration & safety (9.k), followed by healthcare & social assistance (.k). The greatest job losses, by industry in NSW, were in manufacturing (-.k) and information, media & telecommunications (-.k)

9 in the year to August. The job losses in manufacturing in NSW come as no surprise, given the woes facing the sector, including the relatively strong Aussie dollar. Leading indicators of employment suggest a further slowdown in jobs growth, while business surveys indicate business intentions to hire remain subdued. We expect the unemployment rate to rise further, with the NSW unemployment likely to approach.% next year. Unemployment Rate (trend, per cent) Employment Change By State (Annual %, as of September 1) NSW 7 Australia NSW 7 VIC QLD SA WA 1 1 Tas St.George Banking Group Forecasts Low interest rates should continue to support a recovery in dwelling investment. Low interest rates along with rising asset prices should also see growth in consumer spending improve, but remain modest. Exports should also witness healthy growth on the back of stronger production capacity in thermal coal and a weaker Australian dollar. We also expect an improvement in public and private investment given the healthy pipeline for road and rail infrastructure and improving conditions for non-residential construction. We expect NSW gross State product to pick up from estimated growth of.% in 1-1 to.9% in 1-1 and.% in 1-1. The NSW Government is expecting weaker GSP growth of.% in 1-1 and 1-1. St George Banking Group Forecasts: Economic Indicators, % Change (year average) (f) 1-1 (f) 1-1 (f) Gross State Product...9. State final demand..1.. Employment Unemployment rate (year average)....7 Sydney CPI...1. Wage Price Index

10 Contact Listing Chief Economist Senior Economist Senior Economist Economist Besa Deda Hans Kunnen Josephine Horton Janu Chan () 1 () () 9 () 9 The information contained in this report ( the Information ) is provided for, and is only to be used by, persons in Australia. The information may not comply with the laws of another jurisdiction. The Information is general in nature and does not take into account the particular investment objectives or financial situation of any potential reader. It does not constitute, and should not be relied on as, financial or investment advice or recommendations (expressed or implied) and is not an invitation to take up securities or other financial products or services. No decision should be made on the basis of the Information without first seeking expert financial advice. For persons with whom St.George has a contract to supply Information, the supply of the Information is made under that contract and St.George s agreed terms of supply apply. St.George does not represent or guarantee that the Information is accurate or free from errors or omissions and St.George disclaims any duty of care in relation to the Information and liability for any reliance on investment decisions made using the Information. The Information is subject to change. Terms, conditions and any fees apply to St.George products and details are available. St.George or its officers, agents or employees (including persons involved in preparation of the Information) may have financial interests in the markets discussed in the Information. St.George owns copyright in the information unless otherwise indicated. The Information should not be reproduced, distributed, linked or transmitted without the written consent of St.George. Any unauthorised use or dissemination is prohibited. Neither St.George Bank - A Division of Westpac Banking Corporation ABN AFSL 71 ACL 71, nor any of Westpac's subsidiaries or affiliates shall be liable for the message if altered, changed or falsified. 1

Victorian Economic Outlook

Thursday, November 1 Victorian Economic Outlook Summary The Victorian economy has been through difficult conditions over the past few years. GSP grew by.% in 11-1, easing from growth of.7% in 1-11, and