Economic update. Is the Australian economic miracle over?

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1 Economic update Is the Australian economic miracle over? Katie Dean Economist ANZ Bank Sydney 9 March

2 What happened to Australia s miracle economy? Current account deficit now at a record 7.1% of GDP Economic growth stalled in the second half of Retail sales growth has collapsed Housing in a cyclical downturn But despite this: Labour productivity is falling and inflationary pressures are increasing and official interest rates are on the rise!

3 Things aren t quite as bad as they seem Global economic backdrop remains supportive Domestic demand slowing but still solid The labour market remains buoyant Surveyed business confidence is high Equity market at record highs Exports set to bounce in 3

4 The global economy remains supportive

5 Global growth has been firing but has past its peak World economic growth OECD industrial production 7 % annual change Real GDP 3 year average ANZ forecast s 1 8 % yearly change Global IP OECD leading indicator mforward 98 3 Note: GDP based on countries aggregated using purchasing power parity weights. Sources: National agencies, IMF, OECD and Economics@ANZ. -

6 United States interest rates will continue to rise 8 US GDP growth % quarterly change saar 3 Non-farm payrolls Monthly change (') Core inflation 3 % yearly change PPI CPI Fed funds rate 8 % Forecasts Sources: Datastream and Economics@ANZ

7 So far, so good as China tries to orchestrate its soft landing Industrial production % yearly change (mma) Financial institution loans % yearly change (mma) Sources: Datastream Chinese authorities tightened monetary policy over - Interest rates were increased and lending was restricted to overheated sectors The Chinese economy still managed to grow by 9.% in! Some leading indicators of growth, such as industrial production, have started to slow - Consensus expectations are for growth to slow to 8% in But this soft-landing is not assured - Can household spending pick up the slack if industrial production slows further?

8 Oil prices are at again record highs - but not when measured in real terms US$ per barrel (West Texas Intermediate) Spot price Oil prices (In December dollars) Note: Shaded areas denote years in which G7 GDP growth was less than % pa. Sources: Datastream; IMF; Economics@ANZ.

9 Higher oil prices are clearly damaging growth but an oil induced recession is still unlikely Oil market balance mn bpd 1 Q1 3 Total oil supply Q3 Source: IEA, OPEC, ANZ Total oil demand (LHS) Market balance (RHS) Q1 Q In we saw a solid rise in oil supply which considerably exceeded the rise in demand This created the biggest surplus for some time, which is well out of step with the higher price. - Indeed global oil production is still running 1mbpd ahead of consumption. The global and Australian economies are much better placed to absorb the impact of higher oil prices than in earlier shocks - Much lower energy intensity and more efficient labour markets Going forward we think that oil prices will fall, however, the market will remain extremely sensitive to bad supply-side news - Saudi Arabia?, Iran?

10 United States twin deficits will continue to weigh on financial markets US Budget balance US current account deficit 1 US$ bn With Iraq & Afghanistan, and 1 & 3 tax cuts Budget forecast $ bn % GDP Sources: Office of Management & Budget, President s Budget for ; Congressional Budget Office; Bureau of Economic Analysis; Economics@ANZ.

11 A sharply weaker US$ would weigh on global growth Real exchange rates Index = 1 Index = 1 Euro US$ Average of Asian currencies Sources: JP Morgan; Economics@ANZ. Asian currencies are JPY, CNY, KRW, TWD, HKD, THB, MYR, SGD, IDR, PHP and INR, weighted by GDP at market exchange rates. In theory, exchange rate changes redistribute economic growth among countries (and types of demand) However this assumes that governments and central banks adopt complementary policies In practice, the ECB (which is mandated to target inflation, not growth) won t cut rates to offset strength, while the BoJ can t cut rates to offset strength (since its cash rate is already zero) Meanwhile the Fed is raising US rates, and a sharp fall in the US$ would put upward pressure on long rates, and hence on mortgage rates

12 Australian economic growth is hitting some speed limits

13 Australia is enjoying its longest run of uninterrupted economic growth since Federation Australian real GDP growth, % change from previous year 1 1 (f) no quarterly data before 199 quarters of negative growth in this period, including episodes of or more consecutive quarters of ve growth 3 qtrs of ve growth in this period 1 qtr of ve growth in this period Note: data are for financial years ended 3 June. Sources: Angus Maddison, Monitoring the World Economy ; Reserve Bank; ABS; Economics@ANZ.

14 The Australian economy is stronger than headline GDP figures suggest Economic growth Terms of trade 7 annual % change 11 index Real gross domestic income Real gross domestic product 3.% 1 1.% Sources: ABS

15 and domestic final demand is still growing strongly annual % change 1 Sources: ABS Economic growth Real gross domestic final demand Real gross domestic product 1 3.% % Domestic demand vs net trade % cont'n to GDP growth Real gross domestic final demand net exports 1 3

16 The Australian economy is running into capacity constraints for the first time in 1 years Unemployment rate % of the labour force % Actual Trend 1 3 Labour shortages Lowest since Nov 197 Highest in the 1-year history of this survey Capacity utilisation ' per week Trend Actual 1 3 Highest in the 1-year history of this survey Capacity as a growth constraint 1 % of manufacturers citing capacity as a constraint on output 1 7 Businesses reporting labour shortages as a constraint on output 1 3 Sources: ABS; National Australia Bank; Westpac/ACCI; Economics@ANZ

17 Capacity constraints are causing labour productivity to slow Average labour productivity % yearly change (per person) Productivity growth slowed abruptly in the December quarter Average labour productivity grew by an average annual rate of % over the last decade......but fell by.% in the year to the December quarter Productivity growth slows because: New labour is of a lower quality Labour has a lower quality or quantity of capital to work with (eg. old computers, old ports) Slower productivity growth means that capacity constraints represent an even more binding limit on the rate of output growth 17 Sources: Commonwealth Treasury

18 ...and are putting upward pressure on some prices Final producer prices % yearly change Domestic Total 1 3 Expected selling prices Net 1 3 Rising domestic material costs and labour shortages has put upward pressure on producer prices Final producer prices were up.3% in the year to the December quarter, led by a strong.% rise in domestic prices Slower productivity growth will increase unit labour costs, which in the past has been a key determinant of consumer price inflation Some surveys of expected selling prices have also picked up 18 Sources: ABS, ACCI/Westpac

19 This is why the RBA is raising interest rates 19 The RBA believe the economy is strong, despite what the official figures say Upstream price pressures are building a high A$ has mitigated much of the domestic price increases so far, can this continue? A strong labour market increases the risk of higher than assumed wage inflation, which remains stubbornly low thus far even though the pass through from employment growth wages consumer prices is tenuous As such, the RBA sees all the risks to inflation as on the upside Housing market may be turning up again and the household sector can carry their debt even at moderately higher interest rates Monetary policy is still stimulatory Presumably where it should be, given that official data shows that the economy is slowing

20 Which way for the Australian economy now?

21 Exporters have found the going tough, but should improve soon Trade volumes Volume of exports $billion 1 Index, Sep =1 Imports Manufactures Resources* 1 8 Services Exports Farm Sources: ABS *includes manufactured metals 1 3

22 Rising commodity prices and higher exports will improve the current account deficit in $billion/qtr - -1 Current account deficit % GDP (rhs) $billion (lhs) % GDP Sources: ABS

23 Consumption is slowing but households are still enjoying very favourable conditions Retail sales % yearly change (trend) Consumer sentiment Index Trend Actual Unemployment rate % of labour force Lowest in 8 years! , 1,8 1, 1, 1, 1, 8 Net household wealth $bn Housing Other Sources: ABS

24 Household debt has risen, but shouldn t be an issue as long as the economy holds up Household debt to income % of disposable income Neth 1 UK 1 8 US Australia Debt servicing burden % of disposable income Total Housing Sources: ABS; Datastream

25 Moreover, a healthy corporate sector will continue to act as a buffer 18 % of GDP Debt to GDP 3 Debt service ratio % of gross income 1 US 3 1 Australia 1 Corporate 1 1 Total Household Source: ABS, Datastream

26 The macroeconomic environment for business investment remain supportive Business confidence Index (trend) Sources: NAB, ABS Profits % of total factor income (trend) Conditions Confidence Capacity utilisation Index (trend) Debt-to-equity ratio Private non-financial corporations % 9 9

27 ...but investment intentions now suggest the cycle is entering a downswing Business investment Business investment intentions* 3 % yearly change Forecasts 1 1 % yearly change * Investment intentions adjusted using -year realisation ratios Sources: ABS, Economics@ANZ - Mining Manufacturing Other

28 Despite the doomsayers, the housing market appears to be achieving a soft landing House prices Annual % change Housing finance commitments $ bn per month Owner-occupiers (excl. re-financing) Investors Sources: ABS

29 Fundamentals are sound and the cyclical downturn in construction will be mild Dwelling approvals 's (annual rate) $bn per quarter (-3 prices) Pipeline Actual Trend Work yet to be done Work done Sources: ABS; Economics@ANZ 9 Rental vacancy rates. qtr ma Dwelling investment 1 $bn/qtr

30 The NSW economy has underperformed Real GDP Employment and population, 3-8 % annual change % annual change (f) Emp Popn NSW VIC QLD SA WA TAS AUS NSW VIC QLD SA WA TAS AUS 3 Sources: ABS; Economics@ANZ

31 The Government has been spending up big, but this will not continue Impact of policy decisions over four years $ billion 1998 election and tax reform 1 election Sources: Budget papers 31 election In the 11 months preceding last year s election, the Government took policy decisions costing a net $bn over the four years to 7-8 (or $bn if the 3- impact is also included) This represents an easing of fiscal policy equivalent to over 1½% of GDP per annum The budget surpluses over the projection period will be miniscule if not in deficit The - Budget is likely to be a tight one Stimulus to growth from the government sector will wane

32 The economic outlook is subdued and inflation remains well contained Economic growth Inflation 8 % contribution to yearly growth % yearly change Domestic demand 'Headline' GDP 3 - Net exports 1 Excluding GST and 'volatile' items Source: ABS, Economics@anz

33 But the RBA will tighten again % pa Interest rates Cash rate 9 day bill futures 1 3 Source: RBA, Reuters, Economics@anz Even with economic growth and inflation modest, the RBA will still raise interest rates - We expect another bp rise, possibly as early as April Australian economic growth is being constrained by the supply potential of the economy - Infrastructure bottlenecks and lower productivity growth The RBA is raising rates because it wants to slow domestic demand to more sustainable levels There is now a risk that the economy will slow by too much - Export recovery not yet assured, domestic demand already slowing But recession is unlikely

34 Summary of forecasts Australia GDP Inflation.3.1. Unemployment... Cash rate (Dec)..7. $A/$US (Dec)

Economics@ANZ Would you like to know more?

35 Would you like to know more? View our research on the web! 3

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