Economic Outlook Thursday, 8 February 2018 Thursday, 8 February 2018 The Australian and Global Economic Outlook: Stronger momentum in the global economy has continued into 2018 despite ructions in financial markets in recent days. Domestically, there remain risks, but an improved outlook for business investment and ongoing strength in the labour market are major positives to the domestic outlook. We expect the RBA to leave the cash rate on hold for all of 2018, reflecting persistently low inflation and spare capacity still existing within the labour market. However, the ongoing rate tightening cycle by the US Federal Reserve and tighter monetary policy from other major central banks around the world should continue to see swap and bond yields trend higher. The Australian dollar ended 2017 at 0.7801, right on our long-held forecast of 78 US cents. Despite some consolidation over the near-term, we expect that the upward trend in the Australian dollar that began in early 2016 to continue. Predominantly reflecting a weaker US dollar profile, we have upgraded our AUD forecast for the end of 2018 from 82 to 84 cents. 6 %pa Australian Economic Activity 6 Underlying Consumer Prices (Annual % Change) 4 Actual Long-run Average Forecasts 5 4 RBA 2-3% per annum Inflation Target Band 2 3 2 0 01 05 09 13 17 Source: ABS 1 Mar-02 Mar-06 Mar-10 Mar-14 Mar-18 Global Economy The news on global economic growth is positive, with a synchronised upswing underway. Global economic growth surprised on the upside over the second half of 2017. In January, the International Monetary Fund (IMF) upgraded its forecasts for global economic growth to 3.9% for both 2018 and 2019. China s economic growth remained sturdy through 2017, with growth of 6.9% over the year, above the government s target of around 6.5%. Momentum in the economy continues with 1
industrial production and fixed asset investment posting strong growth into year end. Consumption growth, however, has eased and the outlook for the property sector is less optimistic, as measures to curb overheating continue to impact. High levels of debt and structural challenges are headwinds to the outlook for China s economy. While some progress has been made here, there is more to be done and it will weigh on economic growth. The outlook for China s economic growth is critical for Australia. The value of Australia s merchandise trade with China was worth two-and-a-half times that of our next largest trade partner (Japan) over 2017. Toward the end of 2017 Trump s tax cuts boosted expectations of economic growth in 2018. In the December quarter 2017, US retail sales were strong, boosted in part by post-hurricane spending. Manufacturing activity has continued to rise and the outlook for business investment has improved. Inflation remained an enigma throughout 2017. The Fed s preferred measure of inflation, core PCE inflation, rose by 1.5% in the year to December. This is still well below the Fed s 2% annual inflation target. Wages growth will need to rise convincingly before there is a sustained increase in inflation. Employment growth and labour scarcity would be expected to drive up wages at some point, and we may be starting to see nascent signs of this in the US economy. Average hourly earnings rose by 2.9% in the year to January, the fastest pace of growth since mid-2009. This suggests the robust pace of jobs growth in the US over the past year may have started to boost wages inflation, although it s still early days. Some slack remains in the US labour market although some employers are reporting difficulty in filling positions. The unemployment rate has held at 4.1% for four consecutive months and the labour market is considered to be at fullemployment. The Eurozone economy has strengthened, with growth outpacing expectations in 2017, supported by very low interest rates. Eurozone economic growth is being driven by Germany, with the economy experiencing robust growth despite political uncertainty. Eurozone harmonised inflation was subdued with an increase of 1.4% in the year to December, well below the European Central Bank target of just under 2.0%. Globally central banks have moved to tighten monetary policy further in recent months. This reflects ongoing solid economic growth and comes despite little evidence of inflation lifting. Given the large amount of monetary stimulus globally and that inflation tends to lag economic growth, central banks have adopted a pre-emptive approach to removing stimulus. Domestic Economy Australian economic growth continued at a solid pace of 2.8% in the year to the September quarter, which is close to a trend pace. Australia s economy has now gone 26¼ years without a recession, which is the world record for the longest economic expansion. Despite this upbeat picture, Australian economic growth is not without its challenges. These include high levels of household indebtedness and slow wage growth, which have ongoing implications for consumer spending. An expected slowing in dwelling investment over 2018 and 2019 will also hinder economic growth. Retail sales growth has been lacklustre over the past year and the pace of growth remains below the long term average. Strong jobs growth over the past year has likely been supportive of consumer spending, which improved in the December quarter, although the annual pace of growth remains soft. While we saw a lift towards year end, it is difficult to envision a significant pickup in consumer spending with high and rising levels of household indebtedness and slow 2
wages growth. Thursday, 8 February 2018 Australia s housing market started to cool over the second half of last year and that trend is expected to continue this year. Dwelling prices in Australian capital cities have declined for three consecutive months according to Corelogic. For the year to January, dwelling prices rose by 3.2%. This was the slowest annual growth since September 2016 and down from a recent peak of 11.4% growth in the year to May 2017. We expect annual growth in dwelling prices to continue to soften nationally this year, although we are not forecasting a sharp decline in prices. Financing for housing has remained fairly resilient, although the pace of growth has slowed. Growth has been concentrated in owner occupier rather than investor loans. Regulatory measures designed to curb investor demand are continuing to have an impact, although investor lending has not weakened substantially. The proportion of first home buyers amongst borrowers has continued to increase, hitting a five-year high, as measures to benefit first home buyers by State governments take further effect. While there are signs of softness in other housing market indicators, including prices and auction clearance rates, housing finance is continuing to garner some support from population growth and ongoing low interest rates. In recent years, low interest rates and strength in the housing market have supported further dwelling investment. However, the tide has turned for dwelling investment and it has declined in 2017. Building approvals are now down 23% from the peak reached in August 2016, suggesting the pipeline of residential building work has narrowed. Despite having already peaked, building approvals remain above their long-term average. Building approvals are very volatile and in trend terms have edged up 3.3% over the past year. This implies while residential building activity is likely to decline, the contraction will be measured rather than steep over the coming year. While the consumer is looking increasingly weary, businesses are feeling revitalised. The NAB business survey indicates that business conditions and confidence are elevated, reflecting a business sector that is in good health. NAB business conditions held at a reading of 13 in December, well above the long-term average of 6. Business confidence lifted to 11 in December, from 7 in January and also well above the long-term average of 6. Business surveys portray a positive environment for employment as well as business spending. After contracting for ten consecutive quarters, business investment has increased in two out of the past three quarters. In the September quarter, annual growth in business investment was positive for the first time since the June quarter 2013. The headway in business investment reflects improving global economic conditions and a pickup in business conditions locally. A pipeline of government spending on infrastructure is expected to be supportive for private investment. The non-mining sector is the driving force behind the pickup in business investment. By industry, the strongest growth in business investment has come from the manufacturing sector, followed by other industries, which include the services sector. Investment in the mining sector continues to lag, although the unwinding of the mining investment boom appears to have largely run its course. Investment plans suggest businesses in other industries intend to lift investment this year, as do manufacturers, however, the investment intentions in the mining sector remain lacklustre. Strength in the labour market continued into year end, with a whopping 403.1k jobs added in 2017. It was the largest calendar year increase in jobs since these records began in 1978. The strength in jobs growth has been driven by full-time jobs, with an increase of 303.4k in the year to December, while part-time jobs increase by 99.7k over that period. For the year to December, 3
employment rose by 3.3%, the strongest since April 2008 and well above long-term (10-year) average growth of 1.6%. The unemployment rate edged up to 5.5% in December, although that is down from 5.8% a year earlier. Although there has been a broad downward trend in the unemployment rate, the increase in jobs has been mostly reflected in an increase in the workforce participation rate, which rose to 65.7% in December, from 64.8% a year earlier. As more jobs have been created, discouraged workers have entered the workforce in search of jobs. Despite all the positive news on the jobs front, there is still slack in the labour market. The Reserve Bank of Australia estimates that full employment equated to an unemployment rate of 5.0%. Additionally, the underemployment rate remains elevated. This measures those people who are employed part-time but would like to work more hours. The underemployment rate was at 8.3% in November 2017, which was equal to the reading a year earlier, indicating there is still further labour market slack that can be reduced. Wages growth remained subdued at 2.0% in the year to the September quarter. This is up from record low wages growth of 1.9% in the year to the June quarter, although wages growth is still very slow. More broadly, CPI inflation is also weak, with both the core and the headline measure below the RBA s 2-3% target band in annual terms. Inflation is expected to remain below the RBA s target band for some time. Within the inflation mix, prices for some items, particularly discretionary items, such as audio, visual and computing equipment, fell over the past year. However, prices for some items are growing much more quickly than average. Unfortunately, some of those items are non-discretionary, including electricity, petrol, medical and hospital expenses and childcare. Hence, in this low wage growth environment, price increases for essential items are causing pain for many consumers. An upturn in global trade has benefited the region. This supported Australian trade, which was in surplus through most of 2017, although moved to deficit in December. The trade deficit was driven by a large jump in imports, suggesting a positive outlook for domestic demand. The current account deficit narrowed in 2017, compared to the previous year, with the improvement driven by the goods and services balance. Commodity prices strengthened towards the end of 2017. The iron ore price has increased since November and is currently around US$75.50 per metric tonne, with solid demand from China providing support. The price for coking coal has been supported by production cuts in China amid attempts to limit winter pollution. The price for coking coal trended higher over 2017, although it has retraced some of its year-end strength over the past month. Interest rates We maintain our view that the RBA will leave the cash rate on hold for the remainder of this year. We see the next rate move as up and occurring in early 2019. There have been some signs of improvement in the domestic economy. The outlook for business investment has brightened in step with a sustained pickup in business conditions. Public investment spending will also provide a strong contribution to growth. However, there continues to be downside risks to consumer spending given ongoing slow wage growth and high household debt levels. Dwelling investment is likely to drag on growth over the coming year. In addition to these downside risks to the domestic economy, inflation has remained low. Underlying inflation has held below the RBA s 2 to 3 percent per annum target band for just over two years. We expect inflation to remain low for some time, particularly given wage pressures 4
remain muted. The subdued inflation outlook would suggest that the RBA does not need to be in any hurry to lift rates any time soon. However, an improving labour market and an increasing likelihood that the unemployment rate will decline suggest that the next move will be up. We believe that the labour market will be an important trigger for the RBA in determining when it decides to lift interest rates. Financial markets (based on overnight-indexed swaps) are attaching a 67% probability of a rate hike by December this year, considerably lower than the over 90% chance priced in early December. However, yields on bond and swaps, particularly on longer-dated securities, have risen over the past few months, resulting in a steepening of the yield curve. Three-year swap yields have lifted 24 basis points to 2.21% as of 7 February, since hitting a recent trough on 28 November. Australian 10-year government bond yields have lifted 40 basis points over the same period. The key influence on longer-term yields has been from overseas developments. US 10-year government yields have increased sharply in a short period of time, pulling Australian yields higher. Indeed, US 10-year yields exceeded their Australian counterpart on 2 February, for the first time since 2000. Moreover, US official interest rates are expected to exceed the RBA s official cash rate this year. Bond yields have been driven higher by the tightening cycle by the US Federal Reserve, which is now well underway. The median expectation of the Federal Reserve s FOMC is for three 25 basis point hikes in the Fed funds rate this year. While the consensus estimates among economists (surveyed by Bloomberg) are in line with the Fed s FOMC forecasts, financial market pricing suggests that yields should move higher if the Fed lifts interest rates three times this year, as expected. Other major central banks are also beginning to lift interest rates, such as the Bank of England (BoE) and the Bank of Canada (BoC). The European Central Bank (ECB) has cut down its bond purchases, and could finish its bond buying program by the end of this year. Additionally, there are growing signs that inflation pressures could be emerging, further adding to upward pressure on bond yields. US wage growth may be beginning to pick up, as a result of tighter labour markets. A lift in commodity prices over the past few months would also add to global inflationary pressures. In summary, we continue to expect that the RBA will leave official interest rates on hold for the remainder of the year. However, the ongoing rate tightening cycle by the US Federal Reserve and tighter monetary policy from other major central banks around the world should continue to see swap and bond yields continue to trend higher. Moreover, there could be further upside risk to yields if we see further signs of higher inflation amid stronger commodity prices and tightening labour markets in key advanced economies. That being said, we do not anticipate inflation will spike up substantially. Australian dollar After trading within the range of 0.7160-0.8124 over the course of 2017, the Australian dollar ended 2017 at 0.7801 (according to Thompson Reuters). It was right on our forecast of 78 US cents which we had in place since 28 July 2017. 5
The Australian dollar has gained support from an improving global and domestic outlook despite some ongoing challenges for the Australian economy. Importantly, we had expected the US dollar to continue its downward trend, which suggested that the AUD was unlikely to revisit the cyclical low below 70 US cents it hit in January 2016 in the near-term. In the short-term, the AUD is vulnerable to a period of consolidation while the downturn in risk appetite persists. Although this period could draw out a bit longer, we do not view the recent spike in risk aversion in financial markets as being long-lasting. Indeed, US equity markets were due for a correction given valuations had become stretched. Over the medium-term, fundamental drivers should reassert themselves. The global economic backdrop has improved in recent years. It has translated to stronger prospects for demand for commodities, as reflected in higher commodity prices. This should continue to provide a key support for the Australian dollar over the course of this year. We expect however, that the RBA will be less willing to increase official interest rates in the nearterm. The yield advantage of the AUD over the US dollar should therefore disappear and reverse in due course. As such, we think a trend appreciation in the Australian dollar will be gradual. Nonetheless, the Australian economy has seen improvement, particularly with regards to the labour market. Along with the upswing in the global economy, these factors would suggest that the RBA is still moving closer towards the beginning of a rate hiking cycle, rather than further away from it. Moreover, the US tightening cycle is well-underway and well-anticipated; three rate hikes by the Federal Reserve this year will hardly come as a surprise to currency markets. Additionally, further US dollar weakness will also add upward pressure, which we expect will persist as other major central banks around the world pull back on monetary stimulus. Despite some consolidation in the AUD over the near-term, we expect that the upward trend in the Australian dollar that began in early 2016 should continue. Predominantly reflecting a weaker US dollar profile, we are upgrading our AUD forecast for the end of 2018 from 82 to 84 cents. 6
Forecasts 2017 2018 2019 End Period: Q3 Q4 Q1 (f) Q2 (f) Q3 (f) Q4 (f) Q1 (f) Q2 (f) Interest Rates: RBA Cash Rate, % 1.50 1.50 1.50 1.50 1.50 1.50 1.75 1.75 90 Day BBSW, % 1.72 1.78 1.80 1.80 1.85 1.90 2.15 2.20 3 Year Swap, % 2.19 2.19 2.40 2.45 2.55 2.60 2.95 3.25 10 Year Bond, % 2.60 2.63 2.90 2.95 3.00 3.05 3.15 3.25 USD Exchange Rates: AUD-USD 0.7834 0.7809 0.8000 0.8100 0.8300 0.8400 0.8500 0.8600 USD-JPY 112.51 112.69 110.00 108.00 106.00 104.00 102.00 102.00 EUR-USD 1.1814 1.2005 1.2200 1.2400 1.2800 1.3200 1.3200 1.3400 GBP-USD 1.3398 1.3513 1.4000 1.4100 1.4200 1.4400 1.4600 1.4800 USD-CHF 0.9683 0.9743 0.9400 0.9300 0.9200 0.9100 0.9000 0.9000 USD-CAD 1.2472 1.2571 1.2400 1.2200 1.2000 1.2000 1.1800 1.1800 NZD-USD 0.7209 0.7098 0.7200 0.7300 0.7400 0.7500 0.7600 0.7600 USD-CNY 6.6528 6.5068 6.4000 6.3000 6.2000 6.1000 6.0000 6.0000 USD-SGD 1.3576 1.3360 1.3200 1.3000 1.2900 1.2800 1.2700 1.2600 AUD Exchange Rates: AUD-USD 0.7834 0.7809 0.8000 0.8100 0.8300 0.8400 0.8500 0.8600 AUD-EUR 0.6630 0.6500 0.6560 0.6530 0.6480 0.6360 0.6440 0.6420 AUD-JPY 88.10 88.00 88.00 87.50 88.00 87.40 86.70 87.70 AUD-GBP 0.5850 0.5780 0.5710 0.5740 0.5850 0.5830 0.5820 0.5810 AUD-CHF 0.7590 0.7610 0.7520 0.7530 0.7640 0.7640 0.7650 0.7740 AUD-CAD 0.9770 0.9820 0.9920 0.9880 0.9960 1.0080 1.0030 1.0150 AUD-NZD 1.0870 1.1000 1.1110 1.1100 1.1220 1.1200 1.1180 1.1320 AUD-SGD 1.0635 1.0433 1.0560 1.0530 1.0707 1.0752 1.0795 1.0836 * Note that the AUD cross exchange rates have been rounded. 2016-17 2017-18 (f) 2018-19 (f) 2016 2017 (f) 2018 (f) 2019 (f) GDP, % 2.0 2.8 2.7 2.6 2.3 2.8 2.8 CPI (Headline), % 1.7 2.0 2.1 1.3 1.9 2.1 2.2 CPI (Underlying), % 1.6 1.8 1.9 1.5 1.8 1.8 1.9 7
Contact Listing Chief Economist Senior Economist Senior Economist Besa Deda Josephine Horton Janu Chan dedab@stgeorge.com.au hortonj@stgeorge.com.au chanj@stgeorge.com.au (02) 8254 3251 (02) 8253 6696 (02) 8253 0898 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 33 007 457 141 AFSL 233714 ACL 233714, nor any of Westpac's subsidiaries or affiliates shall be liable for the message if altered, changed or falsified. 8