NSW ECONOMIC OUTLOOK NSW Economy Still Counts Thursday, 7 July 11 Summary: The NSW economy remains an important part of the Australian economy. It is Australia s largest and most populous State and is often characterised as Australia s only true global city. The global financial crisis hit NSW hard due to the dominance of the finance & insurance industry. However, since the second half of 9 NSW has embarked on the road to economic recovery. The economic expansion has recently lost some steam but remains intact. We expect economic activity to continue expanding in NSW and move closer to its long-run average in 11-1. We characterise the NSW growth outlook as the middle ground because the growth outlook will be driven by a string of positives but the upside will be capped by a string of negatives. The positives include the benefit NSW is receiving from the net income injection courtesy of the rising terms of trade. This growth in income is underpinning economic activity together with exports and private business spending. Business investment will underpin NSW economic activity, although less so than in other States. Engineering work yet to be done is at its highest level in more than two decades. Mining is a small segment of the NSW economy but NSW s largest export is coal. China s hunger for commodities has driven up commodity prices. Thermal coal production in the Hunter and Newcastle region of NSW has ramped up as a result. The negatives are the interest-rate sensitive sectors of NSW, especially as NSW households shoulder the largest mortgages in Australia and the prospect of further RBA rate rises remain. Some of the State s key industries such as financial services, retailing and trade-orientated manufacturing are more interest-rate sensitive and have been be more adversely impacted by higher interest rates and the stronger Australian dollar. Retailing has eased in NSW as it has nationally, but NSW consumers have created bigger cocoons for themselves. There is a possibility that some of this caution is relinquished later this year but in the near term little turnaround is likely. Tight labour markets, growing household incomes, greater purchasing power from a high AUD and a pick up in economic activity are fundamental pillars of support for the consumer. House prices are softening in NSW, mirroring the national trend. This spot of the NSW economy is likely to stay soft over the next year as the combination of strong house price growth and higher interest rates last year keep buyers on the sidelines. Dwelling construction has been anaemic at best. A modest pick up is likely in the year ahead but not enough to address the housing shortage. The housing shortage is starkest in NSW and suggests to us that Sydney house prices over the next - years are likely to outperform many other capital cities. Across Australian capital cities, vacancy rates are lowest in Sydney. We expect the NSW rental market to tighten further before a house price recovery establishes later next year. The labour market remains tight in NSW with the unemployment rate close to %. Further falls in the unemployment rate are likely, despite the pace of employment gains moderating more recently. St.George Bank NSW Economic Outlook 7 July 11 1
Contents: Pages Importance of NSW Economic growth outlook Political backdrop Industry analysis - Labour market - Wages Consumer spending -7 Housing 7-9 Business investment 9 Government spending 1 Inflation 1 Key forecasts 11 Contacts listing 1 St.George Bank NSW Economic Outlook 7 July 11
Importance of New South Wales: In recent times, the resource-rich States of Queensland and Western Australia, amidst Australia s record high terms of trade and a mining boom, have dominated headlines as Australia s key drivers of economic growth. However, the State of NSW remains a very important part of the Australian economy. It is the largest State economy in Australia accounting for 1% of Australia s gross domestic product (GDP). The NSW economy is also larger than many national economies in the Asia Pacific region, including Singapore and Malaysia. NSW is also the most populous state in Australia, with over seven million residents. It is also the most educated, with the highest proportion of the working age population holding tertiary qualifications. Sydney is often dubbed the most multicultural city in the Asia Pacific and is a key factor behind its position as Australia s only global city. Its highly skilled labour force, international linkages and its proximity to Asia are some reasons why NSW is an attractive environment to conduct business. In Australia, % of the top companies alone are in NSW. NSW is a leading services State, with % of the industry income derived from services. Its capital city of Sydney is known as the financial and business hub of Australia. Subsequently, it has a large share of the finance & insurance services, property & business services and communications. % Share of Australia's GDP % NSW State Final Demand LR average Y/Y % % 1 1 - Q/Q% - NSW VIC QLD WA SA ACT Tas NT - 97 99 1 7 9 11 - Economic growth outlook: Economic activity in NSW began a recovery in the second half of 9 after the NSW economy was struck hard by the impact of the global financial crisis (GFC). The GFC was particularly negative for the NSW economy, due to the large share of the financial services industry in NSW. Economic activity continues to grow in NSW, but the pace of economic activity has slowed in the last two quarters. State final demand, a regular State measure of economic activity, grew by.% in the March quarter 11 and by.% over the year. This is under, albeit close to the long-run average of.1% in NSW. In comparison, national domestic final demand rose by.% over the year to the March quarter. We expect NSW economic activity to pick up and grow at trend in 11-1. NSW is in the middle ground it will grow at trend next financial year and it will be characterised by as many positives as negatives. St.George Bank NSW Economic Outlook 7 July 11
The positives supporting economic activity in NSW include business investment, exports and farming. But the negatives will be the interest-rate sensitive sectors owing to NSW s dominant mortgage belt. Political backdrop: The change from a State labor government to an O Farrell-led Liberal government earlier this year in NSW marked a major political change. The number of seats the new government won suggests that the population was looking for a change in government and this change might have provided a boost to sentiment. Details on public spending and policies for this new government will be spelled out in the State government budget on September. The State s credit rating remains at AAA from credit rating agencies Standard & Poor s and Moody s. Industry analysis: In gross value added terms, financial & insurance services are the biggest industry in NSW economy (at 9.%). It is followed closely by the manufacturing industry at.%. Manufacturing has declined as a share of the State s income, although it is still a vital element of the NSW economy. Percentage Shares of the Economy* Industries Australia NSW Financial and insurance services 1. 1. Manufacturing.. Professional, scientific and technical services.1 7.1 Construction 7..9 Health care and social assistance.7. Transport, postal and warehousing..9 Wholesale trade.. Public administration and safety.. Retail trade..1 Education and training.1.1 Information media and telecommunications.. Mining 9.. Rental, hiring and real estate services.. Administrative and support services.. Accommodation and food services.. Electricity, gas, water and waste services.. Other services 1. 1. Agriculture, forestry and fishing. 1. Arts and recreation services..9 * For Australia, using GDP and for NSW, using GSP; Source: ABS, St.George St.George Bank NSW Economic Outlook 7 July 11
Mining is a smaller component of the NSW economy than in other States (at.% compared with the national average of 11%). But mining still makes its presence felt, predominantly in coal. The NSW mining industry comprises 1.% of Australia s total mining industry and coal is NSW s largest export; coal comprises approximately % of the total value of all exports. China s industrialisation has driven up commodity prices. Coal production in the Hunter and Newcastle region has significantly benefited from higher prices for thermal and coking coal. Major development projects to expand coal production are in the pipeline in the Hunter Valley region and several port expansions at Newcastle are either committed or under construction. Higher commodity prices have resulted in a massive surge in Australia s terms of trade (the ratio of export prices to import prices). Consequently, the terms of trade are now at an intergenerational high. The rising terms of trade is providing a net income injection boost to the Australian and NSW economy, which is helping to underpin economic activity. Some industries other than mining are likely to directly benefit from the resources boom in NSW. One of the most notable industries to benefit is perhaps professional, scientific & technical services that are NSW s third largest industry. This industry includes services in engineering, accounting, architecture, scientific research, computer systems design, accountancy, advertising, market research, legal and management consulting. The resources boom and associated rise in the terms of trade has contributed to the appreciation of the Australian dollar (AUD). In trade-weighted terms, the AUD has risen by 11.% in the past year. The higher Australian-dollar is making it tougher to compete for trade-exposed industries not related to the resources sector. The best example here is tourism. Despite the high AUD, NSW exports are rising and expected to grow further. Interest-sensitive sectors are also doing it tougher in NSW because NSW households shoulder the largest mortgages in Australia. Labour market: Labour markets nationally and in NSW remain tight, reflected in unemployment rates sitting near % and close to natural rates of unemployment. However, the pace of employment gains has eased both across Australia and NSW. This moderation was expected because the pace of gains recorded over the second half of last year and the early part of this year was likely too strong to be sustained for a long period of time. Despite the moderation in employment growth, we expect the labour market to remain tight and the unemployment rate to fall further over the next 1-1 months. The moderation in jobs has been sharper in NSW but then the gains last year were also sharper. Last year, NSW added close to 1k jobs, which was close to % of all jobs created in Australia. However, this year so far, NSW has shed around 7k jobs whereas across Australia k jobs have been added. We expect the NSW jobs market to recover and find its middle ground in the second half of this year. The unemployment rate in NSW has tracked a little higher than for Australia for much of and 9 as the GFC gripped NSW tighter. However, the gap has narrowed throughout last year and early this year. Strong job gains over 1 saw the NSW unemployment rate hit a ½-year low in December 1 of.%. The unemployment rate currently stands at.%, slightly above the national unemployment rate of.9%. These rates are likely to be not far from the natural rates of unemployment, which threaten wage pressures building. Over the year to May and across industries, the number of job gains was strongest in accommodation & food services, retail trade and financial & insurance services. These trends prevailed despite the high Aussie dollar weighing on tourism and lacklustre sales in retail. In terms of the fastest employment growth, the strongest industry was mining. Mining only employs a small fraction of the NSW labour force of 1.%, but employment growth in this industry was the fastest given the presence of the coal industry in the State. Employment in mining in NSW rose by 7.% over the year to May. St.George Bank NSW Economic Outlook 7 July 11
%pa Wage Growth Unemployment Rate % % Australia 7 7 NSW NSW Australia M ar-99 M ar- M ar- M ar- M ar-11 Jan- Jan- Jan- Jan- Jan-1 Wages: The strength of the NSW labour market is also reflected in firm wage growth. The best measure of wages in the economy is the wage cost index. The wage cost index in the March quarter rose by 1.% with annual growth of.% over the year to March. This matches the wage growth of Australia wide of.%. This pace of growth is still relatively well contained, as it is below the Reserve Bank s unofficial line in the sand of.% per annum. Consumer spending: Retail sales growth has languished, as higher interest rates, elevated house prices and high petrol prices have left consumers with less money to spend. This soft growth in retailing is reflected in greater consumer caution. NSW has not been immune to the national trends and is one of the hardest hit States because house prices and mortgages are highest. Retailing in NSW has risen only.% over the year to May in trend terms compared with.% nationally. Both the NSW and national retailing growth rates are below the long-run average. A broader measure of consumer spending is the household final consumption expenditure data in the national accounts. It shows that in the year to the March quarter, NSW household spending rose by.%, in line with the.% growth seen Australia-wide. 1 Value of Retail Sales (trend, annual % change) 1 Index 1 Consumer Sentiment (-month moving average) Index 1 9 National NSW 9 1 NSW Australia 1 11 11 1 1 9 9 - Jan- Jan- Jan- Jan-1 - Source: Westpac 1 St.George Bank NSW Economic Outlook 7 July 11
Greater consumer caution had not shown up in consumer surveys until more recently. Consumer sentiment has softened in recent months. Nationally, the index reading remains above 1, which indicates that more consumers are still optimistic. But in NSW, the index fell below 1 in June for the first time in two years indicating that NSW consumers are more pessimistic. The prospect of more tightening from the Reserve Bank and higher prices for utilities are causing NSW consumers to build a bigger cocoon. There is a possibility that some of this caution is relinquished later this year but in the near term little turnaround is likely. The RBA has welcomed the broader caution among consumers because it has led to a rise in the savings rate and an improvement in consumer balance sheets. It also helps the RBA in fighting inflation. Slower than average growth in the retail sector of the economy makes room for other sectors, such as mining, to grow at above-average rates, allowing the RBA to better manage the mining boom. However, given the strength of the labour market, improved purchasing power from a high exchange rate and strong growth in household incomes, there is some possibility that retail spending undergoes a modest recovery later this year. Separate to the cyclical forces at work (and discussed above), retailing is also undergoing a broader structural change related to e-commerce, globalisation and the high Australian dollar. While foot traffic in retailing is recording modest growth, online sales are growing rapidly. It is estimated that online spending has been growing at average annual rate of more than 1% since. While online retailing makes up only % of overall household consumption, this share is set to get bigger. Online retailing potentially makes it less relevant to have as many multiple physical shopfronts. Housing: House prices across Australia have moderated this year due to the combination of higher interest rates, the expiry of the first-home-owner s grant (FHOG) and low affordability. According to the Australian Bureau of Statistics (ABS) measure, Australian average capital city house prices fell.% in the year to the March quarter. Index 1 Housing Prices (ABS measure) Index 1 %pa Dwelling Investment %pa 1 Australia 1 Australia 1 1 1 NSW 1 - NSW - 7 9 11 - M ar-7 M ar-9 M ar-97 M ar- M ar-7 - This softening in house prices nationally is replicated in other measures such as the RP-Data- Rismark series, which also revealed prices fell further in April. House prices in Sydney have moderated in line with the rest of Australia. But Sydney has outperformed the Australian capital city average according to the ABS, rising by.% in the March quarter. The softness is more dominant in the premium part of the housing market, defined as the % most expensive suburbs (according to RP Data-Rismark). St.George Bank NSW Economic Outlook 7 July 11 7
NSW Population and Dwelling Starts ' ' 1 1 Source: ABS % Source: REIA Vacancy Rates % Population change 1 1 7 7 Dwelling starts 1 1 1 9 9 1 Syd M elb Bris Adel Per Hob Dar Canb We expect house prices to continue to soften modestly over the next 1 months both across Australia and in NSW, as interest rates remain high and house prices pull back after strong growth last year. Further, the prospect of another rate rise from the Reserve Bank remains on the radar with the capex upswing deepening and reducing spare capacity in the economy. Housing Shortage (Annual and in 's) * State 9 1 11 (f) 1 (f) NSW.. 7. 7. 99. Vic 1. 7... 11. QLD.7 7... 1.1 SA... -1. -. WA.1..7. 11. Tas -. -. -.9-1.7 -.1 NT 1. 1. 1.7.. ACT 1. 1.9 1. -. -. Australia 1.1 99. 1.1 1. 1. * As at June 11, Source: ABS, BIS Shrapnel Importantly for the housing story, a chronic shortage of housing persists in Sydney and nationally. Population growth has eased from the recent peak in -9 but remains solid. The pick up in dwelling construction has been anaemic at best and means this chronic shortage of housing is set to persist. Dwelling construction should improve modestly in 11-1 but not by enough to narrow the housing gap between supply and demand. The shortage of housing and softening in conditions over the next year means rents are likely to keep rising. Rents have increased over the past year in NSW, for two- and three-bedroom houses and two-bedroom multi-unit dwellings. The tightening rental market is reflected in vacancy rates. Vacancy rates in Sydney are low at 1.1% for the March quarter and are the lowest among all capital cities in Australia. Vacancy rates under % are representative of super tight rental markets and suggest that Sydney rents are set to rise further and should underpin investment demand for housing. St.George Bank NSW Economic Outlook 7 July 11
Housing construction has been soft in NSW and most of Australia, which has constrained the supply of housing. Further, building approvals in NSW have lagged behind the rest of Australia for much of the past decade. Some improvement in residential construction occurred throughout 9-1, but this has since eased following interest rate rises and an unwinding of federal fiscal stimulus. The subdued growth in the housing supply suggests we are unlikely to see house prices weaken substantially; it would be unusual to see a collapse in house prices at a time when unemployment is low and underlying demand is high. Therefore, our prediction is of a softening or moderation in house prices only. The size of the shortage in housing in NSW means that over a longer time frame (- years), we expect house price growth to be strongest in Sydney and in the resources-rich States of Brisbane and Perth. The housing shortage is projected to grow to nearly 1k in 1 across Australia with the shortage in NSW accounting for 77% of the national housing shortage. The expected lift in economic activity in NSW and a tightening of rental markets will likely help establish the conditions needed for a recovery in house prices late next year. Until then buyers will stay on the sidelines, especially first-home buyers. Business Investment: $bn NSW Capital Expenditure (by asset) $bn $bn 1 NSW Engineering Construction $bn 1 Total Work yet to be done Equipment Work done Buildings 9 9 97 1 9 Work commenced 9 9 The mining boom and strong terms of trade in Australia are expected lead to an increase in investment over the coming year. Nationally, businesses have indicated they intend to raise investment by 1.% in 1-11 and by a large.% in 11-1. Although this expected spending is predominantly mining investment, we expect NSW investment to also show growth over this period. Business investment in NSW has lagged behind the rest of Australia, largely owing to the surge in mining investment in the resource-rich States. In the March quarter, NSW business investment rose by 1.% over the year to the March quarter compared with.% over the year in Australia. However, construction engineering is still strong and likely to receive a boost from coal mine projects in the pipeline and some key transport projects currently underway. Work yet to be done in the engineering sector in NSW is estimated at close to $ billion, the highest since at least the mid 19s. This work to be started will help underpin economic activity and jobs in NSW. St.George Bank NSW Economic Outlook 7 July 11 9
Government Spending: Government spending has been strong over the past two years, as the government increased fiscal spending in the wake of the GFC. This stimulus has been winding back in recent quarters. Government spending fell.7% in the March quarter and is down.% for the year. NSW performed better in the March quarter, with government spending up.%, however, it has declined.% over the year. Inflation: In the March quarter, headline inflation in the capital cities jumped 1.%, taking the annual rate up to.% from.7%. This spike was driven by one-off factors related to the natural disasters in Australia, as well as seasonal influences and the higher oil price. Consumer price inflation in Sydney rose to an annual rate of.% in the March quarter, from.% in the December quarter. Currently Australia s underlying inflation (which strips out volatile items) rose by.% over the year to March. This points to inflation being contained as it sits within the lower part of the RBA s -% per annum target band. Underlying inflation measures by State are not available but we expect that inflation trends in NSW would be similar to the national average. It is likely we are past the low point in underlying inflation. Underlying inflation rose by.9% over the March quarter after a period of benign increases over 1. Inflationary pressures are expected to continue to build up, as domestic economic activity accelerates over the next two years. The deepening upswing in business investment will be the fundamental driver of growth. Rebuilding after the domestic natural disasters will also boost growth after June. The RBA expect underlying inflation to hit the top of its target band by the end of this year and break above the band in 1. These RBA inflation forecasts suggest more tightening is on the cards. We would not fully rule out a rate hike as soon as August but we think a tightening this soon is now highly dependent on a high reading for June quarter inflation and an easing of global growth concerns. We view the more likely timing of a tightening as October or November. y/y% Headline Consumer Prices y/y% Underlying Consumer Prices (annual % change) Average of capital cities Sydney RBA Target Band Underlying inflation RBA forecast ( M ay SoM P) 1 RBA Target band 1 1 7 9 11 1 St.George Bank NSW Economic Outlook 7 July 11 1
Key Forecasts: Long Run Forecasts Economic Indicators: Average 9-1 1-11 11-1 1-1 State final demand.9...1. Gross state product (GSP). 1.7... Employment. 1...1.1 Unemployment rate..7...7 St.George Bank NSW Economic Outlook 7 July 11 11
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