The Forward View – Australia: December 2017

The year in review and the year ahead.

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Overview:

  • 2017 was a year of divergence between the business sector and the household sector. GDP data confirmed healthy (though volatile) growth momentum in the first three quarters, mainly led by business and government investment. Strong business conditions broadened across industries and states, enabled by strong profitability. Households meanwhile continued to restrain their spending amidst further weakness in wages and household income growth, despite strong employment, while housing construction now appears to have peaked in a trend sense. Net exports didn’t contribute as much as expected, partly because LNG has been slower to ramp up, partly due to weather disruptions, and partly due to offset from capital imports.
  • The RBA’s focus through 2017 shifted towards addressing concerns about household balance sheets amidst rising housing prices, concerns which were ultimately addressed through tighter macro-prudential measures. Momentum in house prices is now slowing more clearly, particularly in Sydney and the apartment space. Meanwhile, strong employment outcomes enabled the central bank to maintain its belief that wages/inflation will eventually turn up, although the jury is still out about the strength of any upturn.
  • In many ways, 2018 will be a continuation of 2017. A moderate improvement in economic growth to 2.9% in annual average terms is forecast (although momentum should slow as the year progresses), driving some further lowering of the unemployment rate to 5.2% by end-2018. Business and government investment will lead (with some offset from capital imports), dwelling construction will pull back a little but remain high and LNG exports will add to growth. Further strength in employment growth will help to narrow the gap between business and households spending, although our forecasts for wages suggest that any improvement in consumer spending will be glacial, particularly if wealth effects have an impact as house prices slow.
  • Underlying inflation is forecast to pick up slowly to 2% by end-18, which together with early evidence of some pickup in wages growth should be enough to see the RBA commence tightening in the second half – we have 25bp hikes in August and November pencilled in. This would take the cash rate up to 2%, a level which is still considered stimulatory.
  • Key developments to watch include: the transmission from employment to wages amidst forces such as globalisation and digital disruption; momentum in house prices and credit growth and how that impacts on monetary policy and/or macro-prudential policies; the path of the USD, commodity prices and the AUD (forecast to depreciate to USD0.72 by mid-year); domestic energy prices (to remain high and troubling for some sectors); and margin compression in retail.

For further details, please see the attached document.