The Forward View – Australia: September 2018

A strong first half and easing downside risks.

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Overview:

  • Overall there has been little change to our view on the economy over the next couple of years. Growth is expected to remain above trend which should see the labour market tighten, wages growth lift and inflation more broadly begin to rise. As spare capacity is reduced, and inflationary pressures become more evident, we expect the degree of accommodation in monetary policy to be gradually reduced, with the RBA beginning a process of rates normalisation towards a more neutral setting. The speed at which this occurs is highly dependent on the pace at which the labour market continues to tighten and how quickly this is translated into faster wage growth and broader price pressures.
  • While the national accounts show growth was particularly strong in the first half of 2018 with a solid outcome in Q2 following an upwardly revised Q1 – we have not changed our view on the future and pace of growth to our recent forecasts. With our quarterly profile broadly unchanged, we expect growth of around 3¼% in 2018, slowing to 2.7% in 2019 and 2.5% in 2020. Public sector investment in infrastructure, strong growth in exports and a recovery in non-mining business investment are expected to drive growth over the next few years. In addition, the drag from falling investment in the mining sector is expected to wane as the last of the LNG mega-projects enter the production phase. It is also likely that there will be some new mining investment as depleted mines are replaced and because a higher level capex will be required in the future to maintain production with the now larger capital stock in the sector. Consumption is expected to grow only modestly as wage growth – and therefore household income growth remain weak. The cooling in the housing market will also see a modest decline in dwelling investment, though the large pipeline of work to be done, suggests it will remain high.
  • Overall, we think the risks to our forecasts are relatively balanced. Business conditions in the NAB business survey rebounded somewhat in August, partially reversing some of the downward trend in recent months which we had previously highlighted as a risk. Significant uncertainty around the consumer remains. We expect only modest growth in consumption over the next two years, with a series of headwinds facing households. Slow wage growth, high debt levels and slowing growth in wealth are expected to weigh on households. On the positive, tax cuts to low income earners may provide some support and there are signs that wage growth is lifting from low levels but these factors are more likely to provide support near the end of the forecast horizon. The potential for an escalation in US-China trade tensions also remains a risk.
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