In this video Westpac Chief Economist Bill Evans comments on this week’s NAB business survey; the sharp decline in Westpac’s Consumer Sentiment Index; November’s unemployment data, a speech by RBA Governor Glenn Stevens and what we might expect next week from the new Federal Treasurer’s mid-year economic and fiscal outlook statement.
If you’re interested in Westpac’s view on the world economy I’ve also included a transcript of one of their latest economic updates below the video
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Westpac’s latest economic update
The world economy slowed in 2013 from growth of 3.2% in 2012 (5.2% in 2010; 4% in 2011) to 2.8% in 2013.
We expect a similar lack lustre performance from the world economy in 2014 although the International Monetary Fund is more upbeat, expecting 3.6%. The US economy is likely to remain “stuck” in a 1.5%–2.0 % growth range despite a reduced drag from fiscal policy due to a renewed slowing in housing and business investment while both consumer and business confidence remain constrained by concerns around Washington. Europe is likely to remain in recession for a third consecutive year. China will be comfortable with growth in the 7–7.5% range as it works through excessive credit growth and makes some genuine progress to restructuring the economy to encourage consumer spending especially by raising domestic confidence in the quality of domestic goods and services. The emerging markets with large current account deficits like India; Brazil; and Indonesia are likely to remain cautious as FED tapering of QE3 threatens funding their gaping current account deficits .
In such an environment it is little wonder that we are predicting below trend growth (3%) for Australia in both 2013 (2.5%) and 2014 (2.6%). A further headwind for Australia’s growth is the peaking of the mining investment boom. Australia’s mining investment boom has been dominated by six large LNG projects all of which have run significantly over budget prompting investors to eschew any major new projects. Fortunately growth (as opposed to employment) will be cushioned by a substantial lift in net exports. In 2012 mining investment added around 1 ppt to growth whereas in 2014 it is likely to subtract around 0.25 ppt’s from growth ( a 1.25 ppt’s of GDP turnaround) . Resource export growth added around 1 ppt to growth in 2012 but that is expected to increase to around 1.3 ppt’s in 2014 ( a 0.3 ppt’s turnaround). Nevertheless, particularly from the perspective of the labour market, it will be important for the economy to rebalance towards non mining investment; consumer spending and residential construction.
In this regard the picture is mixed. Businesses have shown considerable resistance to expansion , either through investment or employment. The dominant business strategy has been to protect profits by increasing work hours and constraining wages. Demand for labour has, to date, not responded to record low interest rates apart from in the residential housing market where progress has been heavily regionalised. Strong house price inflation has benefitted construction activity in NSW whereas other states have seen much more variable results.
While consumer confidence had recently been boosted particularly in response to the election of the new government respondents still feel decidedly uncomfortable about job security and hence consumers have been cautious. In fact the December print on consumer sentiment revealed a significant pullback as households questioned their earlier buoyant confidence in the new government. This discomfort around job security stems from that conservative approach from business. Until there is some “circuit breaker” in the Australian economy which will encourage businesses to invest and employ the economy is likely to be operating below capacity.
In previous cycles this “circuit breaker” has been interest rates but despite record low rates business confidence and spending have remained dormant. There is likely to be a role for fiscal policy to provide the economy with a strategic boost , most likely through an expanded infrastructure program. However, to date, fiscal policy has emphasised fiscal consolidation just at a time when it would be the best “circuit breaker” for the economy. Prospects for a boost from fiscal policy have taken a dive following the release of the government’s latest economic statement which reveals a $68 bn deterioration in the 4 year fiscal outlook. That is certain to ensure a marked tightening in discretionary fiscal policy in time May Budget, undermining confidence and incomes.
A further threat to consumer spending will be the likely rise in the unemployment rate through 2014. Despite lack lustre jobs growth and strong population growth the unemployment rate has only increased by around 0.5% over the last year as the participation rate has declined markedly. This is partly due to the ageing of the population but also a dominant “discouraged worker” effect. With the participation surely near its lows the unemployment rate looks set to climb quickly. We expect the unemployment rate to print 6.5% by mid year further unnerving consumers. While the government’s forecasts are more optimistic in the near term it is now expecting the unemployment rate to stay around 6.25% until 2016/17.
Interest rates are at 50 year lows but do not appear to be boosting investment and spending. The Reserve Bank has become nervous around the prospect of further cutting rates for fear of sparking an excessive lift to house prices and laying the foundation for a credit fuelled housing boom. It is our view that prices will soon peak in Melbourne and Perth while near recession conditions in South Australia and Tasmania are containing prices in those regions. It is only in Sydney where income growth has outstripped prices and further “catch up” is likely. Furthermore, there is a marked absence in this cycle of First Home Buyers, a source of demand which has proved necessary in previous housing upswings.
Media interviews and a recent testimony to a parliamentary committee on economics by the Reserve Bank Governor reveal a current mind-set that interest rate cuts have probably run their course. We disagree expecting that conventional policy will need to do more ” work” in this cycle. However time will be required to convince the Bank of the need for further rate relief. The next rate cut of 25 bp’s is likely around mid 2014 (May) with a follow up move in August.
The Reserve Bank is now predicting below trend growth in 2014 indicating that it sees the need for more stimulus. However its “fear” of overstimulating housing has led it down an unconventional policy path. In lieu of further rate cuts the Reserve Bank has opted for “talking down” the AUD including threatening to use intervention to lower the currency. Of course there are potential costs to such a bold policy including carry losses (selling AUD which yield 2.5% and holding zero yielding US securities) or the risk of policy failure and the need to adversely revalue those foreign reserve holdings in the event of a rising AUD. These issues will be weighed heavily by RBA management before it takes the intervention decision.
The decision by the FED to begin tapering its QE is likely to see markets anticipate an orderly $10 bn per meeting reduction in QE over the course of 2014. However markets should be mindful of the “data dependence” aspect of the policy. It is also important to note that the impact of the first tapering was moderated by the associated strengthening of the forward guidance by down playing the 6.5% unemployment “trigger”. We, in fact, expect that after a follow up taper in January the data flow in the US is likely to require a pause to tapering at the March meeting. This scenario complicates the outlook for the AUD. Currency markets could, conceivably, price the AUD on the basis of an end to QE. That would see further short term weakness prior to a “recovery” in the event of a pause. With the AUD currently trading around USD 0.885 it could easily fall further. A reasonable hypothesis is that markets will price AUD as if QE has ended. That would see the premium above fair value fully eliminated. However we currently assess fair value around USD 0.87–0.89 so there might be limited downside from here. In fact is there was a pause in tapering in March that would probably provide a boost for the AUD. Further weakness can be expected when the RBA resumes rate cuts in May.
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