The Australian economy December 2016 / January 2017

Australian economy: stumbled in 2016 outlook for 2017 remains sound.

Output contracted in September quarter ...

The Australian economy, having surprised to the high side in a challenging environment in the year to June stumbled mid-year. The Australian Statistician reported that the economy contracted by 0.5% in the September quarter, after a 0.6% increase in June. This is the first decline in output since the Queensland floods of March 2011, a -0.2%, and since the GFC impact in December 2008, a -0.7%. Annual real GDP growth slowed from an above trend 3.1% in June, with trend judged to be 2.75%, to 1.8% in September.

... impacted by election uncertainty and one-offs.

We do not see this number as portending a sharp deterioration in the Australian economy. We remain cautiously comfortable with our forecast of 3.0% GDP growth for the year to December 2017. However, the risks remain to the downside, particularly around employment and consumer spending. Conditions in 2017 will be supported by: stronger income growth, as the terms of trade increases; lower interest rates, boosting housing; a lower dollar, boosting exports; and a much reduced drag and reduced negative spillover effects from the mining investment downturn. That said, conditions will remain uneven, with a growth divide between the non-mining states in the south-east and the mining regions of the north and west.

Outlook remains sound, albeit with downside risks.

The economy did lose momentum in 2016, although the extent of the slowdown was exaggerated by a number of one-offs coinciding to produce the September result. In that quarter, declines were reported for: home building activity, disrupted by weather; public demand; and net exports, each of which have been trending higher and are set to resume their upswing. The July 2 Federal election, which followed the longest campaign in recent times, would have unnerved businesses and households. Also, financial conditions were tightened over the second half of 2015, leading to a 7% contraction in housing finance over the three quarters to March 2016. More recently, finance has stabilised in response to RBA rate cuts.

‘Income recession’ comes to an end ...

On national income, notable is an emerging ‘stabilisation’ in the terms of trade after a 34% retreat over the four years to 2015. Over the June and September quarters, the terms of trade rose by 6.8% as commodity prices have risen off their lows. For the terms of trade, we expect a near 20% jump in 2016, followed by a pull-back over 2017 and 2018 given that recent higher prices are partly due to temporary supply factors. Nominal GDP growth strengthens from 1.9% in 2015 to a forecast 6.0% in 2016 and then moderates to 4.0% in 2017 and 3.2% in 2018. The surge in commodity prices will boost mining profits, tax revenues and export volumes in the near term but an investment response and stronger wages growth are unlikely.

... as commodity prices bounce off their lows.

Labour market trends have been a key dynamic associated with the shifting momentum over the past two years. In 2015, jobs grew by a brisk 2.8% in response to the labour intensive activity of the home building boom and strength across the service sectors. However, this included an element of overshoot, which has given way to an undershoot in 2016, with employment up a sluggish 0.7% annualised year to date. Our Westpac Jobs Index points to a resumption of solid job gains heading into 2017 consistent with rising demand across the non-mining economy.

Jobs growth to rebound from current under shoot ...

Consumer spending slowed to only a 2% annualised pace over the June and September quarters, a marked deceleration from the 3.1% increase in the year to March. Households reined in their spending as the soft patch in the labour market crimped wage income growth. Going forward, households will receive a boost from a likely rebound in the labour market and from the emerging stabilisation of the terms of trade, which is seeing a reduced drag on national income. We expect consumer spending growth to recover to 3.0% in 2017, but with risks centred on labour market developments.

... supporting consumer spending ...

Trends across the other components of domestic demand will be mixed. Public demand, up 4.7% over the past year, is forecast to grow by a solid 2.8% in 2017, with upside risks, as governments lift infrastructure investment and add public servants to expand frontline services, notably in health. Home building activity is expected to be broadly flat over 2017, with modest gains near-term after approvals rebounded to record highs in 2016. Business investment will contract at a much slower rate, an 8% fall in 2016 moderating to a 2% decline in 2017. The end of the mining investment downturn is in sight, with work on the remaining gas projects to be progressively completed in 2017. Non-mining investment, up an estimated 3% in the year to September 2016 is expected to eke out a similar gain in 2017.

... and exports to be a growth engine in 2017.

The export sector had been a bright spot until June and September, which saw the first back-to-back negatives for real net exports since 2011. Of note, resource export volumes inched lower in September, -0.1%, including falls in metal ores (dominated by iron ore) and other mineral fuels (including LNG). Resource exports will resume their upward trend, led higher by LNG as new projects begin operation. The uptrend in service exports, in response to rising demand from Asia, will continue. Over the past year, a stellar 10% increase in service exports directly added 0.4ppts to annual GDP growth, with positive spillover effects. For the 2017 year, real net exports are forecast to add around 1ppt to growth.

Andrew Hanlan, Senior Economist

Reproduced from the December 2016 / January 2017 edition of Westpac market outlook

Business focus also has the following articles from the December 2016 / January 2017 edition of Westpac's Market Outlook;

Australian interest rates December 2016 / January 2017

Australian dollar December 2016 / January 2017

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.