The Australian economy October 2016

Australian economy: outlook sound despite recent patchier conditions.

Output resilient in challenging environment.

The Australian economy’s output performance, in aggregate, has been resilient in what remains a challenging environment, supported by record low and falling interest rates and a sharply lower dollar. This was confirmed in the June quarter national accounts, with annual growth lifting to 3.3% from 3.0% in March. That outcome is above trend, judged to be 2.75%. We continue to expect real GDP growth of 3.0%yr for December 2016 and for December 2017, incorporating a shift in the mix of activity, with the home building boom to slow, albeit potentially a little later than originally anticipated, and the mining investment drag to wane. That said downside risks persist. World growth is sluggish, at a forecast 3.2% for 2016, and global financial sector vulnerabilities remain.

Incomes to fluctuate on commodity volatility.

On national income, notable is an emerging stabilisation in the terms of trade after a 34% retreat over the four years to 2015. In the June quarter, the terms of trade rose by 2.4%, with the prospect of further near-term gains as commodity prices bounce off their lows. While we characterise these developments as evidence of an emerging stabilisation, the jump in commodity price (particularly coal) includes an element of overshoot. For the terms of trade, we now anticipate an 11% rise in 2016, followed by a 14% pull-back in 2017. Nominal GDP growth strengthens from 2.0% in 2015 to a forecast 6.2% in 2016 and then dips to 1.7% in 2017. General spending decisions in the economy in 2017 are unlikely to be greatly impacted by these income fluctuations; the jump in commodity prices is temporary and unsustainable.

Non-mining economy advancing ...

Conditions across the domestic economy remain uneven, with a growth divide between the mining states, feeling the impact of the mining investment downturn and lower commodity prices, and the non–mining states. Mining investment fell 36% over the year to June, directly subtracting 1.6ppts off GDP. With around 75% of the investment downturn behind us, this drag will moderate to a forecast 0.5ppts in 2017. Taking a more complete view, the impact of the resources sector on GDP was broadly neutral over the past year, with the investment drag offset by expanding resource exports and weaker capital imports.

... supported by lower rates and a lower dollar ...

The key elements of the non–mining economy (household and public demand, as well as net service exports but excluding business investment) grew at an above trend pace over the past year, up 3.9%, adding 3.2ppts to GDP. Lower interest rates and a lower dollar are boosting housing and net service exports. Also, public demand is no longer the headwind it was. A near 2% contraction in 2014, as governments focused on budget repair, gave way to a near 4% rise over the past year. The public sector is hiring again, boosting frontline services such as health, and lifting infrastructure investment. Despite this, as highlighted previously, non-mining business investment in aggregate remains sluggish, for now.

... and exports performing strongly.

The export sector is a bright light, and will remain so in 2017, with volumes up 9.6% over the year to June, contributing 2.1ppts to annual GDP growth. This is the strongest annual growth in exports since 1997 (excluding the Sydney Olympics period in 2000). Resource exports rose 15% over the year, as additional capacity came on stream, contributing 1.9ppts to activity over the period. Moreover, service exports are performing well boosted by the lower dollar.

However, consumer spending slowed in Q2 ...

Notwithstanding the generally positive tone of the June national accounts, conditions across the nonmining economy have become a little patchier as we progress through 2016. In particular, consumer spending slowed in the June quarter, increasing by only 0.4%, to still be a solid 2.9% above a year ago. In part this was due to unseasonable weather conditions in the quarter. More fundamentally, sluggish jobs growth during the first half of the year, following an overshoot in 2015, weighed on wage incomes. Also, since late 2015, there has been some re-emergence of risk aversion, as evident in the Westpac-MI Consumer Sentiment survey. Increased uncertainty around public policy, including taxation, ahead of the July 2 Federal election, may have been a factor. Also, lending conditions in the housing market were tightened in the second half of 2015, with a focus on the investor market.

... as the labour market moves through a soft spot.

Nevertheless, we expect consumer spending to regain momentum before years end and to increase by 3.2% through 2017, supported by improved income growth and in the wake of the RBA cutting rates in May and again in August. Retail sales may have passed the low point, rebounding in August, up 0.4%, after a relatively flat spot through May to July. Also, home building activity is set to become more supportive near-term, after consolidating in the June quarter. Dwelling approvals, which peaked in the first half of 2015, have now rebounded in 2016, to be back at historic highs. As to the labour market, we see this as moving through a soft spot. Employment rose by only 0.7% annualised in the six months to June, lifting to 1.3% by August. This represents a consolidation after the hiring burst of last year. In 2015, employment rose by a brisk 2.7% in response to the jobs friendly activity of the home building boom and strength across the service sectors. Our jobs index points to a return to around trend employment growth over the coming half year, thereby providing greater support to household incomes.

Andrew Hanlan, Senior Economist

Reproduced from the October 2016 edition of Westpac market outlook

Business focus also has the following articles from the October 2016 edition of Westpac's Market Outlook;

Australian interest rates October 2016

Australian dollar October 2016

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 October be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved October differ substantially from these forecasts.

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