The Australian economy March 2017

Australian economy: positive end to 2016 growth to lift to above trend in 2017.

A strong end to 2016 ...

The Australian economy ended 2016 on a positive note, rebounding from a mid-year slowdown associated with the July Federal election. Real output grew by 1.1% in the December quarter, after a 0.5% contraction in September, a decline that in part reflected the impact of a number of one-offs. Still, annual GDP growth for 2016 was disappointing, at 2.4%.

... rebounding from a mid-year slowdown ...

For 2017, the outlook appears sound. Our forecast for annual real GDP growth for December 2017 remains 3.0%, which is a little above trend, of 2.75%. The headwind of the declining terms of trade has passed and has become a modest tailwind. Moreover, the mining investment drag is waning, moderating from a direct subtraction of 0.9ppts in 2016, to a forecast –0.5ppts in 2017, and –0.1ppts in 2018. Activity conditions in the year ahead will be supported by: a lower dollar, boosting exports; lower interest rates, assisting housing; and robust public demand, led by an upswing in investment centred on transport projects. However, weakness in wage incomes, which has constrained consumer spending, remains a downside risk. Moving into 2018, a downturn in home building activity and the associated negative spillover effects on employment and household spending will weigh on growth. Real GDP growth in the year to December 2018 is expected to be below trend, at a forecast 2.5%.

... associated with July Federal election.

National income conditions have shifted dramatically with commodity prices having bounced sharply off their lows. In 2016, the terms of trade increased by 16%, after a 32% fall over the previous four years. We expect a further rise of 5% in 2017, with strength front loaded. However, the lift will prove to be temporary, with higher commodity prices in part due to supply disruptions and with demand conditions in China likely to cool next year. In 2018, we anticipate a 17% pull-back in the terms of trade. On the back of this terms of trade profile, nominal GDP growth strengthened from a weak 1.9% in 2015 to 6.1% in 2016 and is forecast to be 5.2% in 2017, then moderating to 0.2% in 2018.

Sound outlook for 2017 ...

So what are the likely impacts of this temporary jump in commodity prices? Certainly mining profits will increase, easing the need for cost cutting, and government tax revenues will receive a boost and export volumes may lift as supply responds to the higher prices. However, we are not expecting the mining sector to embark on a new round of investment projects and the pass through to wages and wage incomes is likely to be more muted than is associated with a more sustained commodity price shock.

... supported by low rates and a low dollar ...

The labour market and wage incomes remain a key uncertainty. Employment trends have been a key dynamic associated with the shifting momentum in the overall economy over the past two years. In 2015, jobs grew by a brisk 2.6% 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 gave way to an under-shoot in 2016, with employment up a sluggish 0.8%. Our Westpac Jobs Index points to solid job gains early in 2017, consistent with rising demand across the non-mining economy. However, there is the risk that job outcomes fall short if businesses remain fixated on cost cutting.

... as well as a global upturn ...

Consumer spending bounced back in the December quarter, increasing by 0.9%. However, for the 2016 year as a whole, consumer spending grew by a lacklustre 2.6%, moderating from 2.9% in 2015. For much of the past year, households reined in their spending as labour market softness crimped wage incomes. Going forward, households will receive a boost from a likely rebound in the labour market and from stronger national income associated with the higher terms of trade. We expect consumer spending growth to recover to 3.0% in 2017, but with risks again centred on labour market developments.

... and as headwinds abate.

Investment by the non-mining sectors is expected to advance in 2017, but at a below trend pace, increasing by a forecast 4%. A plus is that non-residential building activity is set to expand, a turnaround from a near 10% decline in 2016. Approvals have lifted off their lows, led higher by social building projects. In addition, spending on software is growing solidly, around 7%yr, as businesses look to improve productivity. However, equipment spending, which accounts for 40% of total non-mining investment, may well remain sluggish, eking out only modest gains in the absence of stronger consumer spending.

Labour market remains a key uncertainty.

Exports are a bright spot and will remain so in 2017. In 2016, exports grew by 9%, directly adding 1.8ppts to annual GDP growth. Of this: resource exports contributed 1.2ppts, including 0.5ppts from fuels (dominated by LNG); and service exports added 0.35ppts. Resource exports will continue to trend higher as new LNG projects begin operation. The uptrend in service exports, in response to rising demand from Asia, will continue. For the 2017 year, exports are forecast to add 1.6ppts to growth, while net exports contribute 0.8ppts (including a 0.8ppts subtraction from rising imports).

Andrew Hanlan, Senior Economist

Reproduced from the March 2017 edition of Westpac market outlook

Business focus also has the following articles from the March 2017 edition of Westpac's Market Outlook;

Australian interest rates March 2017

Australian dollar March 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.

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