What does 2018 have in store for the Australian economy

 Chief Economist, Matthew Peter 

 

QIC expects 2018 to be a positive year for the Australian economy, with growth reaching a trend-like pace of 2.7% following a sub-trend year of 2.4% growth in 2017. A resurgence in non-mining private sector investment will be instrumental in the improving outlook for the economy. Having been crowded out by a high dollar, high interest rates and high wage growth during the years of the mining boom, the reversal of these cost pressures, combined with a strong global economy, have resulted in a sharp improvement in business sentiment and business investment. Non-mining private-sector business investment is currently growing at double digit rates, which we expect to continue over 2018. Improved business conditions have spilled over into a much-improved labour market outturn over second half of 2017.

Labour market data for November showed that the economy added a whopping 62K jobs over month, lifting the annual rate of employment growth above 3%. Improving jobs growth has also boosted consumer sentiment, which has lagged the improvement in business sentiment, with the closely followed Westpac Consumer Sentiment index rising above its long run average and reaching its highest level in four years.

Public sector investment has also blossomed as State governments in Victoria and NSW have embarked on ambitious infrastructure programs. While we do not expect a repeat of the 15%-plus growth rates that occurred over 2016/17, State government infrastructure spending will continue to be a significant driver of growth over 2018.

However, 2018 will also see its fair share of headwinds to growth. After a four-year housing boom, APRA’s macroprudential regulations, stretched valuations and the oversupply of apartments on the eastern seaboard have finally seen the start of a correction in the market. Following four years of annual growth in dwelling investment of 5% or more, 2017 we see dwelling investment flatline. The coming two years will see a fall in dwelling investment as house prices drop by 5%. We expect dwelling investment to fall by 10% over the next two years, split evenly over 2018 and 2019. The decline in the construction of dwellings is required to realign demand and supply conditions in the Australian housing market. Unfortunately, the downturn in the housing market will partially offset the positive impact from robust employment conditions on consumer spending.

Spending by the Australian household has proven quite sensitive to movements in house prices. QIC’s modelling shows that for every $1 increase in housing wealth, households increase consumption spending by around 4 cents. The turnaround in house prices will therefore be a drag to consumer spending over the coming two years. The other headwind to consumer spending has been low wage growth.

The lack of wage growth, despite a decline in the unemployment rate has led some commentators to suggest that wages will remain suppressed due to ongoing structural adjustment from high paying mining jobs to lower paid service-sector jobs and the impact of automation.

Our view is not so pessimistic. Changes in wage growth tend to lag changes in the unemployment rate by up to a year. During the peak of the mining boom, the unemployment rate troughed in the first half of 2011, but wage growth peaked in 2012. With the end of the mining boom, the unemployment rate peaked in the second half of 2015 and wage growth appears to have found its trough in the second half of 2016. As the unemployment rate stabilises at just above 5%, we expect wage growth to continue to drift gradually higher, lifting from an annual rate of around 2% currently, to 2.4% by the December quarter of 2018 and 2.9% by December quarter 2019.

The combination of robust employment growth and gradually rising wage growth will allow household real disposable income to rise from a weak annual growth rate of just 0.5% in 2017 to trend-like growth of around 2.7% over 2018 and 2019. However, with falling house prices a headwind to spending, growth in real consumption expenditure over 2018 and 2019 will be slightly below trend at around 2.4%.

All up, 2018 will be a year of rebalancing in the Australian economy as the housing market corrects and households increase their rate of savings and stabilise debt-to-income ratios. The headwinds from the process of rebalancing will partially offset the rise in business investment that is occurring as the transition from the construction phase of the mining boom shifts into full swing. The outcome is for a year of trend growth, with the RBA in support by keeping rates on hold until the second half of the year.

Table 1: Financial market movements, 7 - 14 December 2017

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,652.0

0.6%

US

2.35%

-1.4 bps

US Dollar Index (DXY)

93.49

-0.3%

Nikkei 225

22,694.5

0.9%

Japan

0.05%

-0.7 bps

USD-JPY

112.39

-0.6%

FTSE 100

7,448.1

1.7%

UK

1.17%

-7.9 bps

GBP-USD

1.343

-0.3%

DAX

13,068.1

0.2%

Germany

0.32%

2.3 bps

EUR-USD

1.178

0.0%

S&P/ASX 200

6,011.3

0.6%

Australia

2.56%

4.2 bps

AUD-USD

0.767

2.1%

Source: Bloomberg

 

For economic update by region click here

About QIC

Investment Capabilities

Knowledge Centre

Latest News

About QIC