The good news is that Australian global economic outperformance has continued in early 2017.
March quarter GDP growth was up by 0.3 percent, which is a soft outcome for Australia, but was significantly better than a quarter of negative growth (which was the fear).
However, there has still been a noticeable slowing in Australian growth momentum over the past few months.
Annual growth is currently around 1.7 per cent, which is well below trend or potential growth that is assumed to be around 2.75 per cent.
So there is still plenty of spare capacity in the Australian economy that needs to be worked through.
Consumer spending growth was slow in the March quarter. Consumers are focusing spending to non-discretionary areas (rather than the retail sector).
High household debt and record low wages growth has allowed consumers to fund additional spending through drawing down on their savings.
The savings ratio continues to track lower (currently at 4.7 per cent from 6.9 per cent a year ago).
The housing upswing has been a major factor in lifting household wealth positions and therefore also giving consumers the confidence to draw down on savings. But, with the numerous factors weighing on the housing market and early signs of slowing prices (particularly in Sydney and Melbourne), the positive impacts of rising wealth will wane on consumer spending power.
It is encouraging to see some lift in private business investment (particularly in the non-mining sector), after 10 consecutive quarters of declines.
Mining capital expenditure still has further room to fall (with another 30 per cent decline during the next financial year).
But Australia is now at the tail end of the mining boom, with the bulk of the weakness behind us.
While non-mining capital expenditure is rising a little, planned capital expenditure growth remains far too low if Australia wants to track back towards its potential growth.
Housing construction will also continue to decline from current levels. Building approvals growth has slowed and while overall construction levels may remain elevated, the contribution to growth from housing is weakening.
At a time of soft growth, weakness in overall construction and capital expenditure spending, it would be helpful for government infrastructure spending to lift.
And there are some positive signs on this front. While total government spending in the March quarter only showed a moderate lift, the outlook is more encouraging with the federal government committing to an additional $20 billion (over four years) in infrastructure spending in the May federal budget, and state budgets showing additional spending on capital expenditure particularly in NSW and Victoria in transport projects.
A key risk for the growth outlook looking ahead is around export growth.
In the March quarter, export volumes declined with resource exports dropping noticeably while import growth was strong which meant that total net exports (exports – imports) detracted from growth
In the June quarter, the negative impacts of Cyclone Debbie on coal exports will be reflected in the GDP numbers, with the monthly April trade numbers already showing a large slump in export growth.
There is also a risk around inventories, with inventories rising in the March quarter and adding a sizeable 0.4 percentage points to growth, which could be run down in the next quarter. So, GDP growth in 2017 will probably be closer to 2 per cent; this is below the Reserve Bank of Australia’s (RBA’s) current forecasts of around 2.5 per cent.
Besides a weakening growth backdrop, another problem is still that the other leading indicators in the Australian growth backdrop remain murky.
Consumer confidence is too negative, the non-mining business investment upswing is moving very slowly, the Australian dollar needs to be lower and there are no signs of any significant lift in inflation.
At the same time, the property cycles in Sydney and Melbourne also appear to be at the beginning of a down-cycle because of a combination of surging unit supply, bank rate hikes, tightening lending standards, reduced investor property deductions, tighter restrictions around foreign buyers and all of the negative sentiment towards housing.
Our view remains that national dwelling pries are on track for a 5 to 10 per cent decline concentrated in Sydney and Melbourne and that unit prices in parts of Sydney and Melbourne (where there has been a significant amount of construction for a number of years) will decline by 15 to 20 per cent.
But it’s not all doom and gloom in Australia: the labour market is holding up quite well and business surveys still remain strong, which is indicative of better growth looking ahead. So, we still see the RBA keeping rates on hold for now.
However, the risks have definitely shifted towards another rate cut during the next few months and signs of a faltering labour market would probably be a trigger for a rate cut.
The RBA’s own outlook around the domestic and global outlook is still optimistic.
The RBA kept the cash rate unchanged at 1.50 per cent in June (for the 10th month in a row) with the commentary indicating: a broad-based pick-up in the global economy, the recent declines in commodity prices (which have erased earlier increases), indications of good business conditions readings in Australia – which are a good sign for non-mining growth at a time when mining capex decline is ‘almost complete’ – continued mixed labour market readings and early signals of a slowing in dwelling prices.
While the RBA appears to be a reluctant rate cutter for now, the sizeable slowing in the domestic growth outlook combined with a slowing in the housing market may give the RBA the room it needs to cut the cash rate again.
Either way, RBA rate hikes are still a long time away, which means that the narrowing of the interest rate differential between Australia and the US will continue.
The risk of lower interest rates also means that there is likely to be a continuation of the relative underperformance of Australian shares relative to global shares (that started in 2009) and a lower Aussie dollar (below US$0.70).
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