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Published 16 December 2013 15:10, Updated 18 December 2013 08:38
Commsec chief economist Craig James has identified his eight big issues for the Australian economy in 2014. Photo: Louise Kennerley
The Australian economy struggled to get out of third gear over much of 2013. But we are hopeful that the economy will finally find fourth gear over the 2014 year.
The main culprit holding back the economy in 2013 was the election. Businesses and consumers simply weren’t prepared to ramp up spending, investment and employment until the election was out of the road. But the economy was also in the transition phase with mining investment topping out while home construction and mining exports were just starting to find their feet.
There were also the budget problems in the US with enforced spending cuts serving to slow economic growth. And China struggled to get past issues in the financial system. But by the end of 2013, growth had picked up in the US and China, and it was looking more promising in Europe.
In line with other forecasters such as the International Monetary Fund, we expect that global economic growth will return to near ”normal” around 3.5 per cent in 2014. One of the main risks is central bank tapering or the winding back of stimulus. Take too long to taper and you risk higher inflation. And if you taper too early you may risk de-railing the economic recovery.
In Australia, we expect that home building and mining exports will pick up the baton from mining construction in 2014 to drive economic growth. And with the election out of the road, home prices rising and a better tone in evidence in the global economy, we expect that consumers will open their wallets a little wider while businesses should respond by lifting hiring and investment. Unemployment could prove reasonably stable with upside risks earlier in 2014 giving way to downside risks as 2014 progresses.
One of the main risks domestically is that the Federal Government is too aggressive in tightening budget spending, rather than relying on stronger economic growth to boost government revenues and thus reduce the size of the budget deficit.
If fiscal or budget policy is too tight, the Reserve Bank may provide some offset by cutting interest rates.
But while there is the risk that the Reserve Bank will cut rates one more time in the first half of 2014, in the second half of 2014 the risk will shift to higher interest rates as economic growth returns to normal.
Turning to the Aussie dollar, over 2013 the currency tracked a US17.5 cent range. For 2014, our currency strategists warn about similar volatility and expect a similar range (to 2013) and should see mid-0.9000s and low 0.8000s trade.
The US ‘taper’
There have been numerous column inches devoted to the US ‘taper’, that is the winding back of monetary stimulus or the ‘tapering’ of bond purchases. Everyone is agreed that the Federal Reserve needs to pull back stimulus at some point; the hard part is in working out when is the ‘right’ time to do it.
As the Reserve Bank Governor counsels, the ‘taper’ will lead to short term volatility on financial markets but the longer-term implications are more positive. Sharemarket investors may fret that the days of cheap money (free money?) are coming to an end, but if the Federal Reserve is toying with the idea of taking the foot off the throttle – even just modestly – that signifies that the economy is doing better. And in a better-performing economy, spending grows and businesses invest and hire staff, and that clearly is positive for revenue and profits
Inflation or deflation?
In many parts of the so-called ‘advanced’ world, interest rates are at or near zero. And in the US, Japan and the UK, central banks have gone further to stimulate economies, buying securities from financial institutions in exchange for cash (quantitative easing). But despite all their efforts, inflation rates in many parts of the western world are lower now than a year ago. One exception is Japan where Prime Minister Abe is determined to get the economy going and end the period of deflation so-called Abenomics. And he has achieved some success with consumer prices up 1.1 per cent on a year ago after falling by 0.4 per cent in 2012.
With more money circulating and chasing fewer goods, the assumption is that inflation will follow. To date, it hasn’t really happened.
If inflation starts creeping higher, it’s a positive development, not negative. It means that economic growth is returning. But it also means that central banks need to be vigilant and make sure that a little inflation doesn’t become a lot, necessitating sharply higher interest rates that could actually choke off economic recoveries.
Housing boom or just a ‘normal’ recovery?
Some commentators are looking at the Sydney housing market and concluding that a boom is underway. And the perception is that, as sure as night follows day, if there is a boom, clearly there follows that there will be a bust.
But interestingly the Reserve Bank isn’t worried about a housing boom – not yet anyhow. Still, it is warning investors not to pay over the top and to realise that property prices can go up as well as go down.
It will also be important to watch trends like the number of people in each home. If household size
continues to increase, then the extra supply could actually lead to a marked softening of home prices.
The rebalancing of China
The new Chinese leadership wants the country to more closely emulate western industrialised nations where household spending plays a greater role in driving economic growth. For instance in the latest national accounts in Australia, household consumption accounted for 55 per cent of the economy (GDP or gross domestic product). In China, the available 2012 data indicated that household spending accounted for almost 36 per cent of the economy with the government sector at 13.5 per cent of GDP; investment at 48 per cent of GDP and net exports at almost 3 per cent of GDP.
If consumer spending grows at a faster rate, then Chinese consumers are more likely to feel that they are benefitting from the expansion of the economy. And in terms of social stability, that is an important factor. Further, there is concern that some provinces may be over-investing in the cities, and those concerns are more likely to be dispelled if growth of retail sales exceeds that of production or fixed asset investment.
The reshaping of Australia
Since 2008 the Australian economy has grown by 14.3 per cent. Of that growth, Mining has contributed 3.2 percentage points (pp) of which iron ore alone has added 2.3pp. But not far behind is Health Care (1.7pp), Professional services (1.6pp) and Construction (1.4pp).
At the other end of the scale, Manufacturing has sliced 0.4pp off growth, while Arts, Agriculture, Transport, Education and Utilities all added nothing to Australia¡¦s economic growth.
So it is clear that Australia has been riding on the back of iron ore (as opposed to riding the sheep back in the 1950s). In the coming year Mining will pull back, but there is plenty of scope for other sectors to grow. In the equivalent five year period before 2008, from 2002-2007, the economy grew 19.8 per cent with Finance (3.1pp), Construction (2.6pp) and Health Care (1.4pp) the main contributors to growth.
The drivers of the Australian economy regularly change and indeed they will again over coming years as the mining construction boom fades and mining exports take over. But clearly other sectors will pick up the slack, with Construction – in particular home construction – the most likely candidate.
Aussie dollar to slip or slump?
Over the past 40 calendar years the Aussie dollar has, on average, tracked a range of US13.7 cents a year or 17.1 per cent. Since the dollar floated the range has been US14.3 cents a year or 18.8 per cent. And over 2013 so far the range has been US17.5 cents or 16.9 per cent. In short, the Aussie dollar is volatile and 2013 has been a year of above-average volatility.
Over 2014 our currency strategists expect a similar trading range, with the Aussie likely holding from the low US80s to the mid US90s. Certainly the Reserve Bank Governor has recently indicated that he thought the Australian dollar should be closer to US85 cents, rather than near US90 cents currently.
Much will depend on the recovery path of the US economy and the extent of tapering undertaken by the Federal Reserve.
Will new conservatism continue?
The conservatism of Australian consumers has been one of the big trends of the past five years. Aussies are saving, not spending. They are more likely to leave money in the bank rather than put money to work elsewhere (although more recently investors have become keen on property again).
Consumers will also shop around for bargains. And it hasn¡¦t just been inherent fiscal conservatism but the internet that has driven this tendency together with a relative firm currency. The internet has allowed consumers to do product comparisons and undertake online shopping – not just in Australia and overseas. Of course the high Aussie dollar has opened the world to shoppers, keeping downward pressure on retail prices and margins here in Australia
If the conservatism continues, then this will mean a continuation or more thoughtful spending and reduced debt levels, meaning that inflation remains under control and interest rates stay lower for longer. Retailers will need to keep costs down, together with margins and they will have to compete harder to improve customer service to lift revenues. Because simply, global competition is here to stay, even if the Aussie dollar eases further.
A new glory era for interest rates?
Over 2013, the cash rate has averaged 2.75 per cent. – the lowest calendar year average since 1959. So while people can debate whether rates are at record lows or not, there is no debate about the last time period that rates have been this low – it was 54 years ago, back in 1959.
If inflation remains under control, there is no fundamental need to lift interest rates markedly. But certainly cash rates are close to zero in many western nations, so it is hoped that rates can rise to at least modest nominal levels to give central banks a degree of flexibility in the future, rather than being forced to rely on the new tools like quantitative easing.
Currently the consensus is that the US federal funds rate won¡¦t rise until perhaps 2015. But longer-term rates are tipped to rise across western nations by between 60-70 basis points over 2014 as global economic growth lifts closer to longer-term averages of around 3.5 per cent. The hard part for central banks will be to get the timing right for lifting policy rates.
Craig James is chief economist at CommSec.