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02 Outlook 2015 Tues 0900 1030 ALAN OSTER
I'm going to start off talking about Australia by talking a little bit about the world. This will be
picked up in a little bit more detail by some of my fellow panellists. But where we're starting off is a
view that says the global economy is very mixed. And when you look at the commodity prices, there
are clear winners and clear losers.
One of the things that I think people haven't really picked up on is most of Australia's major trading
partners actually benefit when commodity prices go down, particularly China and the Asian
economies. If I was going around the world very quickly, my quick view would be Europe is still
very poor. Our view would be that they're still worried about deflation. Commodity prices help
Europe a little bit, but at best, we're expecting something like 1% to 1 1/4% growth this year.
Japan-- still misfiring. Lots of concerns about the amount of stimulus that they've put in there and
got no action. If I had to pick a couple of economies, though, that really matter for Australia, the two
I'd pick would be the US and China. And for me, the good news is that both of those economies look
pretty solid.
For the US, domestic demand's growing around 3%. Put that in context, Australian domestic
demand's growing around 1%. And so the real reason why unemployment's going down in the US is
their domestic economy's looking pretty good. And we think as we go through the middle of this
year-- maybe a little bit after June-- the Reserve will start increasing rates.
But China-- Jeff's going to probably talk more about China. But I'm basically pretty relaxed about
China. I think the focus is on quality of growth, slowing down some of the growth in housing and
also slowing down some of the growth in debt.
China normally, with these big falls in commodity prices, would actually have growth rates about
half a percent higher because of the fall in commodity prices. I don't think too many of us are game
enough to say that. So we're expecting growth in China somewhere around about 7% this year and
something like a little bit less than that next year. So medium term, that's fine.
Last comment I want to say about China, it is the second-biggest economy of the world. It grows at
7%. It's demand for commodities is very large. And in a very simple sense, it takes them a year and
a half to create a new career. So it's a big economy.
And then India are starting to pick up, as well. So lots of confidence coming through the new prime
minister. But growth rate's around 6 1/2%. So a really mixed economy.
Just one comment about commodity prices, particularly iron ore and oil-- what's behind it? Is it a
crash in the world economy? No.
Left-hand side is basically just showing Australian exports of iron ore. And the growth rate in red is
above 20%. BHP and Rio are basically flooding the market. And so what's happening there is they
know that there's a huge amount of supply coming on. And they're basically saying, well, we might
as well supply it because essentially, they can land iron ore into China sub $40 at a term.
Oil-- same sort of concept. What's happening there, if you can see the red line there, that's US
production of oil. Very large increases in the amount of rigs over there, and also, you've got the
shale coming on and the fracking, et cetera.
None of the others are prepared to basically blink. So if you like, Russia is trying to get as much as
they can out. They've got a few problems. And the Saudis are basically saying, well, we're going to
have some short-term pain for long-term gain. So core message to me is these iron ore and oil prices
are going to stay for a long time because of supply effect.
Currency-- always say if I knew exactly what was going to happen to the currency, I wouldn't be
working. Paris is a really nice place. We run fundamental models of where the Australian dollar visa-vis the US dollar is. Things that matter are particularly commodity prices, things like interest rates,
relative levels of unemployment, but also how strong is the US dollar?
Because whilst it might be a lot more expensive to go to the US as a tourist, it's not that much more
expensive to go to Europe. And what we're really seeing is that given the falls in commodity prices
and the falls in Australian turns of trade, the dollar around 77 is roughly where it should be. And as
we go forward, our expectations are the Australian dollar will probably go a bit lower. US, you're
going to have increasing rates. We're still having rate cuts here.
And there are essentially capitals flowing back into the US, and it's going to continue. So our views,
I think, are probably not dissimilar to ABARE. But we have basically 74 this year and maybe a bit
higher next year.
What that means in Australian-dollar terms is if you look on the left-hand side there, black is what's
happening in US-dollar terms. And there's been some big falls. In Australian-dollar terms, what
we're saying is that weaker currency will roughly offset the fall in income in Australian dollars. But
you've still got quite significant reductions in the terms of trade.
Just a few comments about where are we today. This is out of our business surveys. So red is
business confidence. That spike in the middle of the graph there was the change of government last
year. You'd probably fair to say that business didn't like the previous government and the
uncertainties.
But as you go forward, what we see is business confidence starting to erode away. The red dotted
line across the middle there is long-run average. So we've got a situation where confidence is below
long-run average. It's not disastrous, but it's below.
The blue line is probably, to some extent, more important. That's how did you actually go-- what
your outcomes were. And they've been getting better over the last 12 months. They spiked up in
October, which we're not sure why. But then they've faded away. So the story is both confidence and
business conditions are quite weak.
Very different according to which industry-- red is confidence. Blue is essentially conditions. And
then you think zero is roughly the trend line. So if you're just drawing out a few things there,
mining-- and particularly mining services-- are very nervous. So the big guys are hurting the small
guys. And also, you're not building as many mines anymore. And so that's having a big impact in
confidence.
Manufacturings is still struggling, as is wholesale. Retail is still struggling, although they're hoping
that the rate cuts are basically going to make life better. So far, I don't think that's true. But they're
hoping.
And then the better sectors tend to be recreation and personal service-- the consumer buying
services. They've got money. And if they need to do things like education, utility bills, they will.
Strength in the finance sector-- very strong confidence in construction. Construction, you have to be
a bit careful. There's a boom going on in apartments. But construction also covers the construction
of mines. So you've got two effects there.
The other thing that I think it's important when you're thinking about Australia is because you're not
getting very much growth in personal income and you're getting reductions in profits, what you get
is the disposable income flowing through the economy has actually turned negative. And I suspect
when we put the national counts out tomorrow, you'll get another negative out of that. So there's not
a lot of income around for a consumer. And the price effects are having big [? end caps ?] in terms
of company profits.
So as we go forward, I think there's three challenges affecting the Australian economy. Number one
has been there for awhile, and that is mining investment. You're moving from a period where there
was a large amount of investment in your mines to a period where you're not going to be invested so
much and you're going to export. Now from a GDP point of view, in the mining sector, that's
neutral. But the size there shows you as a percent of GDP the extent of the fall you're going to have
in mining investment, and it's roughly half of total investments.
So the big issue for Australia is unless you get the non-mining sector to accelerate, particularly in
investment-- or if you like, filling the hole-- you get GDP looks great because you've got all this
growth in exports going on. So it'll generate 2% growth for you. But the rest of the economy will
only grow at 1%. So the number one issue is why are we keeping rates low and people are talking
about rate cuts? Well, basically, because you're trying to stimulate the non-mining sector because
otherwise you have this big problem.
Second issue is the iron ore price, which I said is supply. From a GDP point of view, it's actually
adding to growth because what we're doing is we're increasing huge amounts of volume. But the
price comes down, and the net income that's generated is down about $30 billion per year.
So if you think about that over what they call the forward estimates and the budget planning and
you're taking 20%, roughly, in terms of company tax out of that-- or royalties-- you lose something
like $30 billion over four years for government revenue. You also have very significant impacts in
terms of wealth in the equity markets in those areas. You have a lot of uncertainty. And it's quite
negative in the short term.
The oil price shock is positive, offsetting that. But the timing is different. Oil price shocks take quite
a long time to come through.
If I'm adding all these things up, the first thing I get is a big fall of inflation. So you're going to see a
big fall in the CPI when it comes out in a couple of months time. We're expecting the 12 months to
growth inflation to be flat and core inflation around 1 3/4%. So that's below the Reserve Bank's
target.
Incomes are much lower, as I said. The government can't spend as much. It reduces some demand
for investment if there's less income floating around. And it also makes people nervous, which flows
into how much investment you're going to do.
I think the consumer will have more money because the fall in the oil price. But just at present, what
they're going to do is they're going to pay the banks back. So they're putting it in the banks. And the
other thing you'll get, eventually, if you get rate cuts is you'll get some increase investment in
dwellings. And then finally, what I was saying before is major trading partner growths for Australia
will actually benefit.
So if I'm adding them all together, the sort of growth forecast we had is the dotted that was at the
end of last year. Where are we today? You can see, we've had a sharper V in terms of these growth
numbers. And so tomorrow we get the GDP. For what's it worth, we're expecting about half a
percent.
The other thing, as I said, inflation-- there's the 12 months to growth. The blue is the actual. The red
is some fancy models we all use, including the Reserve Bank's version.
And the bottom line is for the next six months or so, they're right at the bottom. They improve a
little bit next year. But there's no sign of core inflation going anywhere near the top of the target
range. So that gives you the issue about rates.
The consumer, just as a general comment-- savings rates on the left-hand side. Savings rates in
Australia are unusual in the sense that they went from practically nothing, way up high when the
global financial crisis, and essentially have stayed there. Most of the rest of the world, those savings
rates have come back down to normal. So the Australian consumer is still very nervous and worried.
And you see it also when you ask them about what are you worried about. They all say number one
thing is cost of living. And then you go underneath it and say, what's driving your cost of living?
And the red bar is there. I don't know if you can read the bits, but the things that they really hate are
utility, education, housing, finance, transport-- sort of things you've got to have.
What don't they care about up in the blue-- they don't worry about overseas travel. They don't worry
about entertainments, and they don't worry about keeping up with the Joneses. This is very much an
environment where yes, you're giving the consumer more ability to spend, but he may not do it-- or
she.
Housing-- a lot of people talk about housing. The graph on the left-hand side just gives you some
numbers. It's mainly a Sydney-Melbourne story.
And particularly in Melbourne-- you're seeing some on the right-hand side-- some of the heat
coming out of the market is still very strong in Sydney. But there's a very big shortage of supply in
Sydney, and it's an investor market. So the argument about using interest rates to just kill the
investor market in Sydney and Melbourne is a bit more tricky because if you go outside those cities,
it's a much weaker housing market.
And in terms of our expectations, the left-hand side just shows some fancy models that say
something around about 5% growth in house prices. We're actually a bit weaker than that in our own
forecasts. The other way we can look at housing price-- we go out and we ask 400 professionals,
what do you think? And they actually think about 2%. They're very bearish in the west, which is the
blue line.
So overall, what I'm saying is housing, we expect to slow. And it is slowing now. And it will
continue to slow.
One thing that's not slowing is basically the investment in apartments that's going on. If you look on
the left-hand side, the black line shows the number of houses that are approved by local government.
And then the dark red line there is the number of apartments.
For the last 30 years, four houses get approved for one apartment. Where are we today? It's almost
one for one. And if the pinky line underneath that-- they're apartments that are more than four
stories.
So what's really happening in Sydney, Melbourne, Brisbane-- they're building towers of apartments.
And a lot of it is foreign. You just had some changes in the law. But no one knows exactly how
much because previously, you didn't have to go to Foreign Investment Review Board if it's new.
But in grey bars there, about 16% of new apartments, we think-- or the developers who are
producing it, say-- are by foreigners. And the black line that's going through the roof there-Melbourne, where they're talking somewhere north of 30% of every new apartment is foreign. Now
whilst you have a lot of social implications there about whether they turn the lights on, et cetera, et
cetera, they are building them.
And they're going to keep building them for a while. So if you like, some of the constructors that
were previously building mines are now building apartments. So that's some of the adjustment.
The other thing-- and this is an attempt to say, why are we worried about the mining or non-mining
investment coming back? This is capacity utilisation. The black dots are showing where capacity
utilisation currently are in January. The zero line is the long-run average. And the red bars there are
where they've been over the last five years.
And as a rough rule, construction is above capacity utilisation. So is finance and business services-the rest of them essentially at below capacity. So what that means is if you're not that certain about
what things are happening and you get an increase in demand, all you do is run your machine faster.
You don't go out and borrow. You don't go out and invest more.
And so that's the dynamic that I think Australia's facing. So we get this sort of problem. Red is GDP.
Blue is domestic demand. And so unless you're owning an L&G platform or an iron-ore mine or a
coal mine or whatever, you're living in a world of 1%. 1% growth is not enough, domestically, to
generate enough jobs to keep unemployment where it is.
So left-hand side there, we just have a long-run relationship between growth of employment in our
survey and what they statisticians are publishing. The key messages there as we lead out seriously is
what, about six months? And it's saying, on average, you're going to generate 15,000 jobs a month.
You need somewhere north of 20,000 to keep unemployment where it is. And so what we get in the
blue line on the right-hand side is unemployment going up to about 6.6%, 6.7%, compared to where
we are today.
Just went off.
The last thing I was going to say was on interest rates, I think the Reserve Bank is nervous because
they're looking to lower their basic growth numbers. They have very low inflation.
And as we look forward, they're basically saying, well, the economy's not picking up like we were
hoping it would, and we're going to give it some help. So that's what I think they did in February. I
don't know what they're going to do this afternoon. But I do know that sometime in the next couple
of months, they'll be cutting again.
And our view is there's probably a 30% chance they'll cut twice more this year. That's going to
depend on where the unemployment level is. And as we go forward, the only thing that's offsetting
that is if house prices start to re-accelerate.
So my bottom line on this strained economy is it's OK. It's not going to be as good as the GDP
numbers look. And the Reserve Bank is probably quite concerned about trying to give a bit of a
stimulus. I'll stop there. Thank you.