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Quarterly Economic Report – July 2015
Thursday, 2 July 2015
Executive Summary
The Australian Economic Outlook
•
The global backdrop remains positive with the US economy improving gradually, China
continuing to grow at a firm pace and quantitative easing in Europe and Japan supporting the
prospect of better growth over the next two years.
•
A lift in exports, ongoing low interest rates, the need to replace capital stock, continued housing
and infrastructure construction and the tailwind of a lower AUD are expected to see Australia’s
economic growth pick up to 3.2% annual growth at the end of 2016.
The Outlook for Interest Rates
•
We expect the RBA to leave its cash rate on hold this year, before beginning to increase interest
rates in late 2016, provided the growth outlook unfolds as expected.
•
US bond yields are forecast to rise in coming months. Australian long-term bond yields are
expected to track this move. We believe the rise in bond yields will be limited to some extent by
quantitative easing programmes in Europe and Japan.
The Outlook for the Australian Dollar
•
After sliding in late 2014 and early 2015, the Australian dollar has stabilised within the range of
US$0.76-$0.79 in recent weeks. Mixed US and domestic economic data and broadly steady
commodity prices have been the major factors influencing the Australian dollar.
•
A soft first quarter for the US economy and the stabilisation of Chinese growth have reduced the
short-term downside risk for the AUD. However, rising official US interest rates are still expected
to weigh on the AUD. We remain comfortable with our long-held forecast for the Australian
dollar to end 2015 at $0.73, and end 2016 at $0.75.
Consumer Price Index
Australian GDP Growth
(annual % change)
(annual % change)
20
10
8
16
6
12
4
8
2
0
4
-2
0
-4
-6
1970
1980
1990
2000
2010
2020
-4
1970
1980
1990
2000
2010
2020
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Quarterly Economic Report – July 2015
The Outlook for the Australian Economy
The Australian economy is currently travelling at a sub-trend pace. This trajectory seems likely to
continue for the remainder of 2015 before picking up in 2016.
Aggregate figures, however, are deceptive. Parts of the Australian economy are booming while
others are in distress. The housing construction sector is doing well, particularly in NSW and Victoria
while mining services and parts of the engineering construction sector are facing difficulties.
The Australian economy is more diverse and complex than the headlines often make out. There are
always sectors and businesses that are performing well and always others that struggle.
We expect economic growth in 2015 of 2.4% rising to 2.9% in 2016. Why? Ongoing population
growth stimulates demand for goods and services. A mixture of immigration and natural population
growth has seen Australia’s population grow by 330k over the past twelve months. Further
population growth is expected in 2016, lifting the demand for food, clothing, housing, transport,
health services and entertainment to name a few.
The Australian dollar (AUD) has fallen 17% against the US dollar over the past twelve months. While
the lower AUD is not a ‘silver bullet’, it does provide a tailwind for exporters and businesses that
compete against imports. Just as the stronger AUD made life difficult for manufacturers,
agribusinesses, the tourism sector and the international education sector, so a weaker AUD will
work in the opposite direction. It will save and create jobs. As the Reserve Bank has noted, a weaker
AUD is ‘likely and necessary’ for the Australian economy to adjust following the boom in resource
related construction activity.
A further slowdown in the resources related construction sector should see fewer imports of large
capital equipment. As mines and processing facilities are completed, there will be a commensurate
lift in exports of resources such as iron ore, coal and LNG. The prices might be lower than initially
expected but the volumes are set to increase.
As exports increase and the growth in imports moderates, so the trade sector is expected to add to
economic growth. Trade will also be assisted by steady growth in our major trading partners.
A major factor causing sub-trend growth in Australia is the lack of non-mining business investment.
The boom in mining investment over the past five years is coming to an end. In order for the
economy to register growth close to trend, this investment needs to be replaced. At present this is
not happening.
The dearth of non-mining investment is not just an Australian phenomenon. Following the GFC,
many advanced economies have seen business investment stagnate. Business had ‘tooled up’ prior
to the GFC and now many sectors have excess capacity. Unless current and expected demand
increases, businesses will perceive few profitable avenues for expansion. This should change over
time. Equipment wears out, IT systems become dated, competitors move in and new products are
developed.
Contributing to weak demand across Australia and in other economies has been the tendency to
clamp down on government spending. The urge to cut spending and avoiding borrowing to invest in
infrastructure have served to reduce demand in the economy. In Australia, the policy of asset
recycling is going part of the way towards addressing demand and infrastructure issues, as are the
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Quarterly Economic Report – July 2015
decisions of State governments to moderate the pace at which they plan to achieve, or lift, budget
surpluses.
Are low interest rates working to boost the economy? Let’s remember that the Australian economy
has not seen a recession since the early 1990s. We must be doing something right or we really are
the ‘Lucky Country’. Monetary policy i.e. movements in the RBA cash rate, never operates in
isolation and it is usually best for an economy to have all arms of policy well understood and
working in the same direction. Sadly this has not been the case in Australia for the past few years
with monetary stimulating the economy and fiscal policy effectively holding the economy back.
The RBA cash rate is at the historically low rate of 2.00%. We expect it to remain this low until the
last quarter of 2016. There remains an outside chance it may move lower but this is not our base
case (see the section on interest rates below).
The low cash rate has contributed towards a firmer sharemarket and investment in housing as those
with savings seek better returns. Asset prices have risen, thus forming a base from which
consumption can increase. As yet, consumers are hesitant to spend but as the pain of the GFC
recedes, stronger demand from consumers is expected.
Low interest rates may, eventually, affect/reduce the hurdle rates required by businesses before
they invest. One factor identified as holding back business investment has been high hurdle rates. If
we are indeed in a world of sustained low interest rates, a case can be made for reducing hurdle
rates on projects. This, in turn, could see a lift in business investment over time.
A disappointing and disturbing impact of slow economic growth is a rising rate of unemployment.
Rates of economic growth below 3.0% tend to see the unemployment rate rise even though jobs
are being created. This relationship leads us to suspect that the unemployment rate in Australia
could rise to around 6.4% before gradually falling later in 2016 and into 2017.
Inflation has been well contained in Australia. With wage growth of around 2.4% and slowly rising
productivity, there is little upward pressure on inflation. We expect this continue well into 2016.
A table containing our key forecasts is on page 9.
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Quarterly Economic Report – July 2015
The Outlook for Interest Rates
Low Interest Rates Assisting Growth
The Reserve Bank of Australia has cut interest rates twice this year, in February and May. Monetary
policy is accommodative, with the official cash rate now at 2.0%. Economic growth in Australia is
below its long term trend and is likely to remain so into next year.
Interest rate cuts this year, however, have supported consumer spending and dwelling investment.
The mining investment boom is now paying dividends in the form of increased productive capacity
and strong export growth. The lower Australian dollar (AUD) is also providing support for some
sectors of the economy. Despite these positives forces, economic growth remains lacklustre.
Businesses Still Reluctant to Invest
The transition from mining-investment-led growth, to an economy driven by non-mining investment
is proving to be a slow process. Despite historically low interest rates, businesses are reluctant to
invest and are waiting to see a sustained pickup in demand. The process has become somewhat of
a vicious circle, as lacklustre economic growth and slow wages growth are keeping consumer
demand in-check. What will be the circuit breaker?
It is hoped measures in the Federal Budget to support small businesses will help boost business
investment and retail spending. Additionally, interest rate cuts delivered in the first half of this year
have not yet had time to fully impact the economy and the lower AUD should continue to support
economic growth.
Australian & US Bond Rates
Australian Cash & Swap Rates
(weekly data)
%
9
(monthly data)
%
12
Australian
10-Year Bond
Rate
7
9
5
6
3-Year Swap
Rate
RBA Cash
Rate
3
3
US 10-Year
Bond Rate
GFC lows
1
Jan-00
0
Jan-03
Jan-06
Jan-09
Jan-12
Jan-15
Jan-18
94
97
00
03
06
09
12
15
18
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Quarterly Economic Report – July 2015
Inflation Remains Low
The modest global growth environment and a sharp decline in the price of oil in the second half of
last year have conspired to keep inflation low. Inflation has not been an impediment to interest rate
cuts. Even with low interest rates and the lower AUD (which tends to be inflationary as import
prices rise) inflation is expected to remain within the RBA’s 2-3% target band over the next two
years, with low wages growth helping to keep inflation contained.
Housing Market a Factor
Imbalances in the housing market remain a consideration for monetary policy. However, strong
growth in house prices and lending for housing investors remain predominantly a Sydney issue, and
to a lesser extent Melbourne. It appears the RBA is closely watching the housing market, and
investor lending in particular, but continues to rely on measures by APRA to contain these risks.
Global Bond Yields
After hitting record lows earlier this year, global bond yields have lifted somewhat over the past
month. The prospect of a rate hike in the US this year and diminished concerns about the risk of
deflation have pushed US and global bond yields higher. US bond yields are expected to rise in
coming months and Australian long-term bond yields will track this move. The rise in bond yields
should be limited to some extent by quantitative easing programmes in Europe and Japan. These
will act to increase demand for government bonds and hence keep a cap on bond yields globally.
Effectiveness of Monetary Policy
RBA officials have recently expressed reservations about the effectiveness of monetary policy,
suggesting there is now a higher hurdle for further interest rate cuts. While comments from RBA
officials suggest concern that monetary policy may be less effective at low levels of interest rates,
they indicate that monetary policy is not ineffective; saying that it still provides additional support
to demand.
Interest Rate Forecasts
We expect the RBA to leave official interest rates on hold this year, before beginning to increase
interest rates in late 2016, provided the growth outlook unfolds as currently expected. The soft
growth outlook and the RBA’s acknowledgement that “monetary policy needs to be
accommodative” suggest a risk of a further rate cut if the outlook deteriorates. However, there is a
higher hurdle for further interest rates cuts.
With two interest rate cuts under its belt this year, the RBA is still waiting to gauge the full impact of
these on the economy. Consumer spending and dwelling investment have lifted as a result of the
low interest rate environment. Economic growth is below trend, however, low interest rates, the
low AUD measures from the Federal and some State Budgets are expected to support economic
growth. We therefore expect economic growth to pick up from mid-2016 and for the next move
from the RBA to be a rate hike, although that move is still some way off.
Our full interest rate forecasts can be found on page 9.
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Quarterly Economic Report – July 2015
The Outlook for the Australian Dollar
Recent Movements in the Australian Dollar
After sliding in late 2014 and early 2015, the Australian dollar (AUD) has stabilised within the range
of US$0.76-$0.79 in recent weeks. The currency’s movements generally tracked commodity prices
lower earlier in the year, before stabilising more recently. In particular, spot iron ore prices slid
earlier in the year, but then edged higher over April and May.
Other factors influencing the AUD have been the mixed economic data in Australia and the US.
Domestically, the outlook continues to be for below trend economic growth for the next year. This
is despite some positive surprises of late. Stronger-than-expected GDP growth in the March
quarter, a recent improvement in the labour market and a positive public response to the Federal
Budget in May have given the AUD some support.
In the US, a contraction in GDP over the March quarter raised doubts about the strength of the US
economic recovery, and took a rate hike by the Federal Reserve, as early as June, off the table.
However, the Federal Reserve continues to view most of the early weakness in the year as being
transitory and appears on track to begin raising official interest rates later this year.
Recent signs that growth in China is no longer decelerating have also helped prevent the AUD from
sliding further.
AUD/USD & AU-US 2-Year
Government Bond Spread
AUD & RBA Commodities Index
1.20 1.20
140
6
AU-US 2-Year
Govt Bond
Spread, % (rhs)
1.00 1.00
4
0.80 0.80
2
0.60
0
100
AUD/USD
(rhs)
60
0.60
AUD/USD (lhs)
RBA Commodity Price
Index (SDR Terms) (lhs)
20
Jan-00
Jan-04
Jan-08
Jan-12
Jan-16
0.40
0.40
Jan-95
-2
Jan-01
Jan-07
Jan-13
Jan-19
Currency Forecasts
Recent events have reduced downside risks for the AUD, particularly in the near-term. However,
the broader outlook remains unchanged from earlier expectations, and we remain comfortable
with our long-held forecast for the AUD to end 2015 at $0.73.
The risk remains that once the Federal Reserve (the Fed) begins to raise official interest rates, the
US dollar will strengthen. We expect that the first lift in US official interest rates will occur this year,
and believe that the most likely timing will be at the Federal Reserve’s meeting in September.
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Quarterly Economic Report – July 2015
Consensus US growth forecasts for this year have been downgraded significantly from 3.0% earlier
this year to 2.2%, largely due to the one-off contraction in growth in the March quarter. However,
economic activity appears sufficiently strong to expect that the economy will reach fullemployment by the end of the year. The Federal Reserve would be keen to begin normalising policy
in such an environment as signalled in recent commentary by Fed speakers. By historical
comparison, the Federal Reserve began raising official interest rates in its last tightening cycle when
the unemployment rate was on its way down and stood at around 5.6%, although circumstances
are different this time around.
More important for financial markets will be the path of rate hikes rather than the timing of the
first hike. Federal Reserve members have stressed that the normalisation process will be gradual,
however, markets and Fed officials continue to differ in their views of what “gradual” means.
Median forecasts of Fed officials suggest a Fed funds rate of 0.625% by the end of the year, up from
the current target range of 0-0.25%. For the end of 2016, Fed forecasts imply a Fed funds target of
1.625%, therefore suggesting at least 100 basis points of tightening next year. However, interest
rates futures continue to imply a more conservative path of monetary tightening, implying a Fed
funds rate of just 0.32% by the end of 2015 and 1.09% by the end of 2016. At some point, the views
of the Fed and market will need to converge and poses the risk that the US dollar will appreciate.
Expectations for the Fed Funds Rate
(Effective rate, %)
US Unemployment Rate
11
%
2.0
9
1.5
Beginning of last
Fed tightening
cycle
MId-point of Projections
from Federal Reserve
7
1.0
5
0.5
Market pricing
Implied by Fed fund
futures
0.0
Current
End Dec-15
End Dec-16
3
Jan-95 Jan-98 Jan-01 Jan-04 Jan-07 Jan-10 Jan-13 Jan-16
Domestically, it remains uncertain whether the pace of economic growth will lift closer to trend,
especially given a weak outlook for business investment. The subdued outlook suggests that further
rate cuts by the RBA remain a possibility. We believe that the foundations for recovery have been
laid, and that the economy will pick up sufficiently for the RBA to leave rates on hold well into
2016. Interest rate futures are pricing in a 66% chance of another 25 basis point rate cut by the end
of 2015. This suggests that the AUD could receive some support, if it becomes clearer that the RBA
is done cutting rates as we expect.
The outlook for commodity prices also suggests limited scope for a higher AUD. The prices of most
commodities have stabilised in recent months. Indeed, iron ore prices have risen 23% from their
recent lows earlier in the month. However, strong increases in supply over the next few years
suggests that commodity prices are unlikely to increase much further.
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Quarterly Economic Report – July 2015
Beyond 2015, we expect the Australian dollar to continue to weaken slightly throughout the first
half of 2016, before strengthening over the second half. By then, we expect the domestic economy
will have improved, and markets will begin pricing in the possibility of rate hikes in late 2016.
Upward pressure on the AUD coming from an improving domestic economy is however, likely to be
mitigated by further official rate increases by the Federal Reserve.
Risks
We see the risks to our AUD forecasts as roughly balanced. Both downside and upside risks exist.
The key downside risk to our forecast would be the failure of domestic growth to pick up as
expected and the RBA then deciding to cut official interest rates. However, a key upside risk for our
AUD forecast would be if the Federal Reserve takes a more cautious approach than expected and
further delays rate hikes. This would suggest a weaker US dollar than assumed.
The Chinese growth outlook and commodity prices are also uncertainties. While our core view is
that recent stimulatory policy measures will act to support Chinese economic activity, the
construction overhang within the property sector could continue to weigh on demand for key
commodities. Strong global supplies of commodities also suggest that further declines in
commodity prices are possible. This would point to further weakening in the AUD over the longer
term.
Developments in Greece also pose a large risk to near-term forecasts. While movements in
currencies have been surprisingly muted to date, the results of the Greek referendum this Sunday
will likely result in sharp swings within financial markets next week. Any jump in risk aversion as a
result of the situation in Greece could see the Australian dollar come under pressure in the shortterm.
Other Currencies
We expect the AUD to broadly weaken against most other currencies including JPY, EUR and GBP
over the remainder of 2015. Weak economic growth and monetary stimulus in Japan and Europe
will likely limit Aussie’s losses against JPY and EUR, particularly in comparison to the US dollar.
However, we expect the GBP to remain well-supported as the Bank of England (BoE) seems likely to
be the next major central bank to tighten monetary policy after the Fed.
An exception is the AUD against the kiwi. We expect the AUD to continue to strengthen against the
NZD after the Reserve Bank of New Zealand (RBNZ) cut official interest rates in June and is poised
to lower rates again.
Our detailed currency forecasts can be found on page 9.
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Quarterly Economic Report – July 2015
Major Upcoming Data and Events
Australian Data / Events Underlined
July
th
August
th
1 China Manufacturing PMI Jul
th
3 US ISM Manufacturing Jul
th
4 Aust Retail Sales Jun
th
4 Aust RBA Cash Rate Decision
th
6 Aust Labour Force Jul
th
7 US Non-farm Payrolls Jul
nd
9 China CPI Jul
th
11 Aust NAB Business Survey Jul
th
12 WBC – MI Consumer Confidence Aug
th
12 Aust Wage Price Index Q2
14 US Retail Sales Jun
st
1 China Manufacturing PMI Jun
15 WBC – MI Consumer Confidence Jul
st
15 China Retail Sales Jun
st
15 China Industrial Production Jun
1 Aust Building Approvals May
1 US ISM Manufacturing Jun
rd
nd
15 China GDP Q2
rd
15 US Industrial Production Jun
2 US Non-Farm Payrolls Jun
3 Aust Retail Sales May
th
17 US CPI Jun
th
22 Aust CPI Q2
7 Aust RBA Cash Rate Decision
9 Aust Labour Force Jun
th
9 China CPI Jun
th
14 Aust NAB Business Survey Jun
th
th
th
th
th
30 US GDP Q2
th
th
th
29 US FOMC Rate Decision
10 Aust Housing Finance May
st
th
30 Aust Building Approvals Jun
Forecasts
2015
End Period:
2016
Q1
Q2
Q3 (f)
Q4 (f)
Q1 (f)
Q2 (f)
Q3 (f)
Q4 (f)
RBA Cash Rate, %
2.25
2.00
2.00
2.00
2.00
2.00
2.00
2.25
90 Day BBSW, %
2.23
2.13
2.15
2.15
2.15
2.15
2.30
2.55
3 Year Bond, %
1.70
2.02
2.20
2.40
2.40
2.60
2.70
3.00
10 Year Bond, %
2.32
3.01
3.10
3.20
3.30
3.40
3.70
3.80
Interest Rates:
USD Exchange Rates:
AUD-USD
0.7607
0.7707
0.7600
0.7300
0.7200
0.7300
0.7400
0.7500
USD-JPY
120.13
122.50
124.00
125.00
126.00
126.00
128.00
130.00
EUR-USD
1.0730
1.1147
1.1000
1.0600
1.0400
1.0300
1.0200
1.0000
GBP-USD
1.4818
1.5712
1.5300
1.5200
1.5500
1.5700
1.5800
1.6000
USD-CHF
0.9730
0.9360
0.9500
0.9700
0.9700
0.9700
0.9800
0.9800
USD-CAD
1.2690
1.2490
1.2800
1.2900
1.3000
1.2800
1.2800
1.2800
NZD-USD
0.7470
0.6765
0.6600
0.6300
0.6200
0.6200
0.6200
0.6300
USD-CNY
6.1997
6.2010
6.2200
6.2400
6.2400
6.2200
6.2000
6.1800
USD-SGD
1.3723
1.3474
1.3600
1.3800
1.4000
1.4100
1.4100
1.4100
AUD-USD
0.7607
0.7707
0.7600
0.7300
0.7200
0.7300
0.7400
0.7500
AUD-EUR
0.7090
0.6910
0.6910
0.6890
0.6920
0.7090
0.7250
0.7500
AUD Exchange Rates:
AUD-JPY
91.40
94.40
94.20
91.30
90.70
92.00
94.70
97.50
AUD-GBP
0.5130
0.4910
0.4970
0.4800
0.4650
0.4650
0.4680
0.4690
AUD-CHF
0.7400
0.7210
0.7220
0.7080
0.6980
0.7080
0.7250
0.7350
AUD-CAD
0.9650
0.9630
0.9730
0.9420
0.9360
0.9340
0.9470
0.9600
AUD-NZD
1.0180
1.1390
1.1520
1.1590
1.1610
1.1770
1.1940
1.1900
AUD-SGD
1.0439
1.0384
1.0336
1.0074
1.0080
1.0293
1.0434
1.0575
2014
2015 (f)
2016 (f)
* Note that the AUD cross exchange rates have been rounded.
2013-14
2014-15 (f) 2015-16 (f)
GDP, %
2.5
2.4
2.6
2.7
2.4
2.9
CPI (Headline), %
2.7
1.8
2.2
2.5
1.7
2.5
CPI (Underlying), %
2.6
2.4
2.5
2.6
2.4
2.5
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Quarterly Economic Report – July 2015
Contact Listing
Chief Economist
Senior Economist
Senior Economist
Hans Kunnen
[email protected]
(02) 8254 8322
Josephine Horton
[email protected]
(02) 8253 6696
Janu Chan
[email protected]
(02) 8253 0898
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