Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 284

A surprise domestic growth slowdown

Growth in the Australian economy slowed to 2.8% in the September quarter. There were a number of significant developments in the GDP report.

Firstly, we saw the first 'negative' on new dwelling construction in the quarter following a particularly strong first half. Westpac expects this will be the start of a long run of falls in residential construction reflecting the downturn in dwelling approvals and the expected further contraction as tight funding conditions and falling house price expectations deter both demand and supply of new construction.

Secondly, we saw a particularly weak print on consumer spending reflecting weak income growth (real household disposable income was flat over the year to date) and a decade-low savings rate.

Wages growth is lifting only very slowly while strong employment growth is expected to slow in 2019 as political uncertainty and global tensions in trade and softening demand weigh on the confidence of business. There is also likely to be some wealth effect on consumption through 2018 H2 and 2019 as the impact of falling house prices on households’ balance sheets plays out.

Non-residential construction is also falling – down from the surge in activity we saw in 2017, although we expect this to stabilise through 2019.

Weak second half of 2018 will feed into 2019

Overall, we expect growth in 2018 will print around 3% with the 4% annualised momentum in the first half slowing to 2% in the second half. That weak second half momentum will weigh on 2019. We expect growth to slow in 2019 to 2.6% following ongoing contraction from new dwelling construction; continuing below trend growth in consumer spending; and uncertainties around the Federal election and the global economy.

House prices will be important in 2019. Even though prices have fallen by 9.6% from their peak in Sydney and 5.8% in Melbourne, these adjustments follow cumulative increases in Sydney (40%) and Melbourne (32%) over the previous four years. Affordability is still stretched in both cities.

Unlike previous cycles where affordability was boosted by sharp reductions in interest rates and strong (4% wages growth) income growth, the necessary restoration of affordability in this cycle will need to come from prices.

The additional complication is that even if affordability has been restored and buyers are attracted back into the market, credit is being tightened by the major banks. As we have recently seen in Perth, affordability can be restored but prices can still fall further if credit is tightened.

On the positive side there are other construction cycles which are likely to continue to boost growth. Government infrastructure spending, in particular, continues to lift; we are at the bottom of the mining investment cycle and positive prospects particularly around iron ore and lithium are boosting investment plans.

The September quarter GDP print will come as a disappointment to the Reserve Bank. Recall that in the Governor’s Statement on Tuesday, he noted that “one continuing source of uncertainty is the outlook for household consumption”.

Note that the Bank’s forecast for GDP growth in 2018 which appeared in the November Statement on Monetary Policy was 3.5%. With the first three quarters of the year totalling 2.2%, the December quarter would have to print growth of 1.3% (a 5.2% annualised growth pace) – a highly unlikely event. We can expect the Bank to lower its forecast for GDP growth in 2018 from 3.5% to 3.0% when it next releases its forecasts on February 8, 2019.

That forecast will then challenge the 2019 forecast of 3.25% which appeared in the November Statement. It was reasonable for the Bank to assume some slowing between 2018 and 2019 (Westpac’s growth forecast for 2019 has been 2.7%) particularly with a more clouded outlook for global growth and a likely accelerated contraction in residential investment. That would immediately push the likely 2019 forecast back to around Westpac’s forecast of 2.7%.

So, although we did not get a growth assessment from the Deputy Governor in his speech on Thursday, the GDP print is likely to change the Reserve Bank’s growth rhetoric of strongly above trend to slightly above trend drifting back to trend in 2019.

Westpac has consistently forecast that the cash rate would remain on hold through 2019 and 2020. If we are right that the Bank will revise down its growth forecasts on the basis of this result, then lower expected growth momentum going into 2020 may also temper the Bank’s attitude to rates in 2020 as well.

From our perspective, a central bank forecasting growth around trend rather than well above trend is much less likely to feel the 'responsibility' to normalise rate setting.

The market is too cautious on the Federal Funds Rate

With this domestic growth profile as a backdrop, we confirm our long-held views that the Reserve Bank will keep the cash rate on hold through 2019 and 2020. The RBA's on hold decision will also be backed up by slowing global growth, particularly in 2020 when the US economy will slow back to trend growth of around 1.75%- 2.0% from an above trend 2.5% in 2019 and near 3% in 2018.

Furthermore, the first half of 2019 will see markedly faster growth than the second half when, in particular, the interest rate sensitive parts of the economy (housing and durables) will be weak and employment growth will slow. Despite the fading of the tax cuts, we believe rising wages and strong employment growth will boost household incomes in 2019, supporting solid consumer spending, particularly in services.

Unlike current market assessments of a potential inverse yield curve, we expect that the Federal Reserve will be able to pause earlier than has been experienced in previous cycles ensuring that soft landing. With this growth profile in mind, we expect that the last hike from the FOMC will be in September 2019. By that time, employment growth will have slowed from 2% in the second half of 2018 to 1%, providing the FOMC with the opportunity to go on hold around a neutral setting – full employment; trend growth; and 2% inflation.

That timing implies four more hikes, beginning in December 2018. Markets are currently pricing one hike in December 2018 and less than one more through 2019, indicating that we expect a sharp market surprise around the policy approach from the Fed.

In turn, this 'surprise' is likely to see higher US bond rates and a stronger US dollar. We have slightly lowered our expectation that the US 10-year bond rate expecting a peak of 3.4% by the second half of 2019 and the USD Index will appreciate a further 3-4% by the September quarter. The time for a sustainable fall in bond rates and the USD will be around the time of the FOMC pause, rather than the current circumstances when the US economy is growing near 3% and wage inflation risks are apparent.

Trade policy and China are major risks

Markets are too influenced by the recessions that followed the last two rate hike cycles of the Federal Reserve. These resulted from unique imbalances – the bursting of the dot com bubble and the GFC. No such comparable risk presents itself in this cycle, including trade policy, although ongoing tensions will unnerve markets It seems unlikely that the Chinese authorities will be prepared to make the specific changes to their industry and trade policy that would specifically satisfy the US needs. These would include changes to forced technology transfer, intellectual property protection, non-tariff barriers, forced joint venture investment, cyber intrusions and government industry subsidies.

Consequently, trade disruptions are a certain theme through 2019 although President Trump and China are likely to find ways to avoid the US imposing tariffs on the remaining (around $200 billion, mainly consumer goods compared to the current tranche which is only around 25% consumer goods) imported to the US from China that are not affected by tariff decisions to date. However, we believe the most recent 10% tariff on $200bn will be increased to 25% before mid-year.

We have seen that trade concerns have also weighed on the Chinese economy. Other more significant drags on Chinese growth have been winding back the shadow banking system and pollution policy. Credit policies to direct more growth into the regulated banking system; a more liberal approach to pollution policy; and direct fiscal stimulus will all be used to maintain a managed slowdown in China. We are targeting a 6.1% growth rate in 2019 from 6.4% in 2018.

Other regions are less important to the overall global view. Emerging markets will suffer under the weight of rising US interest rates and a higher USD. Japan will be preparing for the introduction of a new consumption tax and Europe will be impacted by the China/emerging markets slowdown; supplemented by Brexit; Italian instability; political unrest in France and Germany; and a gradual tightening of monetary policy as the ECB halts its balance sheet expansion from the beginning of 2019.

 

Bill Evans is Chief Economist at Westpac.

RELATED ARTICLES

Changed visions: 2021 New Year resolutions

Soft labour market's impact on retirement outcomes

I will survive! Investing amid structural change

banner

Most viewed in recent weeks

Lessons when a fund manager of the year is down 25%

Every successful fund manager suffers periods of underperformance, and investors who jump from fund to fund chasing results are likely to do badly. Selecting a manager is a long-term decision but what else?

2022 election survey results: disillusion and disappointment

In almost 1,000 responses, our readers differ in voting intentions versus polling of the general population, but they have little doubt who will win and there is widespread disappointment with our politics.

Now you can earn 5% on bonds but stay with quality

Conservative investors who want the greater capital security of bonds can now lock in 5% but they should stay at the higher end of credit quality. Rises in rates and defaults mean it's not as easy as it looks.

30 ETFs in one ecosystem but is there a favourite?

In the last decade, ETFs have become a mainstay of many portfolios, with broad market access to most asset types, as well as a wide array of sectors and themes. Is there a favourite of a CEO who oversees 30 funds?

Meg on SMSFs – More on future-proofing your fund

Single-member SMSFs face challenges where the eventual beneficiaries (or support team in the event of incapacity) will be the member’s adult children. Even worse, what happens if one or more of the children live overseas?

Betting markets as election predictors

Believe it or not, betting agencies are in the business of making money, not predicting outcomes. Is there anything we can learn from the current odds on the election results?

Latest Updates

Superannuation

'It’s your money' schemes transfer super from young to old

Policy proposals allow young people to access their super for a home bought from older people who put the money back into super. It helps some first buyers into a home earlier but it may push up prices.

Investment strategies

Rising recession risk and what it means for your portfolio

In this environment, safe-haven assets like Government bonds act as a diversifier given the uncorrelated nature to equities during periods of risk-off, while offering a yield above term deposit rates.

Investment strategies

‘Multidiscipline’: the secret of Bezos' and Buffett’s wild success

A key attribute of great investors is the ability to abstract away the specifics of a particular domain, leaving only the important underlying principles upon which great investments can be made.

Superannuation

Keep mandatory super pension drawdowns halved

The Transfer Balance Cap limits the tax concessions available in super pension funds, removing the need for large, compulsory drawdowns. Plus there are no requirements to draw money out of an accumulation fund.

Shares

Confession season is upon us: What’s next for equity markets

Companies tend to pre-position weak results ahead of 30 June, leading to earnings downgrades. The next two months will be critical for investors as a shift from ‘great expectations’ to ‘clear explanations’ gets underway.

Economy

Australia, the Lucky Country again?

We may have been extremely unlucky with the unforgiving weather plaguing the East Coast of Australia this year. However, on the economic front we are by many measures in a strong position relative to the rest of the world.

Exchange traded products

LIC discounts widening with the market sell-off

Discounts on LICs and LITs vary with market conditions, and many prominent managers have seen the value of their assets fall as well as discount widen. There may be opportunities for gains if discounts narrow.

Sponsors

Alliances

© 2022 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.