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Business Outlook: US recovery accelerating

Deloitte Access Economics


28 January 2014

  • The global economy’s recovery went soggy as governments wound back stimulus and central banks reached limits on how cheap they could make money.  Add in more sustainable growth in emerging economies, and 2013 wasn’t a year to remember.  And there are new risks ahead, including a tapering pace of central bank support.  Yet cautious optimism is the right call:  we still see the US recovery accelerating, Japan better than it was, Europe avoiding its pitfalls, and China hitting current growth targets.  That should be enough to generate a modest lift in global growth, and may also get Australia’s major trading partners back to trend growth in 2014.

  • The dollar is finally starting to take its foot off the throat of Australia’s economy, while the Reserve Bank has done everything shy of shouting the bar in an attempt to get a party started in retail and in housing construction.  Add in good news from the US and solid news from China as well as the growing dividend in export volumes from the nation’s new mines, and there are some powerful positives in play for the Australian outlook.

  • Yet there are key negatives too, with the big daddy of those being the ‘construction cliff’:  resource-related construction has peaked, and its fall from heady heights will hurt an Australian economy where businesses are already facing soft revenues and stagnant profits.  Add in continuing caution from corporates and families and the potential for modest Federal Government cutbacks to address a Budget black hole, and that backdrop for business should keep overall Australian economic growth a bit below trend through to late 2015.

  • A weak economy means weak inflation. Headline CPI growth will be subject to one offs around energy prices (carbon and gas price effects) and cigarettes (due to tax hikes).  These special effects will add a little to overall inflation – but not much.  Stripped of these effects, the story we’ve been telling for a while remains evident:  inflation just isn’t a short term worry in Australia.  The ‘construction cliff’ will keep the economy subdued, and hence little threat of passing pricing power to businesses.  And it will also keep job growth on a leash, and therefore wages too.  Moreover, although it’s unlikely that wage growth will stay near its current record lows, we don’t project it to recover fast.  Finally, it is true that the fading $A is adding to price pressures, but a drooping $A won’t offset the benign impact on inflation of a weak economy and weak job growth.

  • The global crisis led to an extraordinary response, with central banks opening the taps on cheap money.  But 2014 will be the year in which money becomes less cheap, first with less money being ‘printed’, and then in 2015 as interest rates rise.  That will mean the crisis is receding.  Yet there’ll be turbulent times ahead for those markets, sectors and nations addicted to cheap credit.  The story is different in Australia, where a weak economy should keep official rate rises at bay until 2015.  Yet there’s a chance that the receding global crisis will take enough pressure off the big banks that they’ll cut rates even if the Reserve doesn’t.  And, either way, with the world’s central banks winding back their stimulus, the $A will remain under pressure in 2014 and 2015.

  • A slower China and resultant lower commodity prices have sapped strength from Australian interest rates.  That has cut the net income deficit (what we pay to foreigners for lending us money and buying our shares), which is also keeping the overall current account deficit low.

  • Job growth is crawling due to the weak economy and the rapid pace of baby boomer retirement.  And that deadly duo of weakness in job demand and worker supply is set to stay around for a while longer as the construction cliff eats into resource-related construction jobs and as the $A is still at job killing levels.  Yet there are important positives too.  First, interest rates will stay low (boosting job prospects in housing construction and in retail), and the $A is less of a headwind than it was.  Second, although rapid retirement is bad news for employment growth, it helps to limit unemployment rates.  The latter may rise above 6%, but not by much.

  • A Budget crisis?  What a surprise.  After all, both sides of politics promised they could sign on to vast new spending at the same time as they carried out a rapid surge back to surplus.  Errr, no.  But don’t get lost in “who’s to blame?” arguments.  Both sides are, having spent a temporary boom on permanent promises.  The focus needs to be on sensible repair.  More effort should be on expenses, where the bulk of Canberra’s bodies are buried.

  • But all programs need to be assessed on merit, rather than just focussing cuts on the newest programs.  And taxes need to be on the table too:  it’s dumb to pretend they can’t be touched.  And while there is no economic hurry to return to surplus, both politics and history suggests that acting early usually works better.

The big levers of sectoral growth are on the move

  • Turning to sectoral growth prospects, announcements from the likes of Holden show that manufacturing is in trouble.  But it already was, having halved as a share of Australia’s economy and workforce in the past three decades.  We project future growth to be even lower than that of the anaemic past, but not hugely so, with the falling $A suggesting that the currency’s job killing role is already weakening, and that it will weaken further.  

  • Yet the big picture is that the slower parts of Australia’s two speed economy – a group which includes not just manufacturing, but also sectors such as retail, tourism, and the utilities – are now strengthening.  This group had their worst year since the GFC in 2013, but its output prospects are on the improve now that the $A is falling, with wealth rising thanks to housing and share prices, and with electricity prices no longer rocketing up.

  • However, at the same time as the slow bit of the economy is getting better, the strong bit is getting worse.  Mining output gains will continue to be huge – but they already are huge, having grown 20% through 2012 and 2013.  In fact although mining growth will remain great as it reaps the rewards of its huge capital outlays, it is unlikely to be quite as great as it has recently recorded.  Rather, the slowdown in the strong bit of the economy is evident in construction, which shrunk in 2013 and looks set to record sub-par performances for some time as the construction cliff unwinds.

  • Meantime, those sectors which are mostly government-funded – the public sector, plus education and health – look set to maintain trend growth despite all the hoopla about government cutbacks.  That is thanks to the extra (and bipartisan) money that has been promised to schools and disability insurance.  Let’s hope it’s all affordable.

State growth differentials will narrow further

  • The ability to sell to Asia has been great for some States, initially boosting profits, then construction, and finally exports.  Yet resource-related construction will tend to fall faster than mining exports will rise, and the latter don’t employ as many people.  That says ‘the bigger the construction cliff, the bigger the risk’.

  • For 2013-14 the sunbelt (the NT, WA and Queensland) is still outperforming States with a manufacturing base and poor demographics (Tasmania, SA, Victoria and NSW).  Yet those gaps will continue to narrow as project completions sap strength from the sunbelt, and as a falling $A and near record low interest rates pep up those States to Australia’s south and east.

    New South Wales
  • Interest rates are low, the $A is fading, housing prices are rising at a rate of knots – and thereby boosting housing construction – and the State Government is spending on infrastructure.  That combination won’t see NSW sprint, but it should keep the State’s growth rate pretty solid.

  • Victoria is the biggest single beneficiary of the latest $A falls.  Yet that good news comes after slowdown has already hit and, although the State faces rather less risk than others from the loss of resource-related construction work, it is unlikely to be travelling too fast in the near term.

  • Queensland is still weighed down by a coal crisis and by State Government cutbacks, but these are becoming less of a drag, while gas development is boosting the economy, and lower interest and exchange rates help too.  That leaves growth prospects better than many realise.

    South Australia
  • Holden may crash but South Australia won’t.  Yes, Holden will hit manufacturing, meaning that neither new sectoral drivers (such as Olympic Dam) or old ones (such as manufacturing) will generate much in the short term.  Yet that points to slow growth rather than none at all.

    Western Australia
  • The bigger they come, the harder they fall.  And Western Australia’s construction boom has been very big, meaning risks are too.  Yet at least exports are coming on line and the State’s thirst for imports is dropping away, meaning that growth should slow notably without cratering.

  • Recent data have been better in Tasmania, but then again it would have been hard for them to be worse.  This State is the biggest victim of Australia’s ‘two speed split’.  The good news is that a lower $A means prospects are improving, but the bad news is those improvements aren’t imminent.

    Northern Territory
  • With one big egg (the Ichthys project) in one small basket, the Northern Territory is growing rapidly, and today’s construction surge will last longer than in other States.  Yet the key is the next round of projects now lining up (or the lack of them) and known negatives (such as Gove).

    Australian Capital Territory
  • Canberra is still growing comfortably, but there are so many public sector job losses already in the pipeline that the new Federal Government has backed away from its promised further cuts.  Yet that merely puts a floor under what may be a modest couple of years in Canberra.

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Deloitte Access Economics
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