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Business Outlook: The construction cliff looms


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22 July 2013:

  • Global growth continues to disappoint, with Europe’s challenges likely to linger, and with Japan’s better news mostly achieved off the back of a lower yen (and hence achieved via cannibalising growth from other nations).  And although China’s growth looks pretty solid, that nation still faces a tricky rebalancing task (as more economists are now joining us in recognising).  Yet our assessment of the globe is essentially positive.  In the main that is thanks to the US, where rising housing markets look like trumping the negatives from public sector cutbacks...see pages 1-10
  • No, this isn’t a recession – coal and iron ore prices would need to fall a lot more for that to happen.  Yet it hurts anyway:  Australia’s annual national income growth peaked at $115 billion in early 2011, but fell to a bare $49 billion in the past year.  And that’s before the ‘construction cliff’ has even had much of an impact.  In addition, although the $A has shed some cents, it still has a big bite, and while State Governments are moderating cutbacks, their earlier decisions are still having an impact.  Finally, commodity prices remain wobbly, reinforcing the caution felt around the Board tables and kitchen tables of the nation.  Yet the outlook isn’t as bad as many think.  If commodity price falls slow, then national income growth will get a second wind.  Recent $A falls will help here too.  Besides, the ‘construction cliff’ has a bark worse than its bite.  Much of the loss in construction spending simply means fewer imports.  Most importantly, the Reserve Bank will keep interest rates lower for longer.  Yet despite these positives, the challenges are large and lingering enough to keep Australian output growth below trend through to mid-2015...see pages 11-31
  • Inflation ranks as the last of Australia’s worries at the moment.  (That’s great, because it allows the Reserve Bank to focus its firepower on generating growth without having to fight a war on two fronts.)  Demand growth has weakened, and many firms lack pricing power.  Wage growth has moved lower too.  Add in some better news on productivity growth, and labour costs don’t signal developing price pressures.  And while a lower $A may add somewhat to import prices in the next few years, that potential problem is not large.  So if you want to worry about something, then worry about Australia’s politicians, not its price pressures.  Meantime, wage growth is also weak – close to its weakest in a decade – and it too is unlikely to recover fast... see pages 54-62
  • We’re happy the world’s big central banks are printing money like it’ll soon go out of style – global growth needs their support.  But this has moved financial markets into uncharted territory, and they could be choppy in 2014 and 2015 as the printing presses stop and interest rates start to rise.  The Reserve Bank has both the motive (a series of challenges to growth prospects) and the opportunity (inflation isn’t much threat) to move interest rates lower.  More important is that, whether or not rates are cut, they’ll stay low for some time.  The $A has finally shed some excess pounds.  Coming years may see it move lower still, eventually settling near US 80 cents… see pages 63-71
  • The ‘construction cliff’ cuts more into imports than it does the economy.  And that bite is sufficiently big and early that Australia’s trade accounts have been well sheltered from the renewed conniption in commodity markets.  Iron ore, coal, gold and copper prices are all down, but weaker imports means the short term red ink on trade should be well contained.... see pages 72-77
  • Job growth is limping, and the economy won’t be doing it any favours in the next year or so.  The current weakness is due to the lingering impact of ‘dollar damage’ in industries such as manufacturing, as well as cost cutting in sectors ranging from miners all the way through to governments.  And soon the ‘construction cliff’ will weigh on job growth too.  Yet job growth is modest rather than rotten, and has been better through 2013 than it was in 2012.  Lower interest rates will also help.  So although unemployment will lift, it won’t lift by a lot, in part because rapid baby boomer retirement will also help to limit the upswing in the ranks of the unemployed… see pages 78-86
  • It took a long time for Federal and State Governments to realise that they’d promised too much during the glory years.  Taxes were cut too much, public service numbers and wages became bloated, and the punters were served up a steady stream of family benefits and baby bonuses.  Yet the red ink has now revealed just how entrenched the deficits have become.  Nor will they disappear fast.  The States and the Feds have moderated their savings search amid opposition to cuts and, just as the nation realised how badly we’ve blown public sector budgets, we signed on to big new costs (definitely for DisabilityCare, and possibly for Gonski).  With commodity prices (and hence tax revenues) still under pressure, it’ll be a slow path back to better fiscal fortunes... see pages 87-93

    The ‘two speed split’ in sectoral growth is starting to ease as strong sectors settle … see pp 32-53
  • The good news is that the ‘two speed split’ in sectoral growth is starting to ease, and that it will keep doing that for a while.  The bad news is that this narrowing in growth differentials is due to worsening prospects for strong sectors rather than strengthening prospects for weak sectors.  
  • Pretty much every sector is now in cost cutting mode.  That is true in mining, where profits have taken a pounding, and with recent $A falls not moving that much faster than further commodity price falls.  And it is true in mining services and in engineering construction, as the bonanza of recent years gives way to shrinking markets.  It is also true in the public sector.  Although the latest State Budgets moderated the pace of cutbacks, the latter have been big (and cutbacks could become more apparent still after the Federal election).  Even information services, a sector which includes the telecoms, is currently shrinking in size.  Elsewhere, the utilities are also shrinking, in their case because electricity prices have gone through the roof, while the transport sector is among the walking wounded as well, with road transport particularly weak.
  • Yet it is important to remember there are key positives in some sectoral stories.  Although it is at risk of blowback from public sector cost cutting, the health care sector has just seen its biggest burst of growth in a quarter of a century.  And although they’ll be slow out of the blocks, low interest rates will coax better growth out of both the retail and housing construction sectors.
  • But the biggest question marks lie over the ‘dollar dependent’ sectors, including manufacturing, farming, tourism and international education.  The $A’s recent fall is great news for these sectors.  However, it may merely stop the rot, rather than signal renewed recovery.

    The league ladder of State growth tightens as mining construction winds back ... see pp 94-118
  • The dividing line between those States with and without a boom in mining-related construction is already getting smaller.  Trend job growth in the past year was strongest in NSW.  The latter benefits from interest rates that are lower and will stay low.  Even the $A is now off its peaks.  
  • Yet so far this looks like an easing in two speed tensions rather than a full reversal of them – a tightening in the band of growth across States, rather than the ladder being tipped upside down.  Yes, recession is possible in the likes of WA and Queensland.  But that’s not what we forecast:  we see weakness, but it would take much worse news on commodity prices to signal recession.
  • Australia may have slowed, but NSW hasn’t – or hasn’t much.  Most of the nation’s negatives (a coming ‘construction cliff’ and sliding commodity prices) are problems for the rest of Australia, while most of the positives (interest and exchange rates) figure more prominently for NSW.
  • Victoria is doing it tougher than NSW, with the $A leaving some carnage in its wake.  But the State’s population momentum remains good, risks around housing construction are no worse, and even the $A has lost some altitude, leaving Victoria’s overall growth outlook adequate.
  • A last hurrah of gas development plus the slowing pace of Federal and State Government cutbacks should ease the squeeze on Queensland’s growth, but it will be a few years before the export dividend from those gas projects arrives (and that phase will bring few jobs with it).
  • South Australian prospects depend more on the $A than on interest rates.  And ‘dollar damage’ is large.  For example, the loss of Ford in 2016 may threaten other car-related jobs.  At the same time retail sales are still struggling, in part as the State’s population gains continue to disappoint.
  • Western Australia isn’t in recession, and it won’t be unless commodity prices fall enough to close a bunch of mines.  But WA is slowing sharply, though rising exports and more home building will help shelter the economy as it winds back from its resource construction peak.
  • Tasmania is the weakest of all the States.  The $A is stomping on manufacturing, forestry and tourism.  Home building is stagnant, as is population growth.  And there are fewer jobs today than in 2008.  Prospects will lift at much the same pace as the $A falls, but that may be slow.   
  • There’s no ‘construction cliff’ in the Northern Territory, where growth is still accelerating.  The Top End will march to the beat of its own drum – mining-related construction remains strong, while housing construction is also lifting.  Construction may not slow notably until 2015-16.
  • Canberra benefits from lower interest rates and from the fact that, to date, Federal cost cutting has been more talk than action.  That’s good news for now, though chances are whoever wins the election will have to institute cutbacks that may weigh more on the outlook for the ACT.

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