Our expectation a year ago was for growth of around 3 per cent over 2018. However, after a very strong first half and signs of solid but moderating momentum in the second half, we have lifted our 2018 growth forecast to between 3.25 per cent and 3.50 per cent. Given the headwinds from trade uncertainty, credit crunch fears and falling house prices, this is a strong outcome and reflective of the accommodative stance of monetary policy and the positive spill-overs from a strong pulse of public infrastructure spending.
There were several domestic macro surprises of note. The first was the labour force, where despite a slowing in the rate of monthly job creation from the booming levels of 2017, the unemployment rate fell from 5.6 per cent at the end of 2017 to a low of 5 per cent in September and October. While some labour market slack has been absorbed, wages have yet to lift materially, despite the period of wages disinflation appearing to be behind us.
The second macro surprise was the extent of fiscal improvement. Stronger than expected revenue growth and delays in some payments meant that the final outcome for the FY18 budget deficit was $10.1 billion, $8.1 billion better than expected. An improving medium fiscal outlook saw S&P lift Australia’s sovereign rating from AAA ‘negative’ to AAA ‘stable’.
What’s in store for 2019?
More above trend growth
The Australian economy is poised to grow by around 3 per cent over 2019, with a large pipeline of public sector infrastructure projects and the ongoing roll-out of the National Disability Insurance Scheme (NDIS) to drive public sector demand, with positive spill-overs into business investment and employment. With a large pipeline of work yet to be done, dwelling investment is likely to continue at elevated levels but not add to economic growth over 2019. Net exports are expected to add to growth as LNG export capacity continues to expand. Consumption is also expected to grow at a moderate pace in line with further jobs growth and a gentle lift in wages growth.
Gradual lift in inflation
We look for the underlying inflation rate to gradually lift to a little over 2 per cent by the end of 2019. Upward pressure comes from further reductions in excess capacity, the lagged effects of a softer exchange rate and lifting global prices, and the direct and indirect effects from higher fuel prices.
Some further tightening in labour conditions and the flow-on effects from the 3.5 per cent lift in the minimum wage in mid-2018 should exert upward pressure on inflation in the non-tradable sector. Working in the opposite direction is limited rent inflation, given increases in the stock of dwellings, heightened completion in a range of sectors and the risk of further “one off” declines in administered inflation as governments focus on policies to reduce the cost of living expenses in election years.
RBA patiently waiting for stronger wages growth
The November Statement on Monetary Policy forecasts from the Reserve Bank of Australia (RBA) have the economy growing at above trend rates over the next two years and the unemployment rate falling to 4.75 per cent over the second half of 2020. Given uncertainty about the transmission of labour market tightening into wages and inflation, the RBA has ruled out any near term tightening, noting that a period of stability would help create the conditions which would eventually allow them to begin removing policy accommodation.
In our view, further ongoing labour market improvement, along with the lagged effects of a lower currency, less fiscal drag and a large public sector infrastructure pipeline should see the RBA in a position to begin removing policy accommodation from late 2019 onwards. However, the large stock of household debt held will increase the potency of any cash rate increases and is the reason why we anticipate a more modest and drawn-out tightening cycle by historical standards.
We see the balance of risks tilted to the downside and clustered around the deferral of consumption and investment because of uncertainty about the path of domestic and global policy settings. These are unlikely to be powerful enough to get the RBA easing, but could significantly push back the timing of the first monetary tightening.
Compared to 2017, home values across the capitals declined over the year but Canberra and smaller capitals such as Hobart, posted some of the strongest growth nationwide at 4% and 9.3% respectively, according to Tim Lawless, research director, APAC, CoreLogic.
Sydney values have declined by 8.1% from their peak in July 2017 and Melbourne by 5.8% from a peak in November 2017 –further declines are likely in 2019 with prices in Sydney on track to fall 15% in total.
“There are some mainstream economists who are suggesting Sydney and Melbourne could be down by as much as 20% from peak to trough but I’m a little more optimistic than that,” Lawless says.
“I wouldn’t say that would be a worst-case scenario, more a realistic case. We have already seen Sydney dwelling values fall by around 9.5% peak to trough, so it isn’t that much of a stretch to see the overall market fall another 5% over the year,” he continues.
Looking ahead, Lawless adds, “The best case outlook would be that conditions start to level out; we start to see a rate of decline easing off and then the market finding a floor.
“Under a worst case scenario, we would see credit tightening further, economic conditions slowing down and potentially mortgage rates starting to rise as well,” he continues.
In reality, Lawless says it is most likely the actual outcome will fall somewhere between the two extremes, with the bad news concentrated in Sydney and Melbourne and steady conditions in the other capitals. It is also likely that Hobart will see a slow down in its rate of growth.
“We also expect some of the smaller capital cities like Brisbane and Adelaide will continue to show growth and particularly parts of Queensland, on the back of migration rates that are really ramping up interstate,” Lawless says.