Did the Australian economy present any surprises over 2018?
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.
Frank Uhlenbruch is an investment strategist in the Australian fixed interest team at Janus Henderson Investors.