Economic update - Changing growth drivers

By Felicity Emmett, Senior Economist, ANZ Research, July 2017

Australian GDP growth stepped down to an anaemic 1.7% in Q1 2017, the lowest rate since 2009. While some of the weakness in Q1 is likely to prove temporary, a strong bounce in Q2 looks unlikely. Further out, the economy looks likely to muddle through over the next few years, although we continue to anticipate that any pick-up in inflation will be very gradual and expect the RBA to keep the cash rate on hold.

Overlaying some of the temporary factors evident in first half of 2017, however, is a broader thematic. In particular, we think there has been a step-down in the pace of consumer spending growth as households adjust to the new world order of very low wage growth amidst the confronting reality of high mortgage debt. Consumption growth slowed to an annual rate of 2.3% in Q1, and even this level of spending required a reduction in the saving rate to 4.7% due to continued weak income growth. The effects of weak income growth are being exacerbated by substantial rises in prices for non-discretionary items, like utilities bills, education and health costs.  While retail sales have stepped up in the latest couple of months, we expect household consumption growth to remain close to 2% y/y over the next year or so, given ongoing pressure on incomes.

As far as wage growth is concerned, we expect that the overall pace of wage growth will remain very modest. With unemployment expected to remain elevated and ongoing high underemployment (with many workers forced to work part-time when they would prefer to work full-time), wage pressures are likely to remain muted. Moreover, the expected slowdown in house price growth in response to higher interest rates for investors will also remove a key support to consumer spending over the coming year.

With building approvals falling for over a year now, housing construction looks to be past its peak. There is a large amount of work in the pipeline, but we expect housing construction to trend lower through H2 2017 and 2018. The downturn in housing will have implications for employment (given that construction has been a significant driver of employment growth over the past few years) as well as consumption (with recent strong growth in household goods supported by new housing development).

We continue to expect solid growth in non-mining business investment, given the pipeline of non-residential building approvals where approvals in the health sector and tourism related sectors (in particular hotels and casinos) are providing support to the outlook. The ongoing expansion of publicly backed infrastructure projects, especially in NSW and Victoria will also be an important driver of growth.  More broadly, public spending has been lifting strongly over the past year and the recent release of the 2017-18 state and federal budgets has reinforced our view that the public sector will continue to be an important source of growth for Australia over the next few years. With monetary policy currently having little impact outside the housing sector, we see well-placed public sector spending as an important counter to the weaker parts of the private sector.

All up we see GDP growing just 1.8% in 2017 given the weak first half and 2.7% in 2018 (both annual average). As a consequence we now expect the unemployment rate to remain broadly unchanged at current levels through to the end of 2018. This suggests that any recovery in wage growth and hence underlying inflation will be very slow and gradual over the next few years.

For monetary policy, we think our forecast of growth muddling through and a gradual rise in wage and price inflation will be enough to keep the RBA cash rate on hold. This reflects the already low starting point for the cash rate, the Bank’s focus on household resilience and the RBA’s related conclusion that further rate cuts may not have much positive impact on the outlook in any event.

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