Australia's economic path in 2018

Three global macro themes all tie back to Australia.

Summary: Australia's economic and markets outlook is mostly positive for 2018, but it is largely dependent on three key themes — global growth, the commodities cycle and (dis)inflation.

Key take-out: Investors might consider the impact that central bank policy and China-driven commodities demand could have on our local economy and share market. More generally, global growth looks to be supporting Australia, and growth in emerging markets is back at 2011 levels. 

 

The Federal Government has just released its Mid-Year Economic and Financial Outlook statement (MYEFO), announcing it expects a $5.8 billion improvement in Australia's underlying cash deficit this financial year a return to an operating surplus in 2019-20.

Meanwhile, Australia's real GDP growth is expected to rise from the 2 per cent achieved in 2016-17 to 2.5 per cent in 2017-18, and to 3 per cent in 2018-19.

In releasing MYEFO, Treasurer Scott Morrison noted: "The Government is continuing to implement its plan to boost economic growth, create jobs, support small businesses and reduce the cost of living pressures faced by Australians. This plan will continue to support the economy as it transitions to broader-based growth."

But, as always, a lot depends on global forces. So, as we head into 2018, the big question for the Australian economy in a global context is what could happen next?

Low inflation, accommodative monetary policy, growth and rising confidence were all macro themes of 2017 that are likely to be prevalent next year too.

Check out three things below likely to drive our economy and markets in 2018. 

Global growth

Next year, we're potentially looking at the strongest growth on a global basis since 2011.

Momentum has been building since the end of 2016 and there's a belief that will peak next year. Markets have been driven by supportive monetary conditions and positive global sentiment, and the G7 (particularly the Eurozone) seems to finally be responding to the economic environment. We're also seeing better business conditions across the private investment world.

The market implications are that investment flows will head to growth markets, sectors and securities. This again will leave Australia in a slight bind, as the ASX is high in financial securities that are more value plays than growth stocks, and it has low exposure to areas like IT (which has seen the most growth in the US).

Materials and energy are the growth sectors of the ASX. They will have to do a large amount of heavy-lifting in 2018 to offset the likely value lag.

Commodity cycle

With emerging markets growth rates at 2011 levels and demand from global growth showing no signs of peaking, the demand for commodities is forecasted to follow.

China remains the key to demand for commodities. Its demand at the backend of the 2017 was such that copper prices hit three-year highs, coal and nickel were at four-year highs, and iron ore $US15 above the forecasted average rate per tonne.

With Chinese industrial production ramping up, infrastructure projects that were scheduled for 2020 and beyond have been brought forward to create increased demand and lead to elevated pricing in bulk and raw materials. 2018 would appear to be a positive one for commodities.

(Dis)inflation

Global inflation, however, isn't forecasted to make any meaningful jumps. Expectations from the economic world are for a slow and steady rise in pricing as growth continues to accelerate.

The area to watch both globally and domestically is wages. Employment has been benefitting from the uptick in growth, but wages are yet to benefit from the increase in activity – both baffling and concerning in one breath.

There's an assumption for a gradual increase in the global inflation rate for 2018. The effects of digital disruption and other ‘new world' conditions are diminishing employee purchase power though, which could therefore delay the forecasted gradual increase in inflation.

Focusing on Australia and inflation is likely to remain elusive in 2018. Inflation will remain as a reason for the RBA to leave rates on hold over the next year.

The impact of this could be seen on the carry trade. If global inflation increases as forecasted, some central banks will tighten their respective monetary policies (the US Federal Reserve case in point).

Australia has benefitted from the carry trade as it has brought more capital into the country. We are now facing a scenario though where this could reverse and international capital instead heads to higher yield markets. The last time the US had a higher cash yield than Australia the Australian dollar fell to 50c – something to clearly keep our eyes on. 

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