Australia's stocktake reveals a healthy ledger

With the federal budget and Reserve Bank of Australia’s Statement on Monetary Policy having been released over the last fortnight, it is a good time for a stocktake on where the Australian economy is and where it is likely to go over the next year or two.

The bottom line is generally good. Some short-term moderation in growth seems likely but medium-term buoyancy can be expected as easier monetary conditions kick in.

Over 2013, real GDP growth is likely to be a touch below 3 per cent, perhaps around 2.5 to 2.75 per cent, depending on assumptions one might make about commodity prices and the Australian dollar in particular. This mini-moderation is not all that odd or disconcerting given it is due, in part, to what was an overvalued Australian dollar, softer global activity and tight fiscal policy. These constraints on growth are now being moderated by easier monetary policy and a fall in the value of the Australian dollar.

With easier monetary policy and a strong world economy, GDP growth is forecast to pick up to be above 3 per cent in 2014. The Reserve Bank has actually outlined a forecast where GDP growth could be as high as 3.5 per cent in 2014 and 4 per cent in 2015 although the mid-point of their forecasts is for GDP growth of 3 per cent and 3.4 per cent, respectively, in the two years ahead.

If these forecasts are broadly correct, this will see the Australian economy register a 22nd, 23rd and 24th year of unbroken growth, a feat without parallel in Australia and indeed, around the industrialised world. This remains a truly remarkable and wonderful achievement driven in part by good luck from the rise of the terms of trade in the past decade, but also pragmatic and effective action from policy makers at the Reserve Bank and all sides of politics.

The profile for economic growth outlined above will, in the near term, see job creation moderate, which in turn will see the unemployment rate edge higher. While Treasury is forecasting the unemployment rate to rise to 5.75 per cent from 5.5 per cent presently, there could well be an odd month where it threatens to hit 6 per cent.

As the economy moves to a stronger growth phase by the end of 2013 and into 2014, employment growth should pick up which would see the unemployment rate start to fall. As a result, Australia could well extend the period of 6 per cent or lower unemployment beyond the current 10 years.

This climate should see inflation remain low, even though to 2014 and possibly beyond. It should remain nearer the bottom the central bank’s target band of 2 to 3 per cent than the top for the next 18 months or so before its drifts higher as economic growth lifts. Treasury’s budget forecasts were for the underlying inflation rate to remain around 2.25 per cent over the next two years which looks to be a fraction on the low side but given global disinflation pressures and some spare capacity that has developed domestically, this is where the balance of risks lies at least in the near term.

This outlook is sufficiently benign to keep interest rates low. Indeed, in the near term, this inflation outlook would point to the possibility of further interest rate cuts in the months ahead, a point alluded to in yesterday’s release of the minutes from the May meeting of the Reserve Bank of Australia board. The futures market is pricing in a further 25 basis point rate cut by September and the risk of a further 25 basis point cut, to 2.25 per cent, in late 2013 or early 2014.

Australia also has a strong stock market, house prices have been broadly flat over the past couple of years and the household sector has been rebuilding savings and slowly but surely deleveraging. These trends are welcome and are signs of structural changes that should help sustain the economic expansion.

While confidence in the business sector is soft, profitability remains solid, business investment is firm and the trajectory to a budget surplus is entrenched, even though there remains a heated debate over the speed at which the surplus should be delivered.

In all of this, Australia’s economy remains in good shape. It is growing, jobs are being created and inflation is low. With monetary policy now stimulatory and the Australian dollar looking to settle at a lower level, it is reasonable to expect a gentle pick-up in activity by late 2013 and into 2014. This will see the pace of job creation lift and the unemployment remain well contained.

In terms of the shape of macroeconomic conditions, the election on September 14 looks like being a good one to win.