The top 10 big issues for 2013

From GDP growth to bond yields, house prices to the stock market, here's a guideline of what to expect from the Australian economy in the coming year.

The year is ending with the domestic economy on a soft note, with inflation doggedly low and unemployment stuck in an also-low 5 to 5.5 per cent range. The global economy has the glint of a turning point higher, no doubt aided by the most stimulatory policy settings the world has ever seen.

After four years of poor returns, Australian share prices are moving higher and interest rates are near record lows. The Australian dollar remains strong and well above the levels that would normally be seen with the decline in commodity prices and the weaker terms of trade.

In politics, a tumultuous year saw Ms Gillard and Mr Abbott remained leaders of their parties and public opinion polls are generally favouring a coalition victory in the 2013 election. The government delivered on some key issues including the price on carbon, the mining tax and further fiscal policy constraint. The year ended with the slowing economy eating away at government revenue and leaving Treasurer Wayne Swan saying that it was unlikely that the 2012-13 Budget would be in surplus.

With the exception of the persistently high Australian dollar and the budget surplus, none of these other themes were massive surprises.

So what does 2013 hold?

Here are the top 10 issues for the economy and financial markets in 2013.

1. GDP growth

GDP growth is likely to muddle near 2.5 per cent early in 2013 before easier monetary policy and a more positive tone from the global economy boosts activity through the course of the year. A solid pick up in housing construction and a lift in household consumption will be significant contributors to the growth pick up, and will take up some of the slack from a less robust mining sector. With accommodative monetary policy in place, the cash flow for the household sector and business will be growth positive. Government demand will continue to act as a dampening influence on economic activity, moderated in part by the decision of the government to allow the automatic stabilisers to support activity. By end 2013, GDP growth is likely to be around 3.5 per cent.

2. Inflation

Inflation (RBA underlying) will be skewed towards the bottom of the RBA’s 2 to 3 per cent target as the lagged effect of softer growth through 2012 impacts on prices. The persistently high Australian dollar will further dampen import price pressures, at least for the first half of 2013. Another dampening influence on inflation is the moderate wage increases and solid growth in productivity. By end 2013, the moderation in inflation may be dissipating and the market and RBA may legitimately be factoring in inflation risks in 2014.

3. Unemployment

The unemployment rate will be five-point something every month during 2013. And while it might edge up in the first half of the year as the economic expansion unfolds a little below trend, it should end 2013 near where it is now, that is 5.2 per cent. The forward indicators for jobs point to the unemployment rate moving higher in the near term and it would be no surprise to see an off month with unemployment hitting 5.7 or 5.8 per cent. But as economic growth picks up through the year, the unemployment will fall back lower to around 5.2 per cent.

4. House prices

House prices have been weak for two years. Stretched affordability has finally been catching up to house prices and to the extent there ever was a bubble, it has been deflating in an orderly manner. The fundamental drivers of house prices are increasingly positive. Strong population growth is underpinning long run demand, while low interest rates, low unemployment and rising real wages are likely to underscore housing demand and therefore prices. After the weakness of the last two years, it would be no surprise to see house prices rise 10 per cent this year.

5. Monetary policy

Monetary policy will remain accommodative through 2013. The RBA is likely to cut interest rates in the first part of the year as it catches up to the slowing growth and low inflation dynamics prevailing at the moment. The official cash rate is likely to bottom out at 2.5 per cent during the June quarter with ongoing low inflation driving the reasons for the easings. Rates are likely to remain on hold over the second half of 2013, but it would be no surprise to see financial markets starting to price in the risk of a monetary policy tightening as the year draws to a close.

6. Australian dollar

The Australian dollar ends 2012 significantly over valued. It is a classic market overshoot based on strong global investor demand for Australia’s triple-A rated assets. Markets can be prone to overshoot but in time they inevitably revert to fair value. If the Australian dollar reverts to fair value during 2013 it is likely to be trading near US90 cents at some stage. That said, a free-fall in the dollar is unlikely because of the global economic improvement through the year and the possibility that commodity prices move higher as China and the US pick up. The trading range for the Australian dollar for 2013 should be US88 to US106 cents.

7. Australian stock market

The Australian stock market is likely to continue to move higher aided by a move positive growth and profit outlook. A bearish year coming up for bonds will also likely see an asset allocation move to stocks. At some stage during 2013, the ASX200 will break above 5000 and could well trade at 5250 as the year progresses. A positive lead from global markets will be a positive driver with super stimulatory policy prevailing in the US, Europe, Japan and the UK.

8. Bond yields

Bond yields will stay low in the early part of 2013 aided by the policy actions of the US Fed, the European Central Bank and the Bank of England. As the economy accelerated and the market started to become a bit more concerned about inflation risks, bond yields should move higher. It is likely the 10-year government bond yield will exceed 4 per cent from the middle of the year.

9. Australian election

The election should be held in October, around the 19th or 26th. While an Abbott-led coalition victory is more likely than not. That said, the fickle nature of the political environment, the unpopularity of Mr Abbott and a positive policy agenda from the Labor Party could easily see the election go either way. With economic management – including interest rates – usually an important influence in election outcomes, the Labor Party could win. It will be that versus the carbon and mining taxes and issues of trust that will be driven by the coalition in forming the election campaign issues. It is not yet clear whether the election would be market moving, other than if there was a coalition victory, but without control of the senate, there may be a year or so of policy stalemate as the senate blocked policies to remove the carbon and mining taxes.

10. Federal budget

In terms of policy, Treasury is obviously of the view that the budget will record a small deficit in 2012-13. That outlook is premised on a half year of sub-trend economic growth, ongoing softness in commodity prices and the terms of trade remaining weak. For the 2013-14 budget, the government will be incorporating the financial cost of implementing the Gonski education reforms and the roll out of the National Disability Insurance Scheme. When incorporating these policy changes in the budget on May 14, it will find the money to fund it. Expect to see a scaling back of the generous tax treatment of superannuation and more policies that limit benefit payments to high income earners.

My experience in doing these year ahead pieces suggests a success rate of 60 per cent is a good result. And of course, there will inevitably be a raft of events, currently unforeseen, that will blow a few of these predictions out of the water and perhaps reshape the whole economic and political landscape.

I promise to revisit these projections at this time next year.

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