The government has revised up its growth forecast for 2013-14 from 2.5 per cent in MYEFO to 2.75 per cent but retained its 2014-15 and 2015-16 forecasts of 2.5 per cent and 3 per cent respectively. The refusal to recognise that this lift in growth momentum will be sustained appears to hinge on a strange assumption that the recent acceleration in export momentum will not be sustained.
In contrast, Westpac expects growth to lift from 2.75 per cent in 2013-14 to 3 per cent in 2014-15.
We agree that the details of the budget should not significantly impact near-term growth as spending reductions over the next three years total only 1 per cent of GDP, with less than $2 billion of savings in the 2014-15 financial year.
But there is likely to be a short-term impact on confidence. That will be revealed in the Westpac–Melbourne Institute Consumer Sentiment Index, due May 21. We do not believe this deterioration will be sustained.
We are very interested in the medium-term growth outlook. The government notes that in seven of the last eight years, GDP growth has been below trend, with the current level of GDP being around 2 per cent below its long-term trend. It assumes that over the period from 2016-17 to 2020-21, the economy will grow sufficiently above trend to return GDP to its trend level.
We expect that from 2014-15 to 2016-17 growth will be much stronger. However, in 2017-18 and 2018-19, our expectation is that growth will drop significantly below the government's forecasts. During that period, sub-2 per cent growth is expected. This profile is a much more distinct cycle than envisaged by the government. It will have significant implications for markets and financial aggregates.
Below I set out the likely profile and drivers of that cycle.
While we are expecting considerable stability in markets and ongoing sub-trend global growth through 2014, we are not anticipating that the subsequent years will be the same.
Broadly, we are expecting a fairly modest growth story for the major economies in 2014, but a marked lift in 2015 to be followed by very rapid global growth in 2016. Central bank policy responses and associated movements in asset markets are likely to see growth slow in the second half of 2017 prior to a major global slowdown in 2018.
Developments in the US economy will be the key catalyst for the lift in global growth. US growth will gradually gather momentum through 2015 prior to a decisive move above trend in 2016.
Some key drivers of the surge in US growth in 2016 will be: an overvalued equity market which will force firms to adopt growth policies to justify valuations; pent-up demand in the corporate and household sectors after eight years of relative austerity; renewing and upgrading of capital stock, consumer durables and housing. This lift in demand will be self-reinforcing as wages and employment lift, thereby boosting incomes (which will assist in diminishing the perceived [and actual] weight of legacy debts) and household demand.
Through 2014 and 2015, equity markets will continue to be supported by a dovish Federal Reserve which will not begin to normalise interest rates until the last quarter of 2015. That is because the growth momentum in the US economy will remain fairly sedate through 2014, keeping inflation benign well into the second half of 2015. One important growth channel will be the spillover wealth effects of a rising equity market, boosting household and, in particular, business confidence.
The boost to global demand from the lift in US momentum will support higher growth in the manufacturing and commodity exporting economies, so too capital importers. China and the emerging markets will all lift to some degree in response to stronger US growth. In turn, Europe’s external sector will benefit from stronger growth in the US and, perhaps more importantly, China.
The synchronised nature of the demand upturn will lift commodity prices which, complemented by a local Reserve Bank that will be raising rates from around August (before the US Federal Reserve), will support a significant rise in the Australian dollar.
Asset markets and domestic demand in the US will initially be quite resilient to Fed tightening, which we anticipate will be underway by late 2015. The pace of Fed tightening in 2016 will gather momentum. However, there will be a "tipping point" beyond which Fed tightening will have a discontinuous impact on asset markets, confidence and demand. At this point, probably in late 2016 or early 2017, we will see a significant reversal in equity markets with spillover effects for business investment, employment, household incomes and overall growth.
The effects of these developments in the US will have global implications. China and the emerging markets will be impacted through a marked slowdown in external demand. We expect China’s growth in 2018 to pitch in around 6 per cent flat. Emerging markets’ vulnerability to capital outflows (for example India, Turkey, Indonesia, South Africa, and emerging Europe) and falling commodity prices (for example Brazil, Chile, Indonesia, South Africa and Russia) will see considerable stress in those regions. In turn, Europe’s reliance on external demand from both the US and Asia and its financial exposures to emerging Europe and Latin America will test its already fragile system.
For Australian financial markets, the relative stability of 2014 will transform into considerable volatility from 2015. The Australian dollar and interest rates will be on the rise (fixed rates lead RBA rates by around six months), and equity and property markets will be buoyed by confidence in the global developments we anticipate during that period. The Australian dollar will once again “flirt” with parity. The year 2016 will continue to see growth and asset markets supported by global developments. Reversals, firstly in asset markets and then in aggregate demand, will emerge through 2017 and 2018.
In 2018, Australia’s growth rate is expected to fall to 1.5 per cent, the Australian dollar will be back around 80c, and the Reserve Bank will have cut rates back to 3 per cent, having hit a peak of 4.75 per cent in 2017.
Bill Evans is chief economist with Westpac.