Rising export volumes, soaring consumer confidence and strong housing construction data means the Australian economy is likely to avoid slipping into a technical recession.

We have revised our growth forecasts. While the changes are not major they are significant in that we are no longer forecasting a technical recession.
We assess that the signals from the Australian economy in the last few months necessitate a less pessimistic growth forecast. We have identified the following factors that we expect will be instrumental in moderating the slowdown in the Australian economy. Note that we now expect year average growth in GDP in 2009 to be 0.2 per cent compared to our previous forecast of minus 0.6 per cent. For 2010 we expect growth of 1.8 per cent compared to 1 per cent in our previous forecast.

These might seem to be minimal changes but because GDP growth switches from positive to negative and our quarterly profile changes from three consecutive negative quarters (the second quarter, the third quarter and the fourth quarter) to only one (the third quarter) the technical recession label (two consecutive negative quarters) is no longer appropriate. We do not believe that these changes are sufficiently material to change our rate or currency views.

Reasons behind our upward revisions are:

1) Critically, we saw a sharper than expected fall in export prices (21 per cent) in the second quarter – we are aware of export values for April and May and our estimate for June values now suggests that export volumes for the second quarter will increase by 1 per cent rather than contract by 2 per cent. We estimate that will mean that net exports will add 0.3 per cent to growth rather than subtract 0.3 per cent pushing our second quarter GDP estimate to 0.2 per cent from minus 0.4 per cent. The upward revision to net exports plays a significant part in our overall revision to growth in 2009.

However, a word of caution – that was the biggest fall in export prices since the series began in 1974 (second largest decline was 6.5 per cent) and therefore indicates extreme volatility in the net export/inventory/statistical discrepancy mix.

2) Both business and consumer confidence have increased to their highest levels since December 2007. While these spectacular recoveries in confidence are likely to prove fragile and can potentially partly retrace we expect that confidence will establish higher base levels than we had feared earlier in the year.

We also believe that it is difficult to envisage events that could see confidence plunging to levels prevailing earlier in the year. We remain very sceptical about the outlook for the major economies and anticipate ongoing problems with the financial systems of both US and Europe. But these developments will mainly affect the pace of growth in these economies rather than providing dramatic signals that would jolt confidence in the way we saw earlier this year.

Households still have to negotiate the upcoming six month period in which nominal incomes will be contracting as hours worked fall; government handouts cease and interest rates are on hold rather than declining. However, we assess that households have been successful in saving a decent proportion of the cash handouts – one bank reports that 90 per cent of those folks with owner-occupier mortgages have opted to pay down debt rather than reduce interest payments.

We expect that as confidence levels remain relatively high households will be prepared to reduce savings to maintain expenditure levels even as incomes contract. When confidence is low households are likely to seek to maintain savings at the expense of spending – as we are seeing in the US but contrast the level of Australia's Consumer Sentiment Index (109) with the US (66). That observation has prompted an increase to our consumer spending profile increasing growth over 2009 from 1.3 per cent to 1.6 per cent. In 2010 we have raised spending growth from 2.0 per cent to 2.3 per cent.

Higher than expected business confidence will also moderate the downturn in business investment. That will mainly affect plant and equipment since we expect non–residential property and engineering investment will be largely driven by exogenous events (credit availability; external demand; government spending). We have revised the expected downturn in plant and equipment to minus 18 per cent from minus 22 per cent in 2009; and from minus 7 per cent to minus 1 per cent in 2010.

3) Finally, we have increased the strength of the recovery in housing construction. New lending for housing construction continues to surge – the number of new loans for housing construction (owner occupied) is up 60 per cent. That will eventually see strong positive prints on housing construction. We have raised the growth forecast for housing construction in the fourth quarter from 2.5 per cent to 4 per cent and through the year growth in 2010 in housing construction to 23 per cent from 19 per cent.

While the "debate" about recession is occupying great coverage in media and official circles these forecast changes are significant in that they indicate that Australia may now avert a technical recession.

That is our current best estimate but please respect the particularly challenging forecasting task stemming from unprecedented fluctuations in commodity prices; fiscal settings; monetary policy; global growth; and currencies.

Bill Evans is chief economist at Westpac.

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