Australia: Growth in 2018 to lose some momentum as the year progresses - NAB

Analysts at NAB suggest that in many ways, 2018 will be a continuation of 2017 for Australian economy and they are expecting a moderate improvement in growth to 2.9% in annual average terms, up from 2.3% in 2017 (although momentum will slow as the year progresses) with the unemployment rate easing a touch to 5.2% by end-2018.

Key Quotes

“Business and government investment are expected to lead domestic demand growth (with some offset from capital imports), dwelling construction is forecast to pull back a little but remain high and LNG exports should add to growth. While employment growth remains solid (though a little more moderate than in 2017), consumer spending meanwhile struggles to lift much given an expected very slow and gradual improvement in wages and therefore household income growth, and a more muted wealth effect as house price growth slows.” 

“Underlying inflation is forecast to pick up slowly to 2% by end-18, which together with early evidence of a pickup in wages growth should be enough to see the RBA commence tightening in the second half - we have 25bp hikes in August and November pencilled in. This would take the cash rate up to 2%, a level which is still considered stimulatory.” 

“Risks to our forecasts and developments to watch include:

• Wages growth - Australia’s experience is likely to follow other economies – that is, slow transmission from strong labour market conditions into wages. It is likely, though not certain, that globalisation, automation and technological developments are playing a role and that these forces will remain. Our research also suggests that growth in labour productivity is a pre-requisite for a stronger pick up.  That said, if unemployment drops more quickly than expected, we may be pleasantly surprised.
• House prices and credit – The RBA’s concerns about household balance sheets may not dissipate entirely, with household debt still expected to grow more quickly than household income. Further macro-prudential measures may be on the cards, but are not factored in. Housing prices will be critical here, with hikes less assured in the unlikely event that housing prices experience a severe correction. On the flipside, a house price reacceleration may bring forward hikes and/or macro-prudential measures.
• Margin compression in retail/sluggish consumer demand – the competitive environment in Australian retail is heating up at a time when the consumer demand outlook is uncertain. The headwinds already weighing on consumer discretionary spending – most notably low wage growth and high debt – are unlikely to be resolved soon, suggesting retailers will continue to feel the pinch from margin compression. Retailers are already lagging well behind other industries in the NAB Business Survey and that gap is expected to remain, at least to some degree, in 2018. How retailers respond in this challenging environment will be watched closely.
• China’s growth path - while global geopolitical risks abound, a hard-landing in China remains the single largest downside risk for Australia, despite our expectation for a gradual slowdown. An industrial/construction centred slowing would be most challenging for Australia given pressure on commodity demand and prices, although AUD depreciation would be a counterbalancing force. 
• Energy prices - with gas producers now able to send gas offshore, Australia is subject to prevailing prices in East Asia, most of which are oil-linked and well above historic Australian norms. If export prices move higher, following oil, domestic prices could again exceed AUD8/GJ. Higher gas prices (and tighter supply) are likely to have a material impact on the National Electricity Market (NEM) going forward. Dependence on high cost gas generation may put upward pressure on wholesale electricity prices in the summer. If this continues for an extended period, retail prices will rise further.
• Renewed focus on non-residential construction – while the dwelling construction cycle appears to have hit a peak, attention is now turning to non-residential construction, which has been more clearly on the rise on the back of more favourable business conditions and higher infrastructure spending. NAB’s Commercial Property Survey is also pointing to strong confidence in the office and hotel markets in particular. The strength in infrastructure spending has been evident in the pipeline of engineering projects under construction, while we have also seen encouraging signs elsewhere, like in offices where some markets have seen tight supply and strong capital gains. Non-residential building approvals have clearly trended higher and are expected to sustain the improving trend in non-mining business investment growth into 2018 and beyond.
• The USD and the AUD – we have slightly revised our forecasts for AUD/USD to 0.72 by mid-18 as the confluence of narrower rate differentials, softer commodities and risk sentiment are likely to weaken the AUD to the USD0.70-75 range. Technical analysis points to some greater downside risk near term. This would see some upside risk to our economic growth and inflation forecasts, with exporting industries such as agri and services (tourism/education) and import competing industries to benefit the most. That said, the forecast remains highly dependent on the USD path – for now, we are holding to our call for three US rate hikes in 2018 (as per the Fed’s “dot plot” projections), particularly given the likelihood of fiscal stimulus as Trump’s tax bill inches closer to passing Congress.
• Global central banks winding back liquidity – The Fed has started to reduce its balance sheet, and there is an expectation that the ECB will ends its asset purchase program later next year, which may put some upward pressure on global yields and potentially have implications for currencies and other asset markets such as equities. However, any impact from these changes is probably already, at least partially, priced in and major central bank balance sheets will continue to be very large for years to come.”