Where to for the Australian economy?

The Australian economy has had an unprecedented 16 years of economic growth since the last recession and the question is often asked…”are we due for a recession?

The turnaround in the terms of trade has been one of the largest in our history, and this is reflected in the decline of the AUD$ against the US$ from $1.10 at its peak to its low of around $0.70 today.

A huge turnaround in the terms of trade and the dramatic drop in fixed capital expenditure does create risk for the economy and in the past has led to recessions – and Western Australia and Queensland are arguably in a recession now.

The countervailing argument against a recession is that with a floating exchange rate there is an automatic stabiliser that counteracts the detrimental effect of the decline in price and demand for commodities.

With the decline in the currency, the AUD$ price received for exports has held up when converted back to US$ and many producers have also increased their volumes. The lower exchange rate has also led to a pick-up in inbound tourism, a rise in education exports and has made remaining manufacturing and import replacement industries more competitive.

It should be mentioned that a drop in exchange rates is similar to a drop in interest rates and this can do a lot of the heavy lifting for the RBA.

Thus, the drop in the exchange rate, historically low interest rates, a continuing budget deficit (as many austerity measures have been knocked back by the Senate) and the effective change of Government (positive for consumer confidence) have held growth up, especially in NSW and Victoria.

While the futures markets are not predicting a further change in cash rates (they expect the cash rate to remain at 2 per cent out to June next year) the rates are very low and supportive for growth.

Also, while housing is tending to top out, not many people are forecasting a collapse in housing prices as there is still a shortage of housing and continuing underlying demand from population growth and household formation.

Despite the budget deficit the Federal Government is still in a relatively strong position fiscally compared to countries overseas, and the RBA could drop interest rates further if required.

What could go wrong?

It is less likely that problems will originate from local issues, but rather from offshore. The major risk is probably a major slowdown in the world economy and a further decline in Chinese growth.

An increase in US interest rates provides some risk to us, but the interest and duration of US rate hikes is likely to be limited due to low world growth, low inflation and the data not supporting large interest rate rises.

Thus, in conclusion it is likely Australia will continue to have sub-par growth in the 2-3 per cent range and have a two-tiered economy with commodity-based states having lower growth while the larger eastern states have higher growth.

The implications for investment markets will be mixed. Those sectors that benefit from a low dollar will tend to do well, ie soft commodities where prices have held up, tourism and education related sectors, while many commodity related sectors will continue to struggle due to continued demand and pricing pressures.

The strong emphasis by the Government on infrastructure at both the Federal and State levels should be positive for this sector and growth generally.

The information contained in this newsletter is provided on behalf of the IOOF group of companies and is intended for financial adviser use only. It is given in good faith and has been prepared based on information that is believed to be accurate and reliable at the time of publication. Any examples are for illustration purposes only and are based on the continuance of present laws and our interpretation of them at the time.