RBA expects Australian growth to remain at 6 year highs in 2019 and 2020

Principal Economist's View 

One of Australia’s favourite past-times is talking about the housing market. With the cycle clearly turning, there is no shortage of speculation of how far prices may fall. But amidst all the doom-and-gloom projections of the property market, it is important not to lose sight of the broader trends in the Australian economy. Here conditions continue to show signs of improvement.

So much so, that the Reserve Bank of Australia (RBA) this week upgraded its projections for the Australian economy. Real GDP growth is now expected to rise 3.5% in 2018 (up from 3.25% in its August forecast), 3.25% in 2019 (unchanged) and 3.25% in 2020 (up from 3% previously). This is the best growth seen in six years and only the mining boom years of 2004, 2007 and 2012 have registered growth this high in the past 15 years.  

Many pundits will dismiss the RBA’s projections as too optimistic. Indeed, they are above our own forecasts of 3.3% in 2018 and 2.8% in both 2019 and 2020, as well as the consensus view amongst private-sector economists (3.2%, 2.8% and 2.7% respectively as reported in the October survey from Consensus Economics). Not one other economic forecaster is projecting growth to be this strong over the next two years.

But before we hastily dismiss the RBA projections, let’s remind ourselves that they do have some runs on the board. This time last year, the RBA was calling for growth in 2018 to average 3%. The Consensus view was for growth to average 2.8%. While the year is not over yet, the latest quarterly data reveals growth of 3.4% over the year to the June quarter, clearly exceeding the expectations of the optimistic RBA. One-up to the RBA.

So why does the RBA think growth will remain so strong? While it is not possible to do a forensic decomposition of the RBA’s projections, they do appeal to the same forces underpinning most private-sector forecasts. The RBA expects solid growth in public demand, albeit modestly below the pace seen recently, due to strong public infrastructure investment and the rollout of the NDIS. Mining investment is expected to trough in late 2019/early 2020, before starting to rise as firms increase spending to sustain production. Non-mining business investment has increased 9% over the past year and the RBA expects growth to become more broadly based over the next few years, supported by diminishing spare capacity and solid profit growth. A ramp-up in LNG exports over 2019 will also support growth, while the lower Australian dollar will support exports of services and manufactured goods. Weighing on economic growth slightly, the RBA expects dwelling investment to decline gradually.

However, the key difference between the RBA’s view and the average private-sector forecaster most likely relates to consumption growth. The RBA expects growth in real consumer spending to remain solid at around a 3% pace, while the consensus expectation is for growth to slow to 2.8% in 2018 and 2.4% in 2019, before edging up to 2.6% in 2020. Not surprisingly, the RBA doesn’t declare their hand on house prices, but it must be the case that the RBA either expects a smaller house price correction than the average private-sector economist, or the RBA expects smaller impacts from falling house prices on consumer spending. Reading between the lines, it seems that the second explanation probably underpins the RBA view, with the Bank noting that “there is limited evidence that housing price declines have weighed on overall consumption to date.”

Reflecting the upwardly revised growth forecasts and the outturns in the September quarter, the RBA has also lowered its views on the unemployment rate. The unemployment rate is expected to remain around 5% for the rest of 2018 and 2019 (down from 5.5% and 5.25% respectively), before falling to 4.75% by the end of 2020 (was 5%). Nonetheless, wage and inflation expectations are little changed, with the RBA expecting underlying inflation to rise from around 1.75% currently (unchanged) to 2.25% by the end of 2019 (up from 2%) and 2.25% in 2020 (unchanged).

Clearly, the RBA retains the view of ongoing robust growth in the Australian economy, but only a very gradual increase in wage growth and inflation. This is a recipe for the RBA to leave rates unchanged for an extended period. However, if the RBA is more accurate with its forecasts than private-sector economists for another 12 months, then expect the prospects for a rate hike to come into sharper focus in late 2019. 

Table 1: Financial market movements, 1 – 8 November 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,806.8

2.4%

US

3.24%

10.7 bps

US Dollar Index (DXY)

96.72

0.5%

Nikkei 225

22,486.9

3.7%

Japan

0.12%

-0.1 bps

USD-JPY

114.07

1.2%

FTSE 100

7,140.7

0.4%

UK

1.57%

11.0 bps

GBP-USD

1.306

0.4%

DAX

11,527.3

0.5%

Germany

0.46%

5.8 bps

EUR-USD

1.136

-0.4%

S&P/ASX 200

5,928.2

1.5%

Australia

2.76%

11.1 bps

AUD-USD

0.726

0.7%

Source: Bloomberg

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