Growth Weakness Not Yet Over
Real GDP growth is highly likely to slow over the coming years owing to a number of factors: slowing growth in the working age population; a high share of government spending relative to GDP; and a reversal in the country's terms of trade; and the growing risk of deflation. These impediments will result in real GDP growth averaging 2.3% over the next decade, down from 2.7% over the past decade.
Australia's Liberal-National coalition formed the government for a second term, following the July 2 federal elections, but we believe that it will not be able to significantly improve the country's business environment and economic growth prospects over the coming years. The coalition's expected lack of majority in the Senate suggests that risks of policies being delayed and diluted are high. Additionally, the coalition's narrow margin of victory against the opposition Australian Labour Party is a significant setback for Prime Minister Malcolm Turnbull, and there is an increasing possibility that his leadership position might be challenged, which would create further uncertainty for businesses.
We remain bearish on the Australian dollar despite the large fall we have already seen in the currency. While valuations are no longer a headwind to the currency, the trend remains very bearish. Weak economic growth owing to falling investment and correction in the property market amid elevated indebtedness does not bode well for the AUD.
Fiscal reforms in Australia, notably expenditure cuts, will likely be held back due to political gridlock, particularly in the Senate, and we believe that the government led by the Liberal-National coalition will be unable to return the federal budget to a balance by its target of FY2020/21 (July-June). While there is currently no danger of a fiscal crisis, our core view is that this growing burden of the government will undermine the productivity of the private sector and take its toll on economic growth over the medium term.
Following the Reserve Bank of Australia (RBA)'s 25bps cut to its cash rate to a fresh historical low of 1.50% at its August monetary policy meeting, we expect the central bank to keep its key policy rate steady for the rest of 2016 as it looks to assess the impact of its accommodative monetary policy stance. That said, we forecast the RBA to cut interest rates further by another 25bps to 1.25% by H117 as the Australian economy weakens while below-target inflation persists.
Major Forecast Changes
We upgraded our 2016 real GDP growth forecasts to 2.4% (from 2.1% previously) as a result of Australia's stronger-than-expected Q116 real GDP expansion of 4.3% q-o-q in seasonally adjusted annualised terms. Nevertheless, we maintain our 2017 real GDP growth forecast of 2.2% as the strong export performance is unlikely to be sustained as China's economy weakens, while the unwinding investment boom in the mining sector will be further compounded by weakness in the housing market.
We revised our average 2016 Australian dollar forecast stronger to USD0.7400/AUD (versus USD0.7300/AUD previously) owing to the AUD's strength since the start of 2016. However, the country's high level of external indebtedness still leaves the currency exposed to capital outflows amid a slow transition away from its reliance on the mining sector and a weakening residential property market.
The key risk to Australia's economy comes from the potential bursting of the domestic property market boom, particularly as valuations are very stretched, and affordability is very low. Should we see prices begin to decline, the process could become self-reinforcing as banks tighten lending standards and default rates rise. Given the importance of the Australian housing market in increasing overall credit in the economy, declining house prices could usher in a period of intense deflation and deleveraging.
Additionally, should the Chinese economy experience a financial crisis over the coming years as the investment bubble bursts, this would have a highly negative impact on Australian mineral demand, further undermining the country's terms of trade.
|e/f= BMI estimate/ forecast. Source: BMI, National Sources|
|Real GDP growth, % y-o-y||2.6||2.5||2.4||2.2|
|Nominal GDP, USDbn||1,448.7||1,219.4||1,241.5||1,277.8|
|Consumer price inflation, % y-o-y, eop||1.7||1.7||1.0||2.0|
|Exchange rate AUD/USD, eop||1.22||1.37||1.33||1.39|
|Budget balance, % of GDP||-2.8||-2.5||-2.5||-2.5|
|Current account balance, % of GDP||-3.0||-4.8||-4.2||-3.6|
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