THE BIG PICTURE: Is growth stuck in first gear?

The national accounts aren’t useful as a forecasting tool, but as means of checking whether policy is on track, there is no better method.

The latest data shows that the economy grew by only 2.3% over the past year, suggesting that the Australian economy is underperforming. But how correct is this assumption?

At face value, you would assume that a country experiencing a mining boom would be shooting the lights out. But the Reserve Bank has tried to cap activity in other sectors to absorb the huge investment of equipment and labour resources.

The question is whether they are doing too good a job. Because over the past five years – the period of the mining “boom” – the economy has averaged growth of 2.6% per annum. Go back over the past decade and growth averaged 3%. Then go back over the past 15 years and economic growth has averaged 3.3% a year.

So what is “normal” or trend growth?

Well, basically it refers to the sustainable, non-inflationary pace of growth. And while there are numerous factors that influence the trend growth pace, the combination of productivity and population growth are important. When you work through the figures it is clear that the speed limit of the economy has come down over time. On average over the past 15 years, productivity has grown on average by 2% a year and population grew by 1.4%. So the 3.3% average GDP growth makes sense.

Over the past decade, both population and productivity growth were 1.5% and the economy grew on average by 3.0%. And over the past five years productivity growth was 1.1% and population growth was 1.8%. This suggests trend growth of 2.9% with the actual outcome 2.6%.

Overall, the speed limit has come down and, in general, this has been matched by actual economic growth. But the real test of this theory is how inflation trended over time. Using the consumer price measure, “market prices excluding volatile items” inflation has averaged 2.2 to 2.4 % when measured over the past five, 10 and 15 years. In other words, inflation was almost in the middle of the 2-3% target band.

The current “speed limit” for economic growth is probably just under 3% and if interest rates hold at current levels or are cut once more this year, actual growth should gradually rise to trend pace over 2012.

The week ahead

The autumn avalanche continues. Over the past week around a dozen key indicators were issued and in the week ahead investors will have to dissect at least another half a dozen economic statistics. In the US, the highlights are retail sales, production and inflation data.

In Australia, the Reserve Bank kicks off the week with the release of credit and debit card statistics for January. CommSec will also produce its regular, weekly analysis of petrol price trends.

On Tuesday, housing finance data will compete for attention with the latest NAB business survey. We expect that the number of owner-occupier loans lifted by 2% in January but the value of all home loans may have fallen by 2%. The housing market is in the doldrums, but the outlook is somewhat brighter. We expect little change in the results of the NAB business survey. Caution is unlikely to recede until the European debt crisis is resolved.

On Wednesday, Westpac and the Melbourne Institute will release the latest consumer sentiment survey. In February, the index stood at 101.1, so optimists only marginally outnumber pessimists and little change is likely in the latest month. Also on Wednesday, the Bureau of Statistics will release the December quarter data on dwelling starts. In a broad sense we aren’t building enough homes, although it is important to note that people are more comfortable sharing accommodation. We expect that dwelling starts fell by 6% in the December quarter.

On Thursday, the Bureau of Statistics will issue broader data on lending – covering personal, housing, business and lease loans. Lending is 3% lower than a year ago and little improvement is expected to have occurred in January.

Also on Thursday, February data on car sales is released together with the Reserve Bank quarterly Bulletin. Despite the best levels of affordability in 35 years, Aussies are still reluctant to buy cars. Based on industry data, car sales probably fell by 2.5% in February. The main point of interest in the Reserve Bank Bulletin is an article on bank funding costs.

In the US, the week starts with the release of monthly data on the Federal Budget and employment index on Monday with retail sales and business inventories data on Tuesday. Economists expect that sales rose 1.0% in February or a smaller 0.6% if auto sales are excluded. The Federal Reserve Open Market Committee also meets on Tuesday and the language of the accompanying statement will be closely dissected.

On Wednesday, data on import and export prices are issued together with the broader current account data. And, on Thursday, the producer price index (PPI), weekly jobless claims and capital inflows data are released together with the Empire State and Philadelphia Fed regional indexes. Economists expect that the PPI or business inflation data will show a modest 0.2% lift in core prices (excludes food and energy) in February.

And, on Friday, data on consumer prices, industrial production and consumer sentiment are scheduled for release. Inflation figures are back in the spotlight now that the Federal Reserve has introduced an inflation target.

Also of note in the coming week, there are central bank meetings in Norway and Japan. The US Federal Reserve chairman delivers a speech on Wednesday. And, on Saturday, the OECD Economic Outlook report is issued.

Sharemarket, interest rates, currencies and commodities

The Reserve Bank has made clear that it will be watching the Aussie dollar closely in coming months. The last thing it needs is for the currency to remain too high, slowing the economy down, or to fall quickly, boosting inflation. At present the concern is about a strong currency or as the RBA expressed it: “The exchange rate has risen over recent months, even though the terms of trade have declined.”

Unfortunately there is no single model that can determine the “right” exchange rate: The Aussie dollar is influenced by commodity prices, the level of interest rates, the economy, political factors and other currencies, and those are only some of the factors.

At present it would be hard to argue that the Aussie is significantly over-valued. Over 2012 so far, the Reuters CRB commodity index has risen by 3% and the Aussie dollar is up around 3.8% against the greenback.

Financial markets still expect one further rate cut from the Reserve Bank over 2012. The overnight indexed swap market has fully priced in one, 25 basis point rate cut over the next six to nine months. And the implied yield of a 90-day bank bill in December is 4.03%, down from the 4.46% implied yield on the current March contract.

Has the Australian sharemarket, under-performed or out-performed other global markets in 2012? As always, it depends on your perspective. According to data from FactSet, up to March 5 the Australian sharemarket lifted by 10.3% in US dollar terms, short of the 11.6% growth of the ‘world’ index but ahead of the 8.9% growth of the US index.

Still, it is clear that sharemarket gains across the globe have been very healthy, putting the recent correction in perspective. If markets had continued at the pace recorded over the first two months of the year, they would have been headed for a 74% gain for 2012 – clearly unsustainable.


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