The Bank of America has issued an encouraging outlook for the Australian economy in 2016. Against the backdrop of steadying global growth, the bank is forecasting a positive, if modest, year ahead.
The BoA looked at ten areas that should determine how the Aussie economy fares. Below, we’ll take a look at what the bank had to say about each of them. We’ll also give our verdict on the bank’s assessments.
The BoA expects GDP growth to hit 2.7% this year. We can’t make a like for like comparison with 2015, because we’re still waiting on fourth quarter results. In any case, GDP growth in 2016 will improve on last year, according to the bank.
Verdict: It would be quite something if GDP outperformed growth in 2015. If you recall, 2015 began with a bang. The economy grew at 0.9% during the first quarter. Yet when demand for commodities tanked, GDP dropped sharply.
Looking ahead to the rest of 2016, the question mark over commodities is likely to remain.
The fate of the dollar will also play a big part in boosting economic growth. If the dollar trends in the low US$0.60 range, it should help the services sector.
The services sector did its bit for the Aussie economy in 2015. And this year shouldn’t be any different, provided the dollar weakens further.
The sector made its largest contribution to the economy since 2001 last year. Yet despite this, there’s scope for improvement. As the BoA notes, services made up 53% of GDP growth in 2015. That’s despite the sector only accounting for 36% of business investment.
Verdict: Service sector investment needs to rise to match its contribution to GDP. That would help elevate the sector to another level, further boosting growth. It should also help offset slowing mining investment.
The Aussie dollar will again play a key role in how the service sector fares in 2016. Tourism and education in particular stand to gain from a favourable exchange rate.
At the same time, a weaker dollar will make imports more expensive. That could hurt discretionary spending, which is key to driving growth.
There were a few raised eyebrows when the ABS announced the economy added 126,000 new jobs in Q4 2015. Whether you believe these figures or not, one thing is clear: The job market is better off today than it has been for six months.
So where does the job market go from here? The recent boost in employment figures could be tested in the year ahead. The BoA expect to see job losses across both resource and construction sectors in 2016. How this affects unemployment will depend on how fast the construction cycle declines.
The BoA predicts unemployment of just above 6% by year’s end, up from 5.8% today.
Verdict: Unemployment rates may depend on investment levels across the services sector. This should determine whether the sector creates enough work to make up for job losses in the resource sector.
Either way, the jobs market will remain split down geographic lines. Resource heavy states, like WA, could see unemployment climb higher compared to the services driven east coast.
The BoA forecasts house price growth to slow in 2016. It sees risks of modest price declines, especially at the back end of the year. APRA clampdowns on lending, alongside high dwelling prices, are given as reasons for this.
Verdict: It would be a miracle if house prices maintained even the current level for the rest of the year. Already we’ve seen evidence of slowing growth right across the country. Even high growth markets like Sydney and Melbourne have seen prices stagnate.
Of course, like unemployment, there won’t be one rule for the entire nation. You can expect to see house prices hold up much better in Sydney and Melbourne than elsewhere.
The BoA’s bearish outlook on the housing market is in line with market expectations. But it should be noted that market forecasts remain split. Some predict the property market will make a recovery in 2016. Others, like Morgan Stanley, forecast a 7.5% decline in house prices this year.
The BoA says construction levels have peaked across the economy. The only question, as far as the bank sees it, is how fast it begins to decline.
Despite a rise in approvals last year, the sector’s contribution to GDP fell below expectations. It only resulted in a 0.9% contribution to GDP. That’s below historical instances where similar construction booms were met with a 2% rise in GDP.
Verdict: Even with approvals peaking, a lot of construction work remains in the pipeline. Those building approvals still have to be built. In light of that, the sector could fare better than expected this year. But the rise in construction will put downward pressure on house prices in the short term.
Strong employment should help boost household spending in the year ahead. But wage growth could remain at a ‘sluggish’ 3–4%, according to the bank.
Verdict: If wage growth actually matches the BoA’s forecast, we’ll have done well. That’s much better the 2% average wage growth we saw over the past year.
The BoA expects inflation to hit 2.7% this year. The bank says below trend domestic demand and weak wage growth, should keep inflation on a leash.
Imported food prices are also expected to rise again in 2016. Over the past year, prices have risen by 28%.
Verdict: Inflation of 2.7% would come in at just above the Reserve Bank’s 2.5% target. That would make the RBA’s decision easier in keeping interest rates steady.
But the biggest takeaway here is the expected rise in food import prices. Red meat (surprisingly yes, we do import red meat) prices are 50% higher than in 2013. Rising inflation could affect spending as households dedicate more of their budget to food.
The BoA forecast the Aussie dollar dropping to US$0.65 this year. Higher interest rates in the US, and steady rates in Australia, should keep the dollar down.
Verdict: The value of the Aussie dollar could end up at that level. What the BoA might be wrong about is this idea that US interest rates will keep rising. There’s already market discussion suggesting the Fed could cut rates again, and soon. Were that to happen, the Aussie dollar would face upward pressure.
The BoA says the government will have to make tough decisions this year, especially on tax reform.
Verdict: There’s little doubt at this point that tax reform, in whatever shape, is on the way. Whether its GST, super or income tax, something will have to give. A $40 billion budget deficit will force the government into raising additional revenue from taxpayers.
We can also expect further clampdowns on companies moving profits offshore to avoid tax.
While the bank sees risks to economic growth, it doesn’t expect the RBA to move on interest rates. It cites improving business conditions and stable unemployment as reasons for this.
The BoA expect the current global volatility to pass, and commodity prices to stabilise. Should that prove the case, there’d be little need for rate cuts according to the BoA.
Verdict: In the event that the global economy turns a corner, a rate cut wouldn’t be necessary, no. But whether that proves to be the case is an entirely different matter. There are still plenty of international risks that could tip the RBA in lowering rates again.
One of the major risks is that US interest rates fall again. That would force the Aussie dollar higher, which might prompt a response from the RBA.
Junior Analyst, The Daily Reckoning
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