Australia’s economic outlook


Martin Lakos, Division Director
Friday 24 April 2015

Macquarie's highly-regarded equity market strategist, Tanya Branwhite, coined the phrase 'long grinding cycle' (or LGC) to describe current global market conditions, and it is a theme featured throughout her research articles over the past 12 months.

She believes economic cycles are longer, and describes the key characteristics as low inflation (or even the risk of deflation), weak demand growth, and for Australia a re-alignment of its economic cycle away from its traditional peers (in particular, the US).1

"For companies this continues to manifest in lower levels of top line growth," Tanya says in a recent article on equity strategy.

The question is, will the LGC continue in 2015?

Sometimes you need to look back to see where we've come from, to understand where we're going next.

Throughout 2014, Australia's economic growth was below the long-term trend – and it was very narrowly based. Driven by resource sector export volumes, its value declined as commodity prices weakened in the second half of the year. This means that while we are producing more, the economy is earning less.

It has also been well documented that consumer and business confidence has been subdued, impacting business investment and resulting in rising unemployment. Macquarie economist James McIntyre forecasts unemployment to reach 6.3% in the 2015 financial year, and 6.7% by July 2016.2

The Reserve Bank of Australia (RBA) has consistently commented each month on the need for the Australian dollar to be sustainably lower over time to help re-balance the economy. The Australian dollar has depreciated over 13% from its 2014 high in June of $US0.94, yet despite weakening commodity prices the Australian dollar has held stubbornly above most calculations of fair value.

Residential property prices are now cooling after a solid rise, housing approvals may have peaked as has building activity. Key non-residential construction has been lagging due to soft business confidence.

So what is ahead that will differentiate 2015 from 2014?

There are two important developments to be aware of: cheaper oil prices globally and the potential for interest rate cuts to take us to a new record low.

There are two important developments to be aware of: cheaper oil prices globally and the potential for interest rate cuts to take us to a new record low.

Firstly, cheaper oil prices will help to boost economic activity around the world including Australia. While this is not great for oil producers, it will be positive for consumers and industry. The oil price may not necessarily remain below $US60 per barrel, but it will be well below the average price seen through 2014, ($US99 per barrel for 11 months to November 2014) and this is already being reflected at the petrol pump.

We also now expect the RBA to deliver two 0.25% rate cuts in the first quarter of 2015, taking rates to an all-time low of 2%.

Throughout 2014 Macquarie expected Australian interest rates to be on hold at 2.5% for a sustainable period – potentially out to first quarter 2016.  

However the combination of weaker wages growth, commodity prices, confidence and currency has moved to the point where additional monetary policy action is now required.

If interest rates are cut in the first quarter of 2015 as forecast, we would anticipate the Australian dollar will weaken to $US0.78 by the financial year end, which would certainly assist in the re-balancing of our economy.

Historically, small to medium businesses have benefitted more from the flow-on effects of lower input costs, such as energy and interest rates. Any immediate benefits could improve consumer and business confidence, and this may stimulate higher investment activity. Meanwhile, the impact of a lower currency tends to take longer to become visible, but should result in improved competitiveness and productivity.

We can't underestimate the potential impact of these two developments, so as we go into 2015 we are more hopeful the economy will recover towards its long-term growth target of 3.25%.

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1 Tanya Branwhite, Macquarie – Equity Strategy - The 3 "D's" of the LGC...Disinflation, Demand deficiency & Divergence (1.12.2014)

2 James McIntyre, Macquarie – Aussie Macro Outlook – Doubling Down (22.12.2014)