Australia | Jan 11 2010
By Chris Shaw
In the view of Commonwealth Bank chief economist Michael Blythe, a key feature of the Australian economy in 2009 was the development of a framework for a self-sustaining recovery, one that contained the key elements of a resumption in the capital expenditure boom and improvement in Australia’s terms-of-trade, a pick up in residential construction levels and a turnaround in the labour market.
Stronger commodity prices have helped as they have put life back into resource-related capital expenditure plans, Blythe noting projects that had been cancelled or deferred are now coming back on line and new projects are being given the green light. At the same time, the pick up in commodity prices has improved the terms-of-trade, to the extent he estimates the income boost could be as much as 1.5% of GDP in 2010/11.
For 2010 and 2011 Blythe sees Australian commodity prices continuing to trend higher, with iron ore contract prices forecast to increase by around 25% in the next Japanese financial year, hard coking coal prices expected to gain by about 48% and thermal coal prices tipped to gain by around 21%. Base metal and oil prices should also be higher, but Blythe expects the gold price to fall below US$900 per ounce by the end of this year as some of the safe-haven demand that helped the precious metal gain fades away.
The pick-up in residential construction activity is expected to continue this year, Blythe pointing out a typical housing construction upturn adds two to three points to GDP growth over a cycle, which usually lasts two to three years and also has significant second round effects elsewhere in the economy. With the labour market proving more resilient than expected, he sees support for consumer sentiment and spending, all of which are likely to support the Australian economy in the coming year.
As Blythe concedes there remain risks, with the fact the labour market chose to shed hours worked rather than staff during the downturn means a recovery in spending may be more subdued than would otherwise be expected, while capex spending could be limited by a lack of resources and so may not be as strong as expected.
Interest rates are another risk as Blythe notes despite recent rises, official interest rates remain at accommodative levels, which is not really justified given expectations of trend type economic growth in 2010. This means further rate hikes are likely, Blythe expecting the cash rate will be at 5.0% by year’s end. This is the level at which he suggests rates reflect a neutral policy setting, down from 5.5-6.0% previously given a widening gap between nominal and effective interest rates.
This outlook for rates suggests support for the Australian dollar, a trend likely in any case given the currency’s history of outperforming during global economic recoveries. By the middle of the year Blythe expects the Aussie dollar to be at around 0.98 against the US dollar, with a good chance of parity at some point during the first half of the year.
Any indication by US authorities they are ready to lift interest rates should be a signal for sustained US dollar appreciation in his view, but this is not expected before the middle of the year at the earliest. When it does happen, the Aussie dollar should weaken, Blythe forecasting a rate of US$0.90 by the end of the year.
The fact the Australian experience proved to be more of a slowdown than a recession, means forecasters have been revising expectations for the year ahead, Blythe noting new estimates are showing a significant upgrade in forecasts. This reflects the fact policy actions over the past year or so supported the economy, creating a significant divergence between expectations and reality.
Looking globally, expectations are for a recovery in 2010, the International Monetary Fund now forecasting global growth for the year of 3.1%, up more than a percent from its forecast made early in 2009. Any recovery remains dependent on contributions from public policy and a swing in the inventory cycle and while both may not last Blythe sees a better year in 2010 than for the year just finished.
It is likely any recovery remains a sub-par one however, as while growth of around 3.0% is positive it would be well below the 5.0% average in the years leading into the Global Financial Crisis (GFC). Such a sub-par recovery means output gaps will expand further and unemployment appears to have not yet peaked, though on the positive side inflation is expected to remain subdued through this year.
Blythe expects economic underperformance will be concentrated in the advanced economies that were most exposed to the GFC, while less-exposed emerging economies should find it easier to get back to or exceed trend rates of economic growth. The other factor that could hold back many advanced economies is the need to repair damaged balance sheets, as banks remain reluctant to lend and households are increasing savings rather than spending as much as before, all of which suggests a more subdued rate of economic growth.
Upside risk among developed nations is most likely to be centred on the US and UK economies in Blythe’s view as some early indicators are posting positive results, while there appears less upside risk in Japan given ongoing deflation and debt issues and in Europe given weakness in some of its smaller member economies.
With respect to Australia, Blythe suggests the composition of global growth is as important as the magnitude of that growth, as evidenced last year when the stronger performing economies in 2009 were also Australia’s Asian trading partners. Such a trend is expected to continue through 2010, with China again the key. One impact of this will be to create something of a two-speed economy, with the resource rich states likely to benefit the most.
Blythe remains bullish on China’s outlook as economic policy appears to be working and domestic growth drivers are continuing to offset some of the contraction in its export markets, which is also helping make the Chinese economic story appear more durable in his view. (Note: this weekend’s Chinese data revealed a surprisingly strong jump in both exports and domestic demand).
Factors such as exchange rates will be an issue in the coming year however, while capital will continue to flow into markets where perceived returns are the highest. This is creating some asset price inflation, meaning there are risks to the overall sustainability of the strength of Asian economies.
