Australia | Dec 20 2010
By Greg Peel
The economists at National Australia Bank note that stock markets are so far heading to year-end with a more positive bias, and that the US volatility index has fallen to pre-Lehman levels which indicates a return to risk appetite. US bond yields are on the rise, indicating expectations of a stronger US economy ahead aided by the extension of the Bush tax cuts.
An acceleration of growth in the US in 2011 is good news for Australia, says NAB, as it will help shore-up sentiment in the global economy. NAB expects the Australian economy to grow at above trend levels in 2011, driven by an 18% increase in business investment. Government spending will fall by a mere 1% but growth in private consumption will remain soft at 3%.
NAB expects the RBA to hike twice by September to 5.25%, having held off to mid-year, and the Aussie to rise a little above parity but be back in the high nineties by late 2011 and into 2012.
The following are the ten factors which will impact on the Australian economy in 2011 according to NAB.
Factor (1): Over the past few quarters the return to a high rate of household savings has contributed to a pronounced slowing in retail housing demand – more than could otherwise have been expected from RBA rate hikes alone. Should this savings rate begin to fall in 2011 the offset for the currently soft sectors would be an RBA fear of inflation pressure which would lead to more aggressive rate hikes.
Factor (2): There has been little consideration given by politicians or the media over 2010 to Australia's productivity growth, or lack thereof. Yet GDP per hours work has risen only 1.1% in 2010 compared to the 2.25% trend of the last 20 years and the peak of 3.5% in the late nineties. Various reasons are given for this slump, including more lower skilled workers being employed, skilled workers being hoarded ahead of shortages, and technology being channeled toward consumption rather than business investment.
Productivity increases are required, says NAB, to prevent Australia squandering the opportunities presented by the resource boom. It's time politicians began taking note of the productivity implications of policy and began looking to other policies, such as targeted infrastructure investment, which will serve to increase productivity. Which leads us to…
Factor (3): The government's infrastructure enhancement policy launched in response to the GFC has now gone amiss, suggesting the policy was seen only as a form of economic rescue and is no longer required. NAB begs to differ, suggesting the current resource-led boom could last a decade or more and as such opportunities to impact on factor (2) should continue to be taken through further infrastructure enhancement.
The government could pay for the programs by cutting the middle class welfare policies introduced by the Howard government, NAB suggests. Which leads us to…
Factor (4): While NAB is advocating more infrastructure spending, it is also advocating a more rapid tightening of post-GFC fiscal policy than is currently underway. Other policies put in place were a response to expectations of a recession and are thus no longer valid. It will be tough to find savings, but it can be done to provide a more significant budget surplus in 2012-13.
If the government is concerned Australia is becoming over reliant on commodity exports then tighter fiscal policy will undermine the need for the RBA to tighten rates substantially, giving more breathing space to the other sectors in the economy.
Factor (5): It is currently popular to suggest the Aussie dollar, at these lofty levels, is seriously overvalued. NAB disagrees. Modelling the Aussie based on the three underlying fundamentals which determine its value – commodity prices, global risk appetite and interest rate differentials – and applying appropriate timing leads the economists to suggest the Aussie is correctly valued.
NAB sees those three fundamentals improving during the first half of 2011, leading to an Aussie of US$1.050.
Factor (6): Don't call it the “two-speed economy”, says NAB, because that implies a simple delineation between the resources sector and everything else. It's a lot more complex than that, with different sectors being impacted in different ways by the strong Aussie, higher rates, higher household savings and the withdrawal of fiscal stimulus. It's a “multi-speed economy” please, and will continue into 2011.
There is also talk of “Dutch disease”, referring to the 1960s when Holland poured everything it had into its newfound natural gas industry at the expense of the rest of the economy, only to see the gas bubble burst and with it the entire Dutch economy. NAB also disagrees with this simple comparison, suggesting that the driving forces of industrialisation and urbanisation in China and India represent a long lasting period of change. Politicians will, nevertheless, need to manage the multi-speed economy delicately.
Factor (7): The IMF has now decided Australian house prices are only 5-10% overvalued despite having previously suggested 17.5% and without any pullback in the meantime. Yet the IMF does not believe prices will fall by this much if incomes and rents continue to rise. Any correction would be “orderly”.
NAB expects house prices to rise 5-8% in 2011 due to population growth (despite a more recent slowdown in the growth rate) and a lack of dwelling commencements, which are running some 50-80k behind the required rate.
Factor (8): Sovereign debt issues in Europe have been the big topic of 2010 and NAB expects this again to be the case in 2011 and perhaps for more than a decade ahead. However, the economists believe the emergency fund currently in place will prevent any full-blown crisis. Debt restructuring for some countries, such as Greece, will nevertheless be likely.
Australia only sells 4% of its exports to Europe so a slowing in European economic growth is no great disaster. However, Australian banks borrow around 20% of their funds offshore and a more substantial slice of these bond issues find their way to Europe. Debt issues may well thus translate into higher funding costs for Aussie banks, and hence higher rates for Aussie borrowers.
Factor (9): There is a lot of panic every time Beijing tightens Chinese monetary policy, with the fear being a bust may transpire. But it was Beijing that implemented the largest fiscal stimulus package in history and in so doing has shot the Chinese economy back to double-digit growth.
Any tightening from here to a more sustainable pace can only be good news for Australia, says NAB, and so far Beijing seems to be handling its economy post-stimulus rather well.
Factor (10): There is a lot of talk QE2 won't work for the US economy. NAB again dissents, suggesting it already has. This is apparent in the preemptive rise in stock prices and the subsequent improvement in US retail sales.
The weaker US dollar has improved the trade balance and sent economists scurrying to upgrade their growth forecasts, NAB notes. There are also signs the labour market is beginning to look better. NAB expects a modest 2.6% growth rate for US GDP in 2011.
