Did the Australian economy present any surprises over 2019?
Growth turned out to be weaker than expected as downside risks materialised. Offshore, the trade and technology dispute between the United States and China escalated to such an extent that global central banks were forced to provide an offset via a significant easing in monetary conditions. With monetary policy stretched, there has been a concerted call for fiscal policy to play a greater role in supporting economic activity.
Back home, the Australian economy disappointed, with growth slipping to rates well below potential. Curiously, while global trade and offshore manufacturing fell, Australia’s external sector held up surprisingly well. Exports were supported by a softer currency and offshore policy stimulus, particularly in China. Import demand softened as both consumers and business became more cautious. The anticipated slowing in the housing sector looks to have come through faster and sharper than initially thought.
Given the economic cross currents at play, the labour market held up surprisingly well. Average monthly jobs gains to September of around 25,000, compares to a 22,400 rate over the previous year. While labour demand remained robust, so was the response of the supply side of the economy with the participation rate rising to record levels and this helps explain why the unemployment rate edged up over the year.
What’s in store for 2020?
Supportive policy settings should help the economy snap out of its growth funk
After two consecutive years of growth around 2.1%, our view is that Australia’s economic growth rate can lift back towards 2.5% by the end of 2020. Policy settings were eased over the second half of 2019 and the lagged effect of these should help support demand.
An easing in macro prudential settings and lower mortgage rates has helped stabilise property prices. Nationwide, property price trends are uneven, with Melbourne and Sydney prices turning up over the latter part of 2019 – a trend that is expected to continue over 2020. While solid labour market conditions, tax cuts and monetary easing should support consumption, there is a risk that consumers carry over their caution and preference to save rather than spend into 2020.
Apart from moderate consumption growth over 2020, public sector demand is expected to be a main driver of economic growth, with scope for a further fiscal boost in the May 2020 budget. Dwelling investment is poised to be a drag on growth over 2020, but at a slowing rate as the sector troughs. Business investment is projected to pick up from subdued levels as activity in the resources sector recovers and business benefits from the ongoing infrastructure cycle.
Spare capacity remains, limiting inflation gains
With the unemployment rate above its long run neutral rate of 4.5%, spare capacity remains in the economy and this will have to be absorbed before wages can lift at a rate that lifts the inflation rate back into the Reserve Bank of Australia’s (RBA) 2% to 3% target band. Given our growth forecasts, we don’t see the headline inflation rate hitting 2% until the end of 2021.
Monetary policy in unchartered territory
Towards the end of 2019, the RBA had to cut the cash rate three times, bringing the cash rate down to a record level of 0.75%. After starting the year in a patient mind set, the RBA ended up joining offshore moves, partly to absorb spare capacity faster and partly to avoid an appreciation in the currency which would have made it harder to meet its policy objectives.
As the RBA cash rate approaches the zero bound, the benefits from rate cuts are diminishing, with rising risks that increasing caution sees the effectiveness of the cash flow channel dulled as consumers save more and businesses defer investment. There were signs of this happening over the latter part of 2019.
The RBA has also started conversation about unconventional policy as the zero bound looms close. It appears as though negative rates are off the table, with the sequence of preferred unconventional measures beginning with forward guidance, yield curve flattening measures and forms of asset purchases.
Our base case view has the cash rate falling to 0.5% and staying at that level for an extended period. We don’t see the RBA in a position to remove accommodation until late 2022, by which time the next round of fiscal easing should be in play, the housing trough will have passed and remaining spare capacity absorbed. Monetary accommodation will not be removed until the RBA is confident that the inflation rate has settled above the bottom of its 2% to 3% target band.