Australia: Growth to limp through 2015 Asia Pacific Economic Outlook, Q2 2015
Australia’s economic growth slowed further in Q4 2014. Reasons include a weak labor market, high household debt, sliding commodity prices, and poor domestic demand.
Australia’s economic growth slowed further in Q4 2014 to 2.3 percent year over year, in contrast to 2.7 percent in the previous quarter. Annually, the country’s GDP grew at a below-trend pace of 2.5 percent in 2014. The momentum of national income growth slowed in the second half due to lower export prices for iron ore and coal. However, the strong investment in new capacity made in recent years is now coming onstream, meaning that export volumes remain the main contributor to economic growth. On the other hand, domestic demand remained weak throughout the year due to poor consumer and business spending. While a weak labor market, record-low wage gains, and high household debt weighed on consumption expenditure, sliding commodity prices and poor domestic demand resulted in weakening business investment.
The underlying labor market conditions remained soft, as evident from the rising unemployment rate, which increased to 6.3 percent in February—the highest in 13 years. Employers have been reluctant to employ permanent employees as they remain skeptical about economic growth prospects. The new monthly leading indicator of employment, which peaked in January 2014, has been falling since then.1 In other words, employment growth has been weak since early last year, and recent monthly numbers indicate that employment could continue to grow more slowly in the coming months than indicated by the long-term trend.
Business investment remained weak as the economy struggles to transition from mining- to non-mining‐led growth. Expectations of falling commodity prices and a surge in global mine supply in prospect post the rapid expansion during 2010–2013 have led to lower investment growth. So far, investment in non-mining sectors has failed to make up for the winding down of a decade-long boom in mining investments. Total capital spending fell 2.2 percent in Q4, primarily led by a 5.4 percent drop in capital spending by the mining sector. Investment in sectors such as manufacturing, telecom, financial services, distribution, and construction increased, but the drop in mining sector investment offset these increases. Surprisingly, residential investment also fell in Q3 2014, despite the surge in building approvals and housing starts owing to low levels of mortgage lending rates and solid (if slowing) population growth.
On the positive side, weaker domestic demand, poor wage growth, the abolition of a carbon tax, and low international oil prices resulted in low inflation. Inflation was 1.7 percent in 2014 through Q4 compared with 2.3 percent in Q3 2014. At the same time, the average value of the Australian dollar depreciated 6.5 percent in 2014. On a trade-weighted basis, the Australian dollar was around 4 percent below its early 2014 levels, a relatively modest decline given the significant fall in commodity prices during the latter half of the year.
The combination of weak growth, modestly rising unemployment, and a lack of inflation threats led the Reserve Bank of Australia (RBA) to cut official cash rates for the first time in 18 months, reducing the official cost of borrowing to a record low of 2.25 percent. This unexpected move by the RBA in its first monetary policy meeting of the year (held in February) was intended to support domestic demand, which has remained below the average long-term growth trend.2 Lower interest rates are likely to boost domestic demand and offset some of the decline in the investment cycle.
So far, investment in non-mining sectors has failed to make up for the winding down of a decade-long boom in mining investments.
Growth is expected to remain modest this year before gradually picking up to an above-trend pace in 2016. A weak labor market will likely weigh on consumption expenditure, although low lending rates, rising housing wealth due to increasing house prices and a lift in equity markets, and falling fuel prices are expected to partially offset the impact. If global commodity prices remain low, that may, in turn, impact wages, profits, and government revenues. In addition, investment will likely remain patchy this year due to an expected fall in commodity prices, falling mining-related investment, and a slowdown in investment in Australia’s largest trading partner, China. While lower interest rates, a depreciating currency, and stronger growth in the United States might cushion the impact on investment and trade, growth will likely remain in the range of 2.2–2.9 percent in 2015. Net export volumes will continue to be the key driver of growth, and a depreciated currency will further boost export growth in services in 2015.
The below-trend GDP growth and patchy investment outlook suggest that the unemployment rate may continue to remain high. In addition, the pace of wage increases and growth in unit labor costs will likely remain low. A weak labor market, poor domestic demand, and low international oil prices may result in a further fall in full-year inflation rates this year. Of course, a strengthening housing market and continued depreciation of the Australian dollar may offset this fall. Headline consumer price inflation is expected to be in the range of 1.4–2.0 percent this year, lower than the 2–3 percent target range of the RBA.
The RBA communicated in its February monetary policy meeting that it may reduce interest rates further to support growth because it expects inflation to remain within the target range.3 The timing of the rate cut is yet to be decided and will be communicated in future monetary policy meetings. However, given large increases in house prices and the ongoing strong housing asset lending to investors, reducing interest rates might increase risks to the housing market. Thus the RBA has to weigh its options closely before considering whether to make monetary policy more accommodative.