Commodity price rise to boost incomes: HSBC'S Paul Bloxham
GUEST OBSERVER
Growth was considerably weaker in the third quarter of 2016 than was expected, with real GDP falling on the quarter for the first time since Q1 2011.
However, the fall appears to reflect the coincidence of a number of one-off factors, including a temporary disruption to coal exports and inclement weather affecting construction activity, rather than the beginning of a more significant downturn. Recent numbers for retail sales, business conditions and international trade already suggest a solid pick-up in GDP growth is likely in Q4 2016.
In addition, there has been a substantial pick-up in coal and iron ore prices recently. Although this rise did not arrive in time to support the Q3 2016 GDP numbers, it should flow through to a significant boost in income growth in Q4 2016 and beyond. Australia’s commodity price index has risen by 20% in AUD terms since Q3 2016. Our estimates suggest that the pick-up in commodity prices should add around 2.0pp to nominal GDP over the coming year.
Overall, the strong rise in commodity prices and end of the mining investment decline are changing the local growth story. For the past five years, the Australian economic story has been about rebalancing growth away from being driven by mining investment at the end of the commodity prices ‘super-cycle’. Lower interest rates and the fall in the AUD over recent years have supported a housing boom and rising services exports, which have rebalanced growth. The mining sector is now stabilising and is no longer set to drag on growth and incomes.
Given the recent downside surprise to GDP growth, we now expect growth of 2.4 percent in 2016 (previously 2.9 percent), rising to 2.8 percent in 2017 (previously 2.9 percent) and 3.2 percent in 2018 (unchanged).
Although local inflation is currently below the RBA’s 2-3 percent target and wages growth is sluggish, we expect both to rise gradually through 2017. Supporting this, we see the rise in commodity prices as likely to lift national incomes, tax revenues, corporate profits and wages growth. Non-mining business investment is also already showing signs of rising modestly and, although the labour market has spare capacity, it is worth keeping in mind that job creation tends to lag the cycle, rather than lead it. We retain our view that the RBA is likely to keep its cash rate on hold at 1.50 percent through 2017 and have recently shifted our call for 2018, with 50bp of RBA hikes now pencilled in.
Policy issues
The Australian government has passed legislation to re-instate the Australian building and Construction Commission, which is an indication that there has been some progress on labour market reform. This legislation was difficult to pass and was the trigger for the July 2016 ‘double dissolution’ Federal election.
The government has also passed a number of fiscal reform measures, including the ‘backpacker tax’, with the measures set to save the government AUD21bn over the next four years. Tax revenues are also expected to get a boost from rising commodity prices. Offsetting these measures, slower-than-expected wages growth has weighed on the personal income tax take. The government’s focus on fiscal reform has become more pressing since one of the major rating agencies, Standard & Poor’s, put the Australian government on ‘negative outlook’ for its triple-A sovereign rating in July 2016.
Financial stability concerns remain an ongoing issue for the central bank, given a further recent pick-up in housing prices and a modest revival in investment activity in Australia’s housing market. The pick-up in housing market activity has occurred despite local prudential settings having been tightened over the past two years. The pick-up in investor credit growth adds to the case for the RBA to keep its cash rate unchanged over the next few quarters.
Risks
We view the risks to growth as evenly balanced. On the upside, the lift in commodity prices and boost to incomes could provide more support for growth than we currently expect. On the downside, slower-than-expected growth in China could weaken demand for Australian commodities or services exports. The risks to our inflation outlook are tilted to the downside. Changing patterns of employment could put more persistent downside pressure on wage growth, and thus local underlying inflation, than we have currently factored into our central case.
PAUL BLOXHAM IS CHIEF ECONOMIST (AUSTRALIA AND NEW ZEALAND) FOR HSBC.
