Australian economy rides slowing tide

Last year, Australia’s economy surfed a global wave of growth, which delivered an above-trend performance for the first time in six years. This year, the wave looks like it could turn out to be an ‘ankle-peeler’, or worse, a ‘dumper’. As surfers know, an ankle-peeler (also called ‘ankle slop’) doesn’t give you much of a ride and a dumper can sometimes drop you face first into the sand.

The loss of global tidal momentum reflects a number of factors. First, financial conditions have been tightening. The US Federal Reserve has lifted its policy rate by 100bps over the past year, to 2.25-2.50%, and is reducing its balance sheet, delivering ‘quantitative tightening’; the ECB recently ended its asset-purchase programme, removing ‘quantitative easing’; and, China has tightened funding as it reforms its financial system.

Second, the impact of the fiscal stimulus on US growth in 2018, including a substantial corporate tax cut, is set to fade, slowing US growth. Finally, the effects of trade tariffs and the threat of further trade protectionism have weighed on growth, with indicators of trade and manufacturing sector activity broadly declining, including in China and the US.

HSBC’s economics team sees global growth slowing from an above-average 2.9% in 2018, to 2.6% in 2019 and 2.4% in 2020. There are also key downside risks, including a further escalation of trade tensions and that policy makers have less room to cut interest rates or boost fiscal spending than in the past, if growth slows more than expected. Reflecting tighter global financial conditions and weaker growth expectations, there has been a sharp sell-off in equity markets in the past couple of months.

For Australia, weakening global growth presents a challenge, but the key is what happens to China’s domestic demand and commodity prices. After all, China is Australia’s largest trading partner, the dominant source of demand for most commodities as well as services, like education and tourism, and the key driver of growth for the Asian region.

Worryingly, China’s domestic momentum has weakened recently. The manufacturing purchasing manager indices have fallen, and growth in retail sales and industrial production has slowed. However, HSBC’s China economists are positive on the outlook for China’s domestic demand as they expect further policy stimulus measures to be delivered soon. This is expected to include further loosening of monetary policy, a boost to infrastructure investment and cuts to corporate VAT which could boost growth by a hefty 0.9-1.6ppts of GDP.

For commodities, although oil prices have fallen sharply, prices for Australia’s key commodity exports – coal and iron ore – have held up well. This reflects a combination of China’s ongoing environmental policies, which are favouring Australia’s higher grade materials, and the likely impact of a boost to infrastructure investment which supports demand for steel. Australia’s commodity-export prices are at a six-year high in Australian dollar terms.

Locally, the key threat to the surfer’s ride is falling housing prices in the major cities. Sydney and Melbourne housing prices have fallen 11% and 8%, respectively, since the recent peaks, following a significant ramp up in previous years.

So far, the housing price correction has been orderly, with little evidence of rising loan arrears. This largely reflects that the labour market is tightening, with the unemployment rate around a six-year low at 5.1%. A tight labour market has also supported consumer spending. However, a key risk to the outlook is that the weakening housing market begins to weigh on the consumer. We think this is unlikely to happen while the jobs market is strong and businesses are confident.

Business surveys are still showing above average conditions and positive investment plans. High capacity utilisation and strong profits in the resources industry should see mining investment start to pick-up soon. Of course, the risk remains that a weakening global backdrop will see Australia’s corporate leaders start to choose to ‘sit out the back’ and wait for the next wave.

Politics is also expected to play a bigger role in 2019, with an election due by 18 May. With the fiscal coffers charged – partly due to higher coal and iron ore prices – we expect a boost in government spending to support growth, particularly on transport and social infrastructure. With support from the mining sector, a positive labour market and an expected fiscal boost, we expect Australia’s growth to be 3.0% in 2019, but the risks are tilted to the downside.

For the RBA the latest stated public view, from mid-December, is that the central bank sees its next move as more likely to be up than down. Given the domestic momentum, and HSBC’s global and China growth views, we agree with this assessment and expect hikes to begin at the end of 2019. However, if the current wave is a dumper an RBA cut cannot be ruled out.

An ankle-peeler or a dumper? Either way, the global backdrop for 2019 is looking more worrisome for Australia’s economic surfer.

Paul Bloxham is HSBC’s Chief Economist for Australia, New Zealand and Global Commodities. This article first ran in The Australian Financial Review on 10 January 2019.