2014 forecasts – half way through and it’s a mixed bag

1. Economic Growth
The economy is accelerating into the end of 2013 and with very easy monetary policy, a competitive Australian dollar, more favourable conditions in the global economy and fiscal policy moving to neutral, GDP growth is poised to accelerate to around 3.5% by the end of 2014. It might even be stronger than that as the world economy grows at an above trend pace. While every Joe, Glenn and Martin know that mining investment will be a significant drag of GDP, a pick up in household consumption, a housing construction boom and solid export gains will swamp the mining downturn. [Looking reasonably good, although the lift in GDP to 3.5 per cent has already occurred with the March quarter national accounts confirming the acceleration in growth. The question confronting most economists now is whether growth is likely to ease back from this mini-peak and if so, where GDP will end 2014. My current forecast is for GDP to be below 3 per cent by the December quarter.]

2. Labour market
With the economy on a clear upswing, jobs growth is likely to follow to a stronger phase, of course allowing for the usual 6 to 9 months lag. In the near term, the unemployment rate is likely to nudge 6% before it starts to tick lower from around the June quarter. Around 225,000 jobs are likely to be created in 2014 which will see the unemployment rate around 5.25% at the end of the year. [Looking reasonably good, with the unemployment rate hitting 6 per cent in February and then easing to 5.8 per cent in the most recent data. Employment has increased by around 100,000 in the first five months of 2014 although the pace of job creation will be integrally linked to the GDP growth cycle mentioned above. It now seems more likely that the unemployment rate will get to around 5.5 per cent but have trouble falling below that level and that around 200,000 jobs will be added to the economy in 2014.]

3. Inflation
There are some tentative signs that inflation is now less benign than it was a year ago. The surge in asset prices (housing and shares) is underscoring a huge gain in wealth which is spilling over to higher spending and possibly consumer prices. The lower Australian dollar is adding some stimulus to the economy which is also likely to see inflation edge up into the upper half of the RBA’s 2 to 3% target band. Headline inflation to hit 3% by end 2014, but underlying inflation will lift to around 2.75%. [Inflation had indeed accelerated in the early part of 2014 and when the June quarter CPI is released in a few weeks, annual inflation is likely to be around 3 per cent. Underlying inflation is still on track to hold around 2.75 per cent through 2014, so this looks a solid forecast that is still largely on track albeit with some downside risks.]

4. Monetary policy
The RBA will be hiking interest rates during 2014, perhaps aggressively. The growth, labour market and inflation dynamics suggest the current 2.5% official cash rate is just too low. The best bet for now is to expect the RBA to snug and tap interest rates up by around 25 basis points each quarter in 2014 with the cash rate ending 2014 at 3.5%. [Bzzzz. Wrong. The RBA has held the cash rate steady so far in 2014 and it seems set to remain on hold a while longer. While a rate hike looked a shoo in a few months ago, the collapse in consumer sentiment, stalling in the housing market and mixed news globally has allowed the RBA to make the tough decision to leave interest rates steady at a very stimulatory level. No change is now the most likely outlook for interest rates over the remainder of 2014.]

5. Fiscal policy
By the time the government brings down the MYEFO for 2014-15 in the final months of 2014, there will be a clear trajectory to budget surplus for 2016-17 and beyond, largely because the budget’s automatic stabilisers will be super-charging revenue but also as some of the money shuffling from the government pays back the current out-years from the smoke and mirror budgeting that will see the 2013-14 deficit hit something close to $50 billion. In net terms, the government is unlikely to do much to deliver a structural fiscal policy tightening. Most savings measures announced to date have been fully offset to a ramp up of spending elsewhere. The infrastructure spending program is likely to be captured in the budget figuring which will mean the path to surplus will be not much different to that proposed by the previous government. [This looks to be pretty much spot on. A lame budget with lots of fiscal churn – some cuts here and there, extra spending on pet projects and precious little in the way of fiscal consolidation to be seen. Indeed, the move to budget surplus under Mr Hockey’s first budget is slower than the profile left to the new government in the Pre-Election Fiscal Outlook document released during the election campaign.]

6. House prices
Having risen a solid 10% or so in 2013, house price growth is likely to taper somewhat in 2014. A rise of less than 5% for the year is more likely as tighter monetary policy, a rebound in supply and some satisfaction of pent up demand works to take some house price heat out of the market. Indeed, if the RBA hikes a little more than I expect, house prices may be dead flat in the second half of 2014. [House price growth has indeed moderated in recent months although the trend still seems to be up. For the first six months of 2014, house prices are up just 3.3 per cent, a little lower than I was anticipating but the lack of interest rate hikes is likely now to see house prices trend up a while longer, albeit at a more moderate 5 per cent annualised pace.]

7. The Australian dollar
The AUD is ending 2013 about 15% lower than the peak reached during the first half of 2013. There is a very hearty debate being driven by the RBA about fair value for the currency with the RBA judging that the AUD is overvalued. This assessment has some substance although with a lift in the global economy, strong domestic activity and probably wider interest rate differentials all AUD supportive. The recent fall in the AUD has seen a lot of international investors lighten what were very overweight positions. They and others may be tempted to re-enter the AUD market, especially when interest rates rise. All up, it is a scenario where the AUD could easily lift through 95 US cents or regain parity during 2014. Range for the year, 84 US cents to 97 US cents with more time in a 90 to 95 range, especially in the second half of 2014. [Pretty much spot on with the AUD in a broad 86.50 to 95.30 range in the first half of 2014 with the past four months seeing the AUD in that broader 90 to 95 cent range. It is a mixed outlook at the moment with softer domestic growth and falling commodity prices being countered by the still high yield and triple-A credit rating.]

8. Stocks
The favourable growth and earning story is likely to be offset by monetary policy tightening not only in Australia, but in the US and some other major countries around the world. The ASX200 is likely to record a decent gain and should hit 5,750 points during the year although it is likely to be biased nearer 5,500 over the latter part of 2014. The risk to this forecast is to the high side – that the more positive conditions spark a more solid increase in the ASX200 to above 6,000. In other words, buying stocks now, around 5,150 points is a good trade. [A pretty good call, with the ASX around 5,450 having hit 5,550 earlier in the year. The fundamentals remain positive for stocks, and it would not surprise to see a break higher over the second half of the 2014 although 6,000 now seems a stretch. Economic growth and low interest rates are a cocktail fro stock market gains.]

9. Bond yields
The bear market for bonds that unfolded in 2013 is likely to continue into 2014. The 10 year government bond is likely to break above 5% with the rate hikes skewing short end yields higher, meaning a flatter yield curve. The higher inflation rate that is likely to be printed over 2014 will be critical in driving yields higher, as will a reallocation of cash to stocks and away from bonds. [Wrong – the rally in global yields has impacted in Australia and the absence of rate hikes from the RBA has added to the fall in bond yields. The market seems content that US Fed tapering will not see yields spike, with perceptions that inflation will remain low, especially in the Eurozone, helping to hold yields lower. The recent bout of softer local data has added to the bullish run in the bond market. From here, it still seems likely that yields will track high, but that is a low conviction forecast.]

10. Politics
There will be a plethora of political matters that will be important in 2014. There will be, in no particular order, the by election for Kevin Rudd’s old seat of Griffith, the new Senate election for Western Australian and then the State elections in South Australia, Tasmania and Victoria. All will be interesting but largely irrelevant for those looking for clues for implications for Federal politics given the next Federal election will not be held until the end of 2016. [Labor retained Griffith and won in South Australia against the odds. The Coalition did well in the WA Senate replay. On current betting, it looks likely that Labor will win in Victoria when it has its State election in November.]