This article first appeared in the March edition of The Melbourne Review:
ANOTHER YEAR OF EXPANSION
The economy has started 2014 on a strong footing, although there remain quite divergent trends within the changing composition of that growth.
Mining investment is falling away very sharply and perhaps one of the easiest things to forecast for the next few years is for further sharp declines. Many of the huge mining projects of the last decade have been completed or are close to completion. The work is finished. Given the huge capacity in mining built up over that time, there are very few new mining projects on the horizon.
This is well understood and is a critical reason why the Reserve Bank of Australia has set interest rates at record lows.
The other slightly disconcerting aspect of the economy is the softening in the labour force. Over recent months, the rate of job creation has stalled and the unemployment has reached a 10-year high around six percent. This reflects prior softness in the economy, through to about the middle of 2013.
The reason why the labour force result, from a macroeconomic perspective, is only slightly disconcerting is because employment growth lags changes in the business cycle. It has only been in the period since about the September quarter 2013 that the rate of economic growth has started to kick higher.
It is encouraging to see that the rate of GDP growth lifted to an annualised pace above three percent in the latter part of 2013, up from just above two percent earlier in the year.
The partial indicators for the economy in the early months of 2014 suggest that GDP is on track to exceed three percent, perhaps by a wide margin in the near term. This sort of growth should be strong enough to start firing up the labour market, which means that solid rates of job creation will return and the unemployment rate will certainly head lower.
In terms of some of those indicators, retail sales have risen at an annualised pace of nine percent over the last six months, a pace of expansion that normally coincides with uncomfortably high inflationary pressures. Consumers are clearly cashed up, enjoying the massive savings from record low interest rates on their mortgages and the $1 trillion that has been added to their wealth over the past two years from the boom in house prices and higher share prices.
Some of these positive effects are spilling over to the housing market. Importantly for bottom line GDP growth, dwelling construction has reached a record high in recent months to the point where housing construction will add significantly to growth through 2014 and probably into 2015. Favourable demographics from strong population growth and earlier under-building left Australia with a housing shortage which was a critical factor behind the renewed optimism in the construction sector.
In terms of house prices, there is no doubt there is a boom of some importance currently underway. Prices have risen by around 15 percent in the past 18 months and while this is leading to issues of affordability for those not in the market, it is generating a strong lift in wealth and is encouraging builders to build more dwellings so as to take advantage of the higher prices.
Perhaps the most important aspect of the strong growth outlook has been exports and mining exports in particular. In both volume and value terms, exports are rising at a rapid pace. While the price of some key exports has fallen somewhat over the past year or so (iron ore, gold and coal), this is been at least partially offset by the lower Australian dollar and a surge in the volume of those exports. It is this lift in export volumes that is adding substantially to economic growth while the high export values are supporting national income growth. Both are very favourable factors for the economy and look set to continue while ever the global economy is moving to a strong and sustained expansion.
These stronger conditions have added to inflation pressures with the inflation rate accelerating over the past year. The RBA has acknowledged some uncertainty about just how and why inflation has lifted in the past year but there is a clear impact from the lower Australian dollar and the slightly stronger economy.
The end point is that the composition of economy growth in Australia is changing appreciably, with the fall away in mining investment being more than offset by stronger consumer spending, a housing construction boom and robust export growth. This is just what the RBA and Treasury would have been hoping for and it sets the scene for the economy to move into a 24th year of continuous economic expansion.