The mining cliff won’t be bridged

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By Leith van Onselen

Please find below a spectacular chart pack from Westpac’s economics team, which provides detailed analysis of the outlook for the Australian economy at both the national and individual state levels.

A summary of the national economic outlook is provided below:

The Coast-to-Coast Report highlights how the Australian economy has lost considerable momentum through the second half of 2012. In the first half of 2012 annualised growth momentum was around 3.5% while in the second half it slowed to 2.5%. On average we expect growth to slow from 3.6% in 2012 to 2.5% and 2.3% in 2013 and 2014 respectively.

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The key theme will be the inability of demand, including government, to adequately fill the gap in demand created by the slowdown in mining expenditure over the course of 2013 and 2014. Indeed this report highlights that mining investment growth already slowed markedly in the second half of 2012.

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The mining boom is expected to peak in 2013 with mining spending swinging from a contributor to growth in 2012 to a drag in 2014. The expectation from the authorities is that non mining investment and household spending will respond to lower interest rates and accelerate to fill the void. Some evidence has been building with consumer confidence rising by 11% since October although business confidence has been flat.

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Investment, employment intentions and house prices appear to have stabilised but manufacturing, in particular remains weak. Households are concerned about job security. Recent strong growth in equity markets has allayed concerns amongst consumers around the global economy while businesses are responding to soft demand with plans to raise efficiency levels and limit expansion plans.

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With 2013 being a Federal election year both households and business are impacted by political uncertainty. Indeed, political issues have dampened confidence, both business and consumer, through 2012. That is unlikely to pass until well beyond Election Day on September 14 as businesses, in particular, scrutinise the policies of whichever party is elected with, hopefully, a clear majority.

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Fiscal policy stands as a significant headwind to a more robust response by the economy to the low interest rates. In previous easing cycles fiscal policy has supplemented monetary policy particularly around the housing market with direct subsidies to First Home Buyers. In this cycle First Home Buyer subsidies have been reduced and /or been limited in all states. First Home Buyers have failed to respond, in turn constraining any boost to housing finance growth. Investors and upgraders are being required to “carry” the recovery. To date an encouraging response from investors has been limited to NSW with diverse regional conditions highlighting considerable difficulties in engineering a nationwide boost to property markets, despite aggressive rate competition amongst banks. House prices have shown some evidence of responding to near record low rates but, to date, evidence is patchy.

Public demand has also constrained growth. With state governments under considerable pressure to sustain their AAA/AA+ ratings with ratings agencies spending cuts have been imposed at the state government level. Australia’s unemployment rate has edged up slightly despite near record low interest rates.

Until the February Employment Report hours worked and employment to population ratio pointed to weak demand for labour although a falling participation rate has held down the unemployment rate. The February Report, which printed a stunning 71,000 jobs and yet no reduction in the unemployment rate appears to be partly distorted by statistical issues highlighting a significant danger in declaring a return to a strong jobs market. Lead indicators point to ongoing labour market weakness in 2013. We estimate that the unemployment rate is likely to exceed 6% by early in 2014 unnerving households and constraining any recovery in consumer confidence.

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Under these circumstances the output gap will widen and inflation pressures are likely to ease. Efficiency gains by firms, limited demand pressures and an Australian dollar which remains elevated will contain inflation pressures. Following the February Employment Report markets are now forecasting that rates are near bottom with hikes likely in 2014. That is not consistent with our scenario. We expect a further rate cut in June, or shortly thereafter, and an extended period of rate stability. We cannot see a rate hike in 2013 or 2014. Whether a second round of rate cuts begins much later in 2013 and into 2014 will be determined by the state of the global economy. Our view is that the risks favour “disappointment” in the global outlook in the second half of 2013 and into 2014.

Expectations for a solid upswing in China, European stability, and a lift in the pace of underling private demand in the US will dominate global views for the next six months or so. The reality is likely to be less encouraging with China’s growth plateauing in response to modest policy restraint, Europe remaining in recession for another year, and US growth being contained in the 1–2% range as excessive sovereign and household debt constrain confidence. In Europe and the US, governments will deal poorly with high sovereign debt and banks will continue to limit support to the housing market.

Accordingly, while our central forecast is for one more rate cut to be followed by a long period of rate stability the balance of risks favour a renewed easing cycle in late 2013 and into 2014. Under this scenario we look for a marked down shift in global commodity prices around the second half of 2013 and into 2014.

Slowing global demand and increased supply, which has been responding to rising demand in the first half of 2013, will dictate this downshift. We expect the Australian dollar, after peaking around USD1.05 by mid-year, will be on a down trend through 2013 and into 2014. Potential further rate cuts, softening commodity prices and elevated global risks will be headwinds for the AUD.

Full report below.

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Westpac Coast to Coast (March2013)

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.