There are some hangovers from the global financial crisis, and a series of natural disasters here and abroad are hampering activity and confidence. But the weakening of growth is really a changing of gears as the private sector takes over from government expenditure as the primary driver of growth.
Will private expenditure come through in time to fill the gap left by the public sector? We think so. Our gross domestic product forecast is for a quick rebound from 2.6 per cent growth this year to 4 per cent next financial year.
Over the next five years the economy will be strong, underpinning demand for property.
Our problems will be on the supply side as a residual consequence of the GFC, as insufficient investment to underwrite future growth comes home to roost in property and other sectors.
The economy has paused after the initial rebound following the GFC-induced downturn.
To me, that demonstrates the strength of government stimulus to cushion the Australian economy. It worked. Without it we would have had a recession. But now, as governments focus on reducing their budget deficits, government expenditure will start to wind down. Hence the current weakening of growth. We’re switching gears from government to private drivers of growth.
The economy may be a little weak now but it has an underlying strength. Apart from the winding down of major government projects, the current weakness is due to precautionary savings by households and businesses.
Apart from resources, private investment remains patchy. But that will change amid emerging capacity constraints, tighter leasing markets, rising incomes and strong returns on investment.
The commercial office markets are a classic example. My last column argued that we were headed for an office market boom. Indeed, across the board, the undersupply of commercial and industrial building — the collateral damage of the GFC — will recover strongly in a series of rolling investment cycles.
The scene is set for strong growth in private investment to drive economic growth over the next five years. We are already well into the second major phase of resources investment.
Residential construction has picked up strongly and, though currently pausing, will resume its growth over the next few years until rising interest rates trigger a downturn. Next comes a recovery in retail development, followed by industrial and then the office market.
These rolling investment cycles will underpin growth in the medium term, hence my optimism about growth prospects.
But it’s not all rosy.
Current underinvestment means capacity constraints will emerge within two or three years. Add the problem of emerging skilled labour constraints and we have a dangerous demand-inflationary mix. Two years from now we’ll be back to pre-GFC conditions, with capacity and labour constraints inducing demand-inflationary pressure and strongly rising interest rates. Here we go again.
The Reserve Bank sees its primary task as containing inflation. Inflation is not a problem now but the RBA knows it will be, and sees its job as making room for the minerals boom.
Already cash rates have risen from a stimulatory level of 3 per cent to 4.75 per cent. Current economic weakness has allowed a pause but there will be more rate rises. We expect three more over the next year in response to signs of economic strength.
But that’s not the main game. When capacity and labour constraints lead to demand-inflationary pressure in two years’ time the RBA will become really aggressive. We think home loan rates will be 9.5 per cent or higher three years from now. That will kill housing demand.
How can we make room for the minerals boom? Apart from housing, the major collateral damage will be in the domestically produced tradeables sectors — manufacturing, tourism, education and business services. The high dollar, strong commodity prices and comparatively high interest rates will do the damage by hurting competitiveness in both export and import markets. This process of slow and painful structural change has already begun.
Will we continue to see a two-tiered economy? Of course. There will be major differences between winners and losers. The impact of the high dollar will be compounded by high interest rates.
So you see, I’m not worried by the current weakness in the economy. Growth will pick up strongly, but not uniformly. The minerals boom means tradeables gloom, with higher rates and a limited life for the housing upswing.
But there are plenty of opportunities in the underpriced and soon to be undersupplied investment markets. And there are ways to insure ourselves against rising interest rates.
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