An economy on the mend?

WE have heard the Prime Minister and Treasurer crow about the fact that we appear to have turned the corner in Australia. But have we?

Late last year, after the release of the December Quarter GDP figures, most commentators were talking seriously about the possibility of a recession. Talk of this nature tends also to be self-fulfilling.

Fortunately, the Reserve Bank (RBA) was also aware of this possibility. It immediately went into rate-cutting mode and its efforts in reducing interest rates quickly appear to have been a significant factor in helping to stabilise and, more recently, improve confidence.

Both consumer confidence and business confidence have improved during the past three months. Supporting the improvement in perceptions is a whole range of indicators which all point to the fact that the worst appears to be over for the Australian economy.

Housing finance and home sales figures indicate an improving market. Further business investment plans appear to be on the improve as well.

In addition to all of this was the icing on the cake of the GDP rebound for the March quarter. This was confirmation that much of the downturn late last year was due to a post GST and Olympic Games slump in construction activity.

The important question that needs to be addressed is: “Where to from here?”

AMP Henderson chief economist Dr Shane Oliver addresses this in his latest newsletter. He notes that there are several key points to consider.

Firstly, the rebound in growth in the March quarter was very impressive. But he cautions that rebound has been as a result of unsustainable growth in government spending and a spike in consumer spending.

Consumer spending alone contributed 1.3 percentage points to the GDP growth in the March quarter. However, when you look at the rising unemployment levels and the anecdotal evidence from retailers, it is difficult to see this being sustained for much longer. As Dr Oliver sees it: “Just as the December quarter exaggerated the weakness in the economy, the March quarter GDP figures probably exaggerate its strength.

A better guide may be to average growth across the two quarters – this would suggest a growth of around 0.25 per cent a quarter. That is weak, but not a recession.”

Secondly, Dr Oliver is aware of the range of leading indicators that are looking more positive.

He sees the following as indicative of possible stronger growth from later on this year:

p the sharp easing in monetary conditions – as represented by the fall in interest rates and the lower $A;

p the steepening of the yield curve (the difference between long term and short-term interest rates) – which is normally a reliable predictor of stronger growth ahead;

p the recovery in cyclical sectors of the sharemarket, such as building materials, which is also a good predictor of economic recovery; and

p the gradual uptrend/recovery in housing leading indicators – in particular home sales and housing finance.

Finally, Dr Oliver points to the fact that Australia does not have the sort of structural imbalances which many fear may constrain the recovery in the US. In Australia we have a positive household savings ratio. We have not had the substantial decline in share prices that has been experienced in the US.

The current account deficit as a proportion of our GDP is declining quite rapidly and, compared with the experience of the past 20 years, is quite low. This means that our dependence on foreign investment is not as high as it has been in the past.

A further point of differentiation is the lower level of investment that we have made in the information technology arena. This has meant that we have not done so to the detriment of other sectors of the economy.

So what is Dr Oliver’s conclusion?

“ … while domestic considerations are supportive of recovery there are still some headwinds which mean that a sustained reacceleration is unlikely until later this year and that the upswing, when it arrives, may be constrained compared to past experience.”

The headwinds that Dr Oliver identifies are:

p interest rate cuts tend to involve a reasonable lag period. He suggests that a cut in rates usually involves a nine-month lag before hitting the economy;

p unemployment is on the way up. The latest figures showed a slight up-tick in the unemployment rate to 6.9 per cent. The weaker job advertisement series suggests that a rate of 7.5 per cent is probably not too far away. Obviously this will constrain consumer spending;

p the fall-out from HIH, Harris Scarfe and One-Tel will slow the recovery; and

p poor global conditions. The US economy is sidestepping the recession at the present time. The question that has most pundits worrying is whether Dr Greenspan is able to sustain the sidestepping with interest rate cuts and the assistance of President Bush’s tax cuts. If the US does go into recession then it will impact on world economic conditions. This will then flow back into our economy.

Therefore, an improving economy seems to be very much on the agenda. There will not be an easy run through and there may be a number of pitfalls along the way. There seems little need for the RBA to cut rates in this cycle. There may be a modest cut in the next month purely to maintain the parity with the US rates, which look likely to be cut again.

The “little Aussie battler” will improve on the back of the improved strength of the economy. International investors have always favoured countries with relatively good growth prospects.

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