25/08/2008 - 14:23

Economic slowdown concerns not valid

25/08/2008 - 14:23

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Economic forecaster BIS Shrapnel has forecast a return to strong economic growth in the medium-term, once the current episode of ‘overdone pessimism’ has receded.

Economic slowdown concerns not valid

Economic forecaster BIS Shrapnel has forecast a return to strong economic growth in the medium-term, once the current episode of ‘overdone pessimism’ has receded.

In its Long Term Forecasts 2008 to 2023 report, BIS predicts interest rates will be lowered during fiscal 2009, believing the Reserve Bank of Australia will not allow the sharp slowdown in retail spending and building approvals witnessed in the first half of 2008 to cause further contraction in employment, spending and investment.

But while consumer demand and business investment are moderating, domestic demand is still carrying plenty of momentum.

“We are witnessing an overblown crisis of confidence and the effects of a global credit squeeze rather than a debt-constrained slowdown,” says report author and economist Rachael Logie. “National income growth remains strong, underpinned by the profits of the mining boom.”

Ms Logie added that current economic fundamentals remain sound.

“Markets are not generally oversupplied and in the case of residential property there is considerable pent up demand which we expect to be released from 2009/10 as credit conditions start to ease.

“The external sector is also poised for a recovery underpinned by sustained high demand for commodities and a significant depreciation in the Australian dollar over 2009 and 2010, which will boost competitiveness.

“Total business investment activity is also expected to remain at high levels on account of sustained high demand for commodities and the backlog of work required to update the infrastructure network.”

According to BIS Shrapnel the combination of rising supply and slowing demand will ease inflationary pressures, however in the absence of a sharp contraction in demand and accompanying job losses, the economy will not return to the low inflation, low interest rate environment which operated earlier this decade.

“The playing field has changed, both at home and abroad, and inflation is now intransigent,” Ms Logie said.

Earlier this decade, the low inflation environment was characterised by spare capacity in domestic labour and product markets and the disinflationary effects of falling world prices for manufacturers.

“More recently, we have seen the emergence of supply constraints in housing, energy and child care,” she said.

“These supply constraints will ease once investment responds to strong price rises - and in the case of housing, after credit conditions ease.”

BIS Shrapnel believes it is the direction of tradeables inflation, and its effect on costs, prices and wages, together with the domestic labour constraint, that will mean the RBA will struggle to keep inflation within its target bounds in the medium term.

Disinflation from cheap Chinese goods will not provide the dampening impact in the next decade to the same extent as it has in the current decade and a depreciating Australian dollar will see the relative price of imported goods rise.

Wages growth has not been the trigger of inflationary pressures in the current tightening phase as

labour market reforms and institutionalised setting of wages have reduced growth. However, the ongoing tightness of the labour market means wages growth will remain within a four-to-five per cent band, which will make it harder for the RBA to keep inflation within its two-to-three per cent target band.

BIS Shrapnel forecasts slowing investment and consumer spending, and a boost to productivity from prior investment, will push the unemployment rate above five per cent by the second half of 2009.

However, as renewed residential construction activity drives momentum in the economy and GDP growth strengthens again, the unemployment rate will drop back to current levels of close to four per cent by 2012.

“A low unemployment rate means that it wouldn’t take much of a pick-up in investment and employment for the economy to again exceed its speed limit and re-ignite inflationary pressures,” Ms Logie said.

“And the result is that we are likely to see shortened, or flattened, investment cycles accompanied by rising inflation and escalating interest rates.

“We are at the top of the current interest rate tightening cycle, but it is only a localised peak. The

stubbornness of inflation, due to labour constraints, means that we are unlikely to see a return to a low interest rate environment in the absence of a recession.”

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