Looking for the next growth spurt

01 March 2010

There is little doubt that Australia has been one of the best performing advanced economies since the onset of the global financial crisis in September 2008. In the past 18 months, the Australian economy has expanded by around 1.8%. While this is well below average growth, it is a fantastic outcome when put in context of the falls seen in the US (-1.9%), Euro area (-4.3%) and UK (-5.9%) over a similar timeframe.

Moreover, the pick-up in growth is expected to accelerate over 2010 as the economy continues to rebound from a very moderate downturn. Market expectations for the Australian economy have quickly shifted as analysts and policymakers have upgraded their forecasts. The market consensus is now factoring in trend growth of 3% in 2010. That said, we think growth will be considerably stronger than this, running at a pace closer to 3%.

But where is this growth going to come from?

Household spending makes up the largest component of total output, contributing around 55% of GDP. This underscores the importance and value of policy stimulus measures that have supported consumer spending in the wake of the downturn in the broader economy. To be sure, stimulus payments to households helped the economy avoid a recession during 2008/09.

And, with consumer confidence stabilising in the absence of further stimulus, we expect household consumption to grow at just below trend pace in the year ahead, but continuing to provide a solid base for GDP growth.

Residential investment activity is a little later to the party, but will no doubt provide a valuable boost to the economy over the year ahead. Building approvals jumped sharply over the second half of last year, and as at December 2009, owner occupier building approvals were up more than 50%YoY. It is common for residential investment to lag a surge in building approvals by around 3 - 6 months, meaning that actual residential construction is set to bounce sharply in 2010.

It should be noted that while dwelling investment is a relatively small component of total economic output, the flow through into employment and consumption means that the multiplier effect of rising housing markets is a more valuable source of growth than the direct impact would suggest.

Business investment, meanwhile, will be a drag on growth this year. This is because business investment is generally the last component of growth to recover following an economic downturn. That said, the differentiating feature of this cycle is that when business investment does begin to pick-up, the improvement will be far more dramatic than seen previously due to significant mineral and energy projects in the pipeline.

This was highlighted by the recent capital expenditure survey, which suggested a 15% increase in business investment is likely over FY11. Indeed, this is likely to be the major driver of growth in 2011.

Meanwhile, public investment is filling the gap left by the private sector in the short-term, and this is providing a valuable support to growth. Over the second half of last year, the Government approved more than $14.5b worth of education construction work as part of its stimulus program and further infrastructure work is still to be completed.

Some offsetting influence will come from net exports, which is expected to be the major drag on growth in the coming year. This is a result of stronger consumer and business expenditure boosting demand for imports, whilst the appreciating AUD worsens export competitiveness.

On balance, this is a very strong growth outlook, with the Australian economy again expected to outperform market expectations in 2010.