Saturday, February 01, 2014

Steady as she goes. Rates on hold all year

Here is is, the 2014 BusinessDay economics survey:

As the Reserve Bank prepares for its first board meeting of the year the BusinessDay forecasting panel is predicting a rarity - an entire year without a move in official interest rates.

It hasn’t happened since 2004.

A unique blend of 25 of Australia’s leading forecasters in the diverse fields of market economics, academia, consultancy and industry associations, the BusinessDay panel includes several former Treasury forecasters. Over time its average forecasts have proved to be more reliable than those of any of its individual members.

A year ago the average forecast was for a cut in the Reserve Bank’s cash rate from 3 per cent to 2.7 per cent. The Bank cut to 2.5 per cent. In 2012 the average forecast was for a cut from 4.5 per cent to 3.6 per cent. The Bank cut to 3 per cent. This time the average forecast is for no cuts. The average comes in slightly below the current rate at slightly below the current rate at 2.46 per cent by June and slightly above at 2.55 per cent by December.

If rates do say on hold at around 2.5 per cent for the entire year it will be because the settings are already in place to deliver just enough (anemic) economic growth to keep further unemployment (almost) at bay.

The average forecast reflects a panel evenly split. Nine of the 25 members expect rates to fall further, nine expect rates to climb, and seven expect them to stay put. Two of the panel expect cash rates to fall to an ultra-low 2 per cent. One of them, Macquarie Group’s Richard Gibbs expects it to happen in the first half of the year. The most bullish forecast is from Stephen Koukoulas of Market Economics who expects 3.5 per cent by the end of the year and 3 per cent by June. As it happens Koukoulas was spot on last year, predicting a near-record low of 2.5 per cent by year’s end.

The central forecast is for improving global growth partly offset by a further easing in China. The panel expects the world economy to grow 3.3 per cent in 2014. In the United States it expects through-the-year growth to climb to 2.7 per cent. China’s growth should slip further to 7.4 per cent, but there is a wide range around the forecast. Melbourne University’s Neville Norman expects China to grow by 8.2 per cent. Stephen Anthony of the Canberra consultancy Macroeconomics expects 6.5 per cent.

Weaker Chinese growth would mean a further slide in Australia’s terms of trade. The price of Australia’s exports relative to imports has already slid 18 per cent from the peak in late 2011. The panel expects a further slide of 3.9 per cent. Only Richard Robinson of BIS Shrapnel and Gareth Aird of the Commonwealth Bank expect an improvement. Their forecast upturns are modest: 1.4 and 0.7 per cent.

Business investment is expected to stagnate further as resource prices sink. Non-mining businesses are unlikely to fill the gap. The average forecast is for a further decline in investment of 3.2 per cent. Tim Toohey of Goldman Sachs forecasts the steepest decline: 11.6 per cent. Neville Norman is alone among the panel in expecting an increase, of 5.1 per cent.

The panel expects Housing investment to surge as the full impact of last year’s rate reductions comes through. The most impressive forecast is from Tim Toohey who offsets his pessimism about business investment by predicting a 10.5 per cent lift in home building. The average forecast is for a 5.3 per cent increase. One of the lowest forecasts is from the Housing Industry Association itself, which is expecting 1.8 per cent.

The pace of Household spending is also expected to pick up, climbing 2.5 per cent in 2014 after advancing 1.8 per cent over the past twelve months.

The panel believes the boosts in both housing investment and household spending will be enough to lift the pace of GDP growth from 2.3 per cent to 2.7 per cent. The highest forecast, from Stephen Koukoulas is 3.9 per cent. The lowest, from Jakob Madsen of Monash University is 1.2 per cent.

Although welcome, economic growth of 2.7 per cent would be well below the long-term growth rate of 3.4 per cent, and insufficient to stop the unemployment rate rising. The central forecast is for an unemployment rate of 6 per cent by year’s end, up two notches from the present 5.8 per cent.

Population growth means individual living standards will advance by less than GDP. The panel expects GDP per capita to grow by 1 per cent during 2014, which is an improvement on 2013. Jakob Madsen expects it to fall, slipping 0.5 per cent.

Inflation has been edging up with the falling dollar, most recently reaching 2.7 per cent in the year to December. The panel expect it to stay at recent highs, finishing the year at 2.5 per cent backed by an underlying rate of 2.4 per cent. The ANZ’s Justin Fabo picks the highest headline rate: 3.4 per cent. Nigel Stapledon of the Australian School of Business picks the lowest, 2 per cent.

The panel expects the Australian dollar to drift lower, finishing the year at 86 US cents - close to but not quite at the “magic spot” of 80 and 85 US cents identified by Reserve Bank board member Heather Ridout in an interview with Fairfax Media in January. Only two of the panel expect the dollar to end the year back up above 90 US cents: Su-Lin Ong of RBC Capital Markets who expects US 95 and Stephen Koukoulas who expects parity. The lowest forecast, from Stephen Anthony is for US 78.

And the budget deficit will come in pretty much as forecast, both this year and the next in the view of the panel. The result is more surprising than it seems. The forecasts in the government’s pre-Christmas budget update were presented as if they reflected badly on the outgoing Labor government. The update predicted a deficit of $47 billion in 2013-14 and $33.9 billion in 2014-15, unless something changed. The government has set up a Commission of Audit to recommend changes in time to shrink the deficit in 2014-15, but the panel expects little progress. It’s opting for $47.6 billion in 2013-14 and $32.8 billion in 2014-15.

Given the panel’s relatively weak forecast for Australian economic growth it might be of the view that the economy couldn’t take too much progress on the cutting the deficit. If the government reaches a different view and cuts hard, the panel’s central forecast of unchanged interest rates may turn out to be on the high side.

In Business Saturday

The most accurate of the Business Day forecasters this past year was only half human.

“Barry” is a dynamic stochastic general equilibrium model of the Australian economy. Its creator is Stephen Anthony, a former Treasury modeller who set up a private consultancy Macroeconomics in 2007.

Dr Anthony uses his own judgement about fiscal policy and monetary policy and then uses Barry to spit out results for everything else. Barry is built from more than fifty equations.

Last year Barry said the Australian economy would grow by 2.5 per cent (so far it’s been growing at 2.3 per cent), China would growth 7.3 per cent (so far 7.7 per cent), the US would grow through the year growth by 2.1 per cent (2.0 per cent), household spending would grow 1.8 per cent (1.8 per cent) housing investment 2.1 per cent (1.7 per cent). Barry said the Australian dollar would end the year at 90.5 US cents (it ended at 89.2) and a current account deficit would reach $55 billion (it reached $52 billion).

Not everything came out the way Barry and Stephen predicted. Inflation was higher at 2.5 per cent rather than 2.1 per cent, unemployment was lower at 5.8 per cent rather than 6.3 per cent and the cash rate was nowhere near as low. It ended the year at 2.5 per cent, well above the machine-human hybrid’s prediction of 2 per cent.

Only five out of the Business Day panel got the cash rate completely right, and they were completely human: Shane Oliver of the AMP, Nigel Stapledon of the University of NSW, Frank Gelber of BIS Shrapnel, Stephen Koukoulas of Market Economics, and Brad Crofts of the Australian Workers Union. Most of the panel thought it would end the year much higher, some above 3 per cent.

The inflation rate of 2.7 per cent was an easy pick for most of the market economists, but for no-one else apart from Neville Norman of Melbourne University.

Where the academics came into their own was the 2012-13 budget deficit. None of the other forecasters predicted anything like the eventual outcome of $18.8 billion. Professors Bill Mitchell and Jakob Madsen came about as close as possible, picking $20 billion.

All of the other forecasters who went for a lower deficit can be excused. The Treasurer had been predicting a surplus.

In Business Saturday

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