Saturday, July 12, 2014

2014-15 Economic Survey. Dollar dive ahead

The Australian dollar is set to dive to its lowest level in half a decade.

This year’s BusinessDay economic survey has it hitting 86 US cents by June 30, a fall of 8 per cent from its recent range of 93 to 94 US cents.

In another welcome result none of the BusinessDay panel expects particularly weak economic growth. On balance they expect the unemployment to stay at 6 per cent rather than climb to the 6.25 per cent forecast in the budget.

But they expect somewhat slower economic growth than the budget and weaker consumer spending as the economy continues to navigate away from mining investment to new drivers of economic growth.

The BusinessDay forecasting panel is made up of 25 of Australia’s leading forecasters in the diverse fields of market economics, academia, consultancy and industry associations. It includes several former Treasury forecasters. Over time its average forecasts have proved to be more reliable than those of any of individual member.

The panel expects Australia’s terms of trade to slip 4.9 per cent during 2014-15. It appears to be a better outlook than the budget’s which expected a slide of 6.75 per cent, but much of that slide was delivered almost immediately as iron ore prices plummeted 9 per cent between budget night and June 30. The panel’s average forecast masks wide differences in individual expectations. Steve Keen expects a slide of 10 per cent in 2014-15. Gareth Aird, of the Commonwealth Bank, expects a slight increase, the only panel member to do so.

China’s economy is expected to grow at its present pace, advancing 7.3 per cent, as is the United States and the global economy at 2.2 per cent and 3.3 per cent.

Growth in household spending will be anemic, climbing just 2.6 over the year, much less than inflation and population growth combined. The weakest forecast, from Bill Mitchell of Newcastle University, is for spending growth of just 1.8 per cent. Independent economist Stephen Koukoulas is the most optimistic predicting 3.25 per cent, nowhere near the likely combined rate of inflation and population growth suggesting that inflation-adjusted spending per capita will continue to fall.

After falling for a year real wages will mark time, barely climbing. The panel expects inflation of 2.6 per cent and wage growth of 2.9 per cent, well below the rates of 3 per cent that were common this decade and 4 per cent in the last half of the last. Paul Bloxham and Jakob Madsen are the most optimistic, predicting wage growth of 3.5 per cent and Steven Keen and Bill Mitchell the most pessimistic, expecting 2 per cent.

Tom Skladzien, of the Australian Manufacturing Workers Union, ought to have a good handle on wages. He plumps for 2.5 per cent, beneath his forecast for inflation, which is 2.7 per cent. By contrast Julie Toth, who works for employers at the Australian Industry Group, expects wage growth of 3 per cent, well above her inflation forecast of 2.5 per cent.

The lowest forecast for headline inflation is 1.8 per cent from Tim Toohey of Goldman Sachs. But his forecast for underlying inflation is a more standard 2.5 per cent, suggesting he believes the one-off removal of the carbon price to affect the headline but not the underlying number. Shane Garrett of the Housing Industry Association has the highest headline inflation forecast, 3.1 per cent. But he expects a tamer underlying result of 2.8 per cent. The panel member forecasting the worst underlying inflation is Gareth Arid, who predicts 3.1 per cent.

The average unemployment forecast of 6 per cent hides diverging views....

Saul Eslake, of Bank of America Merrill Lynch, expects the unemployment rate to climb to 6.6 per cent by June 2015. Stephen Koukoulas expects it to fall to 5.5 per cent.

Housing investment is set to climb a healthy 7.4 per cent in the view of the panel, but the range of forecasts is extraordinarily wide from a low of 1.4 per cent from the HIA's Shane Garrett (who ought to know about housing) to a high of 15 per cent from Peter Jones, of Master Builders Australia, (who also ought to know about housing).

The entire panel expects business investment to continue to slide, as did the budget. The budget went for a slide of 5.5 per cent. The panel goes for 5.8 per cent  but with wide variation. The most optimistic, Neville Norman of Melbourne University, expects a further fall of just 1.3 per cent. The most pessimistic, the National Australia Bank's Alan Oster, expects 10.2 per cent.

It adds up to historically weak, but not disastrous GDP growth of 2.8 per cent. Steve Keen who this time last year expected growth to go backwards (a recession) is this year happy to forecast 2 per cent suggesting that the worst that is likely won’t be that bad.

But nominal GDP growth (the amount of income generated unadjusted for prices) will grow by just 4.1 per cent, well below the heady rates of 8 to 10 per cent a few years back when the rest of the world was prepared to pay over the odds to grab Australian resources. Weak growth in nominal GDP means weak growth in government revenue, but the panel seems to believe that has been fully accounted for in the official forecasts, opting for a budget deficit forecast little different from the government’s own. Jakob Madsen is by far the least trustful of the official line, predicting a blow out to $65 billion in 2014-15, more than double the government’s forecast. Events in the Senate this past week are making his forecast look more likely by the day. Stephen Koukoulas is the most optimistic, expecting a slide in the deficit to $15 billion in line with his generally rosy view of economic growth.

Most of our panel expect the Reserve Bank to sit on its hands for the rest of this year, leaving the cash rate at 2.5 per cent. In the first half of next year most expect an increase, with two increases to 3 per cent the most popular pick. Commonwealth Bank's Gareth Aird is out on his own, expecting one increase this year and a further two in the first half of next year taking the cash rate to 3.75 per cent undoing two years of cuts.

Most expect an increase in the Commonwealth bond rate as unusually low worldwide rates vanish.

The Aussie dollar is set for a big fall. Only Gareth Aird expects it to climb above its present 94 US cents with Chris Caton, Alan Oster, Stephen Anthony and Shane Garrett expecting 82 US cents and Stephen Koukoulas and Peter Jones expecting 80 US cenPeter Martin is economics editor of The Age

It would be a silver lining to an otherwise manageable but unspectacular year.

In The Age and Sydney Morning Herald

Who got things right, and where did our team get 2013-14 wrong?

This time last year they were far too optimistic about business investment, on average expecting it to stay steady. When the figures are in it will have slid 4 per cent. That mistake probably derived from another one. They expected the Aussie dollar to slide to 89 US cents. Instead it climbed to 94.20.

And the budget blew out in a way none of them foresaw.

This time last year the treasurer Wayne Swan predicted a budget deficit of $18 billion. Our forecasters went for $20 billion. The wildest forecast was for $32 billion. The reality, confirmed by treasury in this year's budget papers, will be close to $50 billion. Our panel are entitled to complain that it is difficult to forecast something that couldn’t have been foreseen. Within weeks of taking office late last year Joe Hockey blew out the deficit by $9 billion in order to top up the Reserve Bank’s reserve fund.

A lot of other things the panel got pretty right. The panel forecast economic growth of 2.75 per cent in the year to June. The most recent figure for the year to March is 3.5 per cent, but the June quarter is expected to be weaker putting the final outcome in the ballpark of the forecasts. The panel got the cash rate exactly right. It expected 2.5 per cent and got 2.5 per cent. It was also spot on about the 10-year bond rate, expecting 3.5 per cent. The final rate was 3.57 per cent.

The ASX 200 climbed broadly as expected, although moved somewhat higher than the panel predicted, finishing at 5395.70. The panel picked 5235.
The hardest task in forecasting is being right where others are wrong. Several of our team were right about business investment where others were wrong, and several were right about the dollar where others were wrong. But only one was right about both. Step forward Professor Jakob Madsen. He picked a slide in business investment of 5 per cent and an Aussie dollar of exactly 94 US cents, both bang on the money.

He says his secret is not to use an economic model.

“I don't believe in models. There is no model in this world that can predict the exchange rate with confidence,” he told BusinessDay from his office at Monash University.

“We can make a guesses, but they are guesses about emotions because the exchange rate is partly driven by emotions.”

Coming from outside of Australia (he used to prepare forecasts for a Danish bank) Madsen was able to think about how Australia would be perceived by foreigners.

“If you would put your money somewhere last year, where would you have put it?  It would have to be somewhere with sound economic prospects,” he says.
He attributes his correct forecast of a dive in business investment to a gift for the obvious. “I couldn’t understand why the others forecast steady investment,” he says. “Investment is sensitive to the business cycle. It was turning down.”

His final tip is to ignore the newspapers. “No offence,” he says. “But if you are always focusing on what’s just happened you are unable to consider what’s happening underneath.”

In The Age and Sydney Morning Herald

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