Foreign investors are expecting growth to slow down in Australia’s economy, partly due to ongoing slow increases in wages, according to Westpac chief economist Bill Evans.
Fresh from a recent trip to visit investors and clients in Europe and the UK, Mr Evans added that political developments were having a larger than normal impact on markets, citing the “spectacular” deterioration in the US in the past six months centred around President Donald Trump and uncertainty ahead of China’s 19th National Congress of the Communist Party. In contrast, the political environment had calmed down in Europe after the French election and signals that Angela Merkel would retain government in Germany.
“Politics can sometimes have significant impacts on markets and we’re seeing that at the moment,” he said.
In Australia, markets were roiled by the government’s surprise announcement of a new tax on the major banks including Westpac in the May federal budget to help return to surplus by 2020.
Asked how foreign investors viewed Australia in the wake of the tax and budget, Mr Evans said the biggest talking point was record low wages growth. He said the central banks, money managers and hedge funds he visited in June were bearish on any material lift in wages from the record low annual rate of 1.9 per cent.
“The really big issue that is confronting markets and central banks (globally) is why is wages growth so low? In the case of Australia, our wages growth is the lowest we’ve seen which is holding back the confidence of consumers meaning a lower growth trajectory than we’ve been used to,” he said.
“And they (the investors) say ‘well you’ve got very little hope of getting much change in your wage story because look at countries like the US, Germany, Japan, the UK, they’ve got full employment and they can’t get any wage pressures. So in your case you’re very, very unlikely to do that’.
“As a result…the general feeling around Australia is that with the mining boom is behind us, and the housing construction boom having and the consumer remaining cautious, the growth outlook for Australia is not encouraging.”
In the federal budget, Treasury forecast wages growth to pick up to 3 per cent by 2018-19, above Westpac’s forecast of 2.1 per cent. The bank’s less optimistic view on wages feeds into Mr Evans’s prediction that the Reserve Bank will hold official interest rates – the cash rate – steady at 1.5 per cent for this year and next, opposed to some peers who believe a hike is on the cards next year.
“Australia has no reason to raise interest rates,” he said. “Even though the market is now predicting a rate hike next year, it’s been our view for a couple of years that rates are going to remain on hold for 2017 and 2018.”
With the US Federal Reserve likely to keep hiking, Mr Evans said this would result in a rare situation where official interest rates in the US were around half a per cent higher than in Australia, helping push the dollar down to US65¢ by end 2018.
“I think by the second half of next year US interest rates will be nearly half a per cent above our own and we’ve really only had a couple of times in the last forty years when that’s been the case and on each of those occasions not surprisingly the Aussie dollar has had to take some of the downward pressure,” he said. “So we’re talking about an Aussie dollar with a six in front of it rather than a seven and I didn’t get a whole lot of pushback on that from these investors.”
In China, Australia’s biggest trading partner, Mr Evans predicted President Xi Jinping may extend his term as China’s leader beyond the current five years at the National Congress later this year, and accelerate the process towards domestic services sectors and consumption.
“We suspect he wants a longer term and therefore it’s in his interests to keep the economy strong now but then once those political issues are resolved to go back to the encouraging reform he adopted in the early years of his presidency,” he said.
A more “reformist” approach by Mr Xi would however reduce demand for bulk commodities such as iron ore – Australia’s biggest export – as China focuses less on infrastructure, manufacturing and housing. “We will see a lower iron ore price which will complement that interest rate story and growth story to put that downward pressure on the currency,” Mr Evans said, as iron ore traded around $US66 a tonne.
Domestically, Goldman Sachs’s banking analysts this week warned households will need to “find” an additional $42 billion of cash flow next year to fund higher mortgage costs due to higher interest rates for investors and interest only borrowers, and as more people move to principal and interest loans.
Mr Evans, however, predicted house prices will flat line, rather than crash, similar to the aftermath of bank interest rate adjustments in 2015.
“The average affect across the whole mortgage book…back then was about 28 basis points (higher). This time it’s about the same and the pressures are continuing,” he said. “I would think by the middle of next year house price inflation will have disappeared. I’m not saying prices are going to fall, but I think the idea that house prices keep going up at double digits will be well and truly reassessed by this time next year.”
Any commentary contained in this article is not intended as financial advice and should not be relied upon as such by you.
By Peter King
Acting Chief Executive Officer, Westpac