Rising interest rates and higher public spending to stimulate economic growth could define the Australian economy in 2017, according to OECD.

 

Analysts predict growth should continue to pick up, although possibly at a slower rate. Nevertheless, considerable risks and unknowns remain that could threaten the outlook for the year.

 

The OECD’s November economic forecast for Australia[1] predicts economic growth will rise to three per cent by 2018.

 

In the forecast, the OECD notes that, “the decline in resource sector investment will tail off and the non-resource sector will be supported by a steady increase in household consumption and investment as wages and employment rise. Further falls in unemployment will help reduce inequality and are not expected to generate strong inflationary pressures.”

 

Jeremy Thorpe, Partner, PwC National Economics Policy and Consulting team, expects the lower growth environment will continue this year.

 

“Mining investment is still depressed and we haven't seen upside in the rest of the economy. We've not had rising interest rates for some time, and that's a challenge in the domestic economy. As the U.S. raises interest rates it will be interesting to see how banks around the world respond,” says Thorpe.

 

“We've relied on construction to sustain us in the post-mining boom recovery. Some of that has been as a result of Chinese investment. When interest rates rise, and if there is uncertainty because of global trade challenges, this could put pressure on the construction sector,” he adds.

 

While activity in the construction sector may decline if interest rates bottom and turn upwards, activity in the infrastructure sector could help Australia’s economy into 2017.

 

Consumers and markets should expect Australian interest rates to rise through the year, with the OECD noting it expects monetary policy will start to tighten towards the end of 2017[2]. This is consistent with other markets such as the U.S., but out of cycle with interest rate movements in Europe and Japan, where rates are not expected to rise for some time.

 

By comparison, the European Central Bank’s interest rate is currently 0%, and is expected to be 0.5% by 2020[3], according to data and projections from Trade Economics; and Japan’s interest rate is presently -0.1%, with an expected increase to 0.1% by 2020[4].

 

The OECD notes higher interest rates in Australia could cool the housing market, while the Australian residential property sector has, in many areas, experienced rising prices for an extended period.  Concerns remain that a continued low interest-rate environment could widen discord between financial markets and recovering areas of the economy.

 

Room to move

 

Turning to fiscal policy, the OECD forecast suggests the Australian Federal Government has tools in its kit to help support economic growth, including tax reform: “there is space for fiscal loosening given the low public-debt burden. Returns would be high for accelerated infrastructure development and investing in skills, an area where Australia falls short of top-performing countries.”

 

Trading Economics' data indicates that the U.S. government debt-to-GDP was 104.17%[5] for 2015, while the figure for Australia was 36.80%[6]. This may be one indicator of how the Coalition government may have room to increase public expenditure to help drive economic growth.

 

The OECD states, “there is room for spending increases, notably an acceleration in the public investment programs underway in telecommunications, roads and public transport systems.”

 

Additional suggestions include aggressive tax reforms by policy makers to drive growth. The OECD says, “reductions in corporate tax rates are… proposed. However, the reforms fall short of a major shift in taxation as recommended in OECD Economic Surveys, which stress the importance of efficient tax bases, such as the goods and services tax, and land tax.”

 

Looking forward

 

Overall, the OECD is expecting economic growth to rise gradually, although it concedes there are a large number of uncertainties in the environment that could call its growth assumptions into question.

 

It says output growth should rise to around 3% by 2018, thanks to the positive impact liquefied natural gas (LNG) projects, that are about to come on line in Queensland, will have on economic growth. Three LNG projects are about to become operational in Queensland according to The Australian Financial Review[7].

 

The OECD assumes the shift from economic growth being driven by mining investment to growth from a more diverse range of industries should also help drive economic performance, as long as macroeconomic policies remain supportive[8].

 

As a result, employment and household consumption could pick up as household savings fall commensurately. The OECD doesn’t expect inflation will rise sharply, which should also help support Australia’s economic recovery, noting “Australia has experienced 25 years without recession, but there are risks looking forward. Commodity market developments, particularly those linked to the Chinese economy, remain an important source of uncertainty and risk.”

 

Overall, the performance of the housing market is the main risk. Should interest rates rise sharply, this will put pressure on households to meet mortgage repayments.

 

Ratings agency Standard & Poor's has also put Australia’s AAA rating on watch. The nation’s cost of borrowing will rise should the rating be downgraded. The negative effect on business and consumer confidence such a step could have is the more worrying consequence of any deterioration in the rating.

 

Ultimately, although fundamental data suggests a rise in economic growth, considerable risks remain that could destabilise Australia’s economic recovery.

Key Takeaways

•  OECD predicts economic growth of 3%.
• Tax reform needed to improve economic conditions.
• Federal Government balance sheet has room to invest in infrastructure.

 

 

[1] OECD, Australia - Economic forecast summary (November 2016)

[2] Ibid

[3] Trading Economics, http://www.tradingeconomics.com/euro-area/forecast, accessed 08/12/16

[4] Trading Economics, http://www.tradingeconomics.com/japan/interest-rate/forecast, accessed 08/12/16

[5] Trading Economics, http://www.tradingeconomics.com/united-states/government-debt-to-gdp, accessed 08/12/16

[6] Trading Economics, http://www.tradingeconomics.com/australia/government-debt-to-gdp accessed 08/12/16

[7] The Australian Financial Review, http://www.afr.com/business/energy/gas/qld-pipeline-could-solve-gas-woes-elliceflint-20161122-gsvbpd

[8] Op. cit