Morgan Stanley remains bearish on the Australian economy, at least in the short term

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  • Morgan Stanley remains bearish on the Australian economy in the short-term, predicting GDP growth will slow to 2% in 2018.
  • It expects falling house prices, soft wage growth and tighter credit conditions to limit household spending, leading to the RBA keeping interest rates on hold for the foreseeable future.
  • The bank is forecasting that the Australian dollar will fall to 71 cents by the end of 2018, a factor that will help to support the economy in 2019.

When it comes to mainstream economic forecasters, few are as bearish on Australia than Morgan Stanley.

At least in the short term.

Rather than expecting an acceleration in the Australian economic growth this year, something that most forecasters, including the RBA, expect, it thinks growth will slow, dragged down by falling house prices, soft wage growth and tighter credit conditions.

It’s a scenario, the analysts say, that will weigh on household spending.

“We don’t think any of the fundamental drivers of our cautious outlook on the economic have changed,” the bank wrote in note released earlier this week.

“We continue to expect GDP growth to weaken in 2018 to 2%, against a consensus expectation for an acceleration of growth to 2.8%, and a RBA expectation of above-trend growth of 3%.

“Our contrarian view is almost entirely due to our cautious outlook for consumption, given it accounts for around 60% of the economy.”

Source: Morgan Stanley

Helping to explain its contrarian view, Morgan Stanley says recent weakness in the Sydney and Melbourne property markets will likely persist throughout the year, something it says will also weigh on residential construction, further limiting GDP growth.

“Our proprietory housing market lead indicator continues to point to further price declines over 2018, and we expect the moderate falls seen to-date to continue,” it says.

“The housing market continues to be in oversupply, despite a decline in completions and migration-driven pickup in demand, and credit is being tightened through macro-prudential and other regulatory measures.

“This leaves us pessimistic on the outlook for housing over 2018, and we expect both prices and activity to continue to decline.”

Along with reversing positive wealth effects driven by strong growth in property prices in previous years, Morgan Stanley says ongoing weakness in wage growth, along with tighter credit conditions, will limit the ability for households to spend.

“The consumer crunch is continuing,” it warns.

“We expect a combination of slow income growth, falling house prices and regulatory tightening of credit to drive consumption growth lower from its already subdued levels.”

Source: Morgan Stanley

While not its base case scenario, the bank says there’s a risk household savings levels could actually increase, an outcome that could further limit the potential for households to spend, at least in the short to medium term.

“In our bear case, we see a slowing in credit growth as banks implement ‘responsible lending’ practices, and this, in combination with a decline in consumer sentiment as house price declines persist, drives a savings rate increase as spending falls below income,” it says.

“This should see households begin to deleverage but would imply a sharper-than-expected deceleration in the economy.”

This, it says, will likely override the lift in business investment that many expect will accelerate in the year ahead.

“The positive area of the economy continues to be investment, where we expect increases in spending by the government and non-mining businesses to offset continued declines in housing and mining investment,” it says.

“However, we do not see the greater business investment leading to above-trend growth — the consumer continues to be key.”

Give its bearish near-term outlook for household consumption, it comes as little surprise that the bank thinks the Reserve Bank of Australia (RBA) will be willing, let alone able, to push interest rates higher for the foreseeable future.

“While consensus and the market have pushed back their expectation for RBA rate hikes, we don’t think they have done enough, and we continue to see the RBA on hold until late 2019,” the bank says.

“With limited prospects for wage and inflation pressures, the RBA will be in no rush to hike rates, and we even see a risk of a cut if softness in the housing market accelerates and broadens.”

A cut.

That would be a surprise to markets, especially as a full 25 basis point increase in the cash rate is now expected by the middle of next year.

Given the prospect of the RBA remaining on the sidelines for even longer, and Australian economic growth decelerating as activity improves elsewhere, Morgan Stanley thinks the Australian dollar will take a bath in the months ahead.

“[We expect the] AUD to depreciate sharply over 2018 against most currency pairs, driven by a out-of-sync economic cycle, increasing interest-rate differentials and subdued commodity price outlook,” it says.

However, with the Australian dollar set to tumble, it says that means the prospects for the Australian economy over the longer-term will improve.

“We expected the AUD to decline to 0.71 against the USD by the end of 2018, providing the boost to competitiveness that allows a modest improvement in growth in 2019.”

Even if growth does re-accelerate to 2.5% in 2019 as Morgan Stanley expects, it would still be well below the 3% plus level currently anticipated by the RBA.

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