Slower growth, higher unemployment and multiple RBA rate cuts: Capital Economics is getting more bearish on Australia

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  • Australia’s economy grew by 2.3% in the year to December, slowing sharply in the second half of the year.
  • Capital Economics believes the slowdown will get even worse this year due to weakness in the housing market.
  • The group sees GDP growth of just 1.5%, an outcome that it expects will see unemployment lift to 5.3%. The RBA forecast in February that GDP growth would be 3% this year.
  • It expects the RBA will now cut Australia’s cash rate to 0.75% by the middle of next year. The cash rate has remained at 1.5% since August 2016. It is already at the lowest level on record.

Australia’s economy slowed sharply in the second half of last year, seeing annual growth slip to just 2.3%.

Capital Economics — already one of the most bearish forecasters on the Australian economy — thinks the slowdown will get even worse this year, courtesy of the housing market.

“We believe that the downturn in the housing market will have a larger negative impact on the economy than most believe and have lowered our GDP forecast for 2019 to 1.5%,” said Marcel Thieliant, Senior Economist at Capital Economics.

“Our view remains that the downturn in the housing market will encourage households to live within rather than above their means as housing wealth falls. Indeed, we think that the uptick in the household savings rate in the fourth quarter should be followed by a further gradual rise over the course of the year.

“We now expect consumption growth to slow from 2.6% last year to just 1.5% in 2019.”

Capital Economics

Household consumption is the largest part of the Australian economy at over 50%, meaning what it does has a large bearing on how the broader economy will fare.

After years of saving less in order to sustain spending levels during a period of weak household incomes growth, Capital Economics expects that trend will reverse in the coming quarters, explaining why it sees the consumer-led economic slowdown continuing this year.

If correct, its view for Australian GDP growth this year would be only half the 3% level forecast by the RBA in early February.

Along with dragging on household spending, Capital Economics believes the housing downturn will weigh on residential construction more than initially anticipated, predicting a “marked drop over the coming year”.

“We now expect dwellings investment to fall by 10% this year instead of our previous forecast of a 7% drop,” Thieliant said. “The plunge in business confidence at the start of the year also suggests that non-dwellings investment growth will keep stagnating.”

The group also warns that Australia is unlikely to get much help from the global economy, predicting that growth will slow from 3.5% to 2.9% this year, an outcome it believes will deliver a smaller than previously anticipated boost to Australia’s external sectors.

Given that bleak backdrop, Capital Economics is forecasting that Australia’s unemployment rate — currently 5% — will lift to 5.3% this year, an outcome it expects will trigger renewed monetary policy easing from the RBA.

However, rather than just two 25 basis point rate cuts as it previously forecast, the group now expects a third cut, taking Australia’s cash rate to just 0.75%.

“If our forecasts prove correct, the RBA probably won’t wait until November before cutting interest rates as we had previously anticipated,” Thieliant said.

“We think that the first reduction in interest rates may happen as early as August, and we now expect rates to fall to 0.75% by the middle of next year.”

Australia’s cash rate has remained at 1.5% since August 2016.

The RBA has stated that a sustained lift in Australia’s unemployment rate is one catalyst that could warrant a further reduction in the cash rate.

NOW READ: Your 10-second guide to today’s Australian jobs report

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