Bill Evans just outlined why he's discouraged about the outlook for the Australian economy

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Australian economic growth will slow and unemployment will rise, while prices for Australia’s key commodity exports, and with them the Australian dollar, will fall substantially.

And house price growth, a near-perennial feature in Australia’s largest housing markets in recent years, will all but disappear.

No, it’s not the view of an Australian asset manager who has just liquidated his fund’s entire share portfolio, but rather that of Bill Evans, Westpac’s chief economist, who, in a note released late last week, has delved a little deeper on his concerns about the outlook for the Australian economy in 2018.

As he’s said recently, it’s a little “discouraging”.

“Despite ongoing low interest rates and a significantly more competitive Australian dollar, we expect growth will slow to 2.5% in the year to December 2018,” he says.

“And that is despite the drag from the contraction in mining investment easing from subtracting 1.2 percentage points in 2016 to only 0.1 percentage point in 2018.

“This is because the significant ‘outperformers’ from a growth perspective in 2016 and 2017 — residential construction and exports — are likely to slow through 2018. In 2016, residential construction and exports contributed 1.7 percentage points to GDP growth. That is likely to slow to 0.7 percentage points in 2018.”

While 2.5% GDP growth next year is hardly dire, it’s still fractionally below what many now deem to be Australia’s trend growth rate. It’s also significantly below the 3.25% midpoint that the RBA is currently forecasting.

Along with a smaller contribution from residential construction and commodity export volumes, another factor that Evans says will weigh on growth is lacklustre spending from Australian households and businesses.

“With confidence remaining muted there appear to be disappointing prospects for household spending and business investment to ‘fill the gap’,” he says.

“The contribution to growth from non-mining business investment and household spending is likely to slow from 2.0 percentage points in 2017 to 1.6 percentage points in 2018.”

That’s not an unrealistic assessment given the symbiotic relationship that exists between household and business spending.

Increased household debt levels, coupled with weak incomes growth largely as a result of record-low wage growth, looks like it’s already having an impact on household consumption levels based on recent GDP and retail sales figures released by the ABS.

With household spending, which accounts for around 60% of the entire economy, already showing signs of weakness, it’s hard to see businesses lifting their investment by any significant degree.

And throw in the prospect of a slowdown in the Australian housing market, something that Westpac says is likely to occur in the period ahead, and it’s easy to see why Evans holds this view.

“We expect that house price inflation will largely disappear over the next year,” he says, citing recent efforts from regulators and the government to cool price growth.

And while some point to increased public investment in infrastructure projects which could help to offset expected weakness in other areas of the economy, Evans says that while they are welcome they are “too timid and targeted tightly at Western Sydney and the NSW/Victorian regions”, noting that early responses to the recent federal budget are “disappointing for employment and investment prospects”.

Given these view, suggesting that the economy is likely to be sluggish next year, Evans thinks that will have implications on the outlook for labour market conditions, inflation, the Australian dollar and the Reserve Bank of Australia.

“Modest growth in household spending, a contraction in residential construction activity and a marked slowdown in house price inflation will restrain employment growth,” Evans says.

“While prospects for a modest fall in the unemployment rate in 2017 seem reasonable it is likely that it will move back to 6% in 2018.

“In such circumstances it appears unlikely that the inflation rate will rise much above the bottom of the 2–3% target band despite sharp increases in electricity prices.”

And with higher unemployment, soft inflationary pressures and an expectation that Australia’s terms of trade will fall 16% next year on the back of weaker commodity prices — placing renewed pressure on national incomes — Evans says talk of a near-term interest rate hike from the RBA seems “misplaced”.

“We expect the cash rate will remain on hold through 2017 and 2018. Indeed the case for lower rates in 2018 seems more reasonable than the case for higher rates,” he says.

Given that outlook and the prospect of further rate hikes in the United States, Westpac says the outlook for the Australian dollar remains “bleak”, forecasting that it will it end next year buying 65 US cents.

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