CAPITAL ECONOMICS: There's little chance Australian growth will hold up and rates are headed for 1.5%

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Australia printed an unexpectedly strong 0.9% growth rate for the first quarter of this year, and it sparked some debate when released whether or not the strength could be replicated in the months ahead.

Internal growth drivers, some said, meant it was an aberration.

But, Capital Economics’ hief Australia and New Zealand economist, Paul Dales, sees no uncertainty in the debate about growth. Rather, in a report released earlier today, he said:

There is little chance that an increase in household spending will prevent the economy from slowing. Employment and wage growth look set to weaken in the second half of the year, while support for real incomes from lower petrol prices will soon fade. Admittedly, there is scope for the household savings rate to fall further from its current high level, but that is unlikely to be enough to stop consumption growth slowing. In fact, the stagnation of retail sales in April suggests that consumers are already tightening their belts.

Dales pointed to the fact that while GDP was solid, “domestic final demand, which excludes inventories and net exports, hardly rose at all in the first quarter”.

Worse still, he says, is the fact that domestic final demand has yet to “respond in full to the deterioration in the terms of trade”.

He also says the deterioration in the Westpac leading indicator of economic growth is problematic, which means he is forecasting growth to slow to just 2% this year.

Source – Capital Economics

All up, when you add in the lack of business investment, a stubbornly high Aussie dollar and less room for consumers to lift consumption materially, Dales says “while markets appear to have concluded that interest rates in Australia have reached their floor at 2.0%, we expect them to be cut again”.

“Accordingly, the Australian dollar should weaken further.”

The good news is he reckons the Aussie will fall to 65 cents next year. But the bad news is Dales reckons the economy is going to be weak enough that the RBA has to cut two more times to 1.5%.

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