MYEFO: Treasury gets real on the Australian outlook

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An economy growing below trend. An economic transition that’s taking longer-than-expected. Falling business investment, not only from mining firms but also those in the non-mining sectors. Significantly weaker commodity prices. Continued household caution, despite recent signs of improvement in the labour market.

The list could go on, but that’s essentially what Australia’s economy is facing at present.

In what some may deem to be a break from recent tradition – having been criticised in the past for offering forecasts deemed to be overly optimistic by some – that’s also what Australia’s treasury department are forecasting in its 2015/16 mid-year economic and fiscal outlook (MYEFO) released earlier this afternoon.

Here’s the department’s economic forecasts, along with its assumptions for the price of iron ore, crude oil, domestic interest rates and the level of the Australian dollar.

While these are often subject to critique, at first glance the vast majority offered appear to be realistic.

Read GDP – economic growth – is now tipped to grow by 2.5% in the current fiscal year, a 0.25% reduction from the level offered in May. Looking further out the forward estimates, economic growth is expected to accelerate to 2.75% in 2016/17, well below the 3.25% level offered in May but in line with Australia’s trend growth rate.

Reflective of subdued domestic economic conditions, forecasts for household consumption and business investment – both for mining and non-mining firms – were lowered.

Forecasts for dwelling investment, while higher for the current fiscal year, were also lowered for 2016/17. With lower iron ore and coal prices helping to mitigate growing LNG exports, the contribution of trade to economic growth was lowered for 2015/16 and left unchanged for 2016/17.

With labour market conditions clearly improving since the budget was delivered in May, forecasts for employment growth, unemployment and labour market participation were all upgraded for the current fiscal year.

There were also small downward revisions made to the outlook for consumer price inflation, both for the current year and next.

Making the forecasts more realistic than what may have been the case previously, the assumptions within the MYEFO document towards the outlook for the iron ore price, crude prices, domestic interest rates and the Australian dollar are hard to pick holes in.

Treasury now forecasts iron ore prices to average $39 a tonne over 2015/16, down from $48 a tonne in the May budget. The costs are based on freight on board pricing, which does not include transportation costs. To provide an indication as to how realistic the forecast is, in the fiscal year to date the iron ore FOB rate has averaged $46 a tonne, according analysis conducted by ANZ.

Elsewhere the average Tapis crude price was lowered to $43 a barrel, down from $64 a barrel in May. The Australian dollar forecast was also trimmed, with treasury now expecting an average rate against the US dollar of 72 cents in the current fiscal year, or 61 in trade weighted terms. These are both lower than the 77 cent and 64 levels used to formulate the May budget.

They are more in line with market expectation, not unrealistic, and present risks not only to the downside but also the upside as well.

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