WARREN HOGAN: Political gridlock is now a real risk to Australia's economic outlook

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No matter what the eventual outcome of the federal election, Australia’s political leadership has been damaged. At best we will see a return of a Coalition government with a slim majority and a much diminished leader in Malcolm Turnbull. At worst there will be a minority Labor government held together by minor players with little economic policymaking experience. A divided Senate seems assured.

The nature of the campaign, which was defined by “Mediscare”, means a highly divisive parliament is in prospect. To top it all off speculation of leadership challenges on both sides is underway. All this makes for a legislative environment plagued by compromise and a lack of strategic clarity. Very few tough political decisions will be made.
Real economic reform will be hard to come by.

For the Australian economy this poses particular problems. The mining boom has been replaced by a housing boom that is looking long in the tooth. Political leadership and economic vision will be critical to Australia’s prospects once the housing boom ends. And it is likely to end in the next term of parliament.

While Australia’s economy and the institutions that underpin it are strong, the potential for political uncertainty and policy gridlock could undermine the confidence of businesses and act as a headwind to investment in new and existing enterprise.

There are also hints in this Australian election result of the type of concerns that drove the Brexit outcome in the UK and the rise of Trump in the US. There has been a surge in primary voting support for minors and independents in what amounts to a snub to the political establishment as well as a drift in community attitudes away from the political centre.

And this is all in the context of an economy doing well. What would these results have looked like if the economy wasn’t growing and wasn’t creating jobs? Despite solid growth and stable unemployment, the political consensus has been shocked. It all seems a long way from last September when the ascension of Malcolm Turnbull to the Prime Ministership inspired a surge in consumer confidence amid hopes of a political leadership focused on long-term economic outcomes.

Confidence is key — and watch the Australian dollar

For international investors and financial market participants the proximity of Australia’s election shock to the Brexit vote will strike a chord and highlight that Australia faces similar political challenges to other developed economies. As a capital-dependant country, this could be both a help and a hindrance.

On the positive side, rising concerns amongst international investors may put downward pressure on the Australian dollar. In the context of a currency that is stubbornly high this may not be a bad thing. A weaker currency takes pressure of Australian business and supports domestic spending and investment.

But if the concerns of investors become acute, then the currency adjustment may turn disorderly and the cost of capital to the economy could rise via higher long-term interest rates and weaker equity value. In a world of QE and abundant financial capital this doesn’t seem likely, not in the short-term anyway. This will need to be monitored closely. A loss of international investor confidence in the Australian economy as the housing boom subsides could be a serious headwind.

The new Australian political scene will add to the list of concerns the ratings agencies have expressed in recent years. Most importantly, a gridlocked parliament hostage to minor players with protectionist instincts will not only cast doubt on the effectiveness of economic policy but will put paid to any expectation that the Australian government’s structural budget deficit can be addressed anytime soon.

Political gridlock and a structural budget deficit have been tolerated for a number of years by investors and ratings agencies. The tipping point could come if we see a loss of economic momentum in the domestic economy either because of the confidence sapping effects of ineffective leadership or through the natural rhythm of the housing cycle. In either case now is not a good time for Australia to lack political leadership and strategic economic clarity.

These economic risks will take months if not years to materialise. In the short-term the key things to watch will be the impact of this election result on confidence. The first post-election consumer and business confidence surveys will be released within weeks but right now all eyes will be on how financial markets interpret the risks.

The Australian dollar and interest rate markets are likely to react. The on-going uncertainty around the final election result combined with the long-term challenges of political gridlock will certainly cause a fall in the currency. It may not be much and it may be short lived. That will depend on what is happening around the world.
For the domestic interest rate markets there is a good chance that the a more aggressive easing from the RBA will be priced in. Political uncertainty breeds economic uncertainty which will hurt growth and employment expectations. The markets will interpret this as raising the chances of more rate cuts.

How equity markets react is not clear. An initial negative reaction is almost assured but how international investors respond to the better than expected result for the ALP will be critical. One of the distinctions between the major parties was around the treatment of big business. The government offered a corporate tax cut as the centre piece of its economic policy. The ALP not only made a direct attack on this policy strategy but also made a Royal Commission into the banks a core policy platform. This means the equity markets should be highly attuned to the likelihood of a Labor minority government as the vote count resumes on Tuesday.

In a world of economic uncertainty and financial market volatility the latest news from Australia will only add to the worries of investors and business.

Warren Hogan has been an economist and financial market strategist for 21 years and is the former Chief Economist of ANZ Bank.

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