Pre-Budget
Economic Outlook: a Quick Guide
Updated 7
May 2018
PDF version [454KB]
Dr Jonathon
Deans
Economics Section
Outlook for the domestic economy
General economic conditions
One of the most important developments of the last 12–18
months has been the increase in private sector investment, as measured by
private new capital expenditure (shown in Figure 1). This increased
substantially between 2010 and 2012, owing to historically significant
increases in mining investment. Between 2012 and 2014 the level of new
investment remained at around $40 billion per year, before falling to less
than $30 billion in 2015–16. That reduction appears to have stopped and
returned to growth in 2017. While it is not certain whether this improvement
will continue, business confidence remains at elevated levels,[1]
which suggests the economic environment is conducive to further investment.
Figure 1: Private new capital
expenditure
Source: Australian Bureau of Statistics (ABS), Private new capital
expenditure and expected expenditure, December 2017, cat. no. 5625.0,
ABS, Canberra, 1 March 2018.
The primary measurement for economic growth is Gross
Domestic Product (GDP), which is the total value of transactions in a given
period. GDP is shown in Figure 2. GDP growth has been relatively subdued over
the last five years, averaging 2.4% per year, slower than the 3.0% average
annual growth experienced between 2003 and 2008. However, a number of
indicators including business investment, business confidence, and rising
employment, point to a likely acceleration of economic growth.
GDP growth can provide a growth dividend to the budget, in
which a growing economy potentially allows the Commonwealth to capture more
revenue and is better positioned to fund services without raising taxation
rates.
Figure 2: GDP and GDP growth
Source: ABS, Australian national
accounts: national income, expenditure and product, Dec 2017, cat. no. 5206.0,
ABS, Canberra, 7 March 2018.
The Reserve Bank of Australia (RBA) has an inflation target
of 2–3 per cent per annum but inflation has largely remained in the 1.5–2.0 per
cent band for the last four years, as shown in Figure 3. While high inflation
is generally regarded as being problematic, low rates of inflation can also
present a challenge. If the increase in private investment flows through to
GDP, it may begin to apply upwards pressure on inflation. Inflation can affect
the budget in a variety of ways but the most direct effects are on GST receipts
and indexation (such as for pensions or fuel excise).
Figure 3: Consumer Price Index
(CPI)
Source: ABS,
Consumer
Price Index, Australia, March 2018, cat. no. 6401.0, ABS, Canberra, 24
April 2018.
Low rates of growth and inflation have led the RBA to
maintain a cash rate target of 1.5 per cent since August 2016. The low cash
rate is a form of economic stimulus, allowing individuals, firms, and governments
to borrow at lower rates of interest. If GDP and inflation were to increase in
response to investment growth, it may lead the RBA to begin raising interest
rates, although financial markets are not pricing in an interest rate rise
until late 2019 and the RBA Governor has indicated that any increase would be
gradual.[2]
Figure 4: Reserve Bank of Australia
(RBA) cash rate
Source: RBA Statistics (Cash
Rate), 4 May 2018.
Household economic conditions
Total employment increased significantly in the past 12
months, with almost 150,000 jobs created in the last 12 months, an increase of
2.6 per cent, as shown in Figure 5. It is likely that the uptick in capital
expenditure contributed to this increase and future increases in employment may
depend on continued growth in this area. Increasing employment supports the
budget by reducing government expenditure on social security while increasing
income tax receipts.
Figure 5: Total employment
Source: ABS, Labour
Force, Australia, March 2018, cat. no. 6202.0, ABS, Canberra, 19 April
2018.
Coinciding with large increases in total employment has been
an increase in the participation rate, which measures the proportion of
Australians in paid employment or actively seeking employment. The
participation rate reached a record high (65.8 per cent) early in 2018,
slightly surpassing the pre–Global Financial Crisis (GFC) peak, although it has
since fallen slightly to 65.7 per cent. The increases in employment and
participation suggest that some individuals may be moving directly into
employment after absences from the labour market, without being included in
unemployment statistics.
Figure 6: Participation rate
Source: ABS, Labour
Force, Australia, March 2018, cat. no. 6202.0, ABS, Canberra, 19 April
2018.
Growing participation has also meant that the increase in
total employment has not led to a significant decrease in the unemployment
rate, which has fallen slightly in the last 12 months (0.3 percentage points)
but remained at 5.5 per cent from January to March 2018. It is not clear how
much slack (potential additional labour supply) remains in the labour market at
this time, but an unemployment rate of less than 5 per cent is generally
regarded as reflecting full employment.[3]
Figure 7: Unemployment rate
Source: ABS, Labour
Force, Australia, March 2018, cat. no. 6202.0, ABS, Canberra, 19 April
2018.
Quarterly wage growth (as measured by the Wage Price Index)
has been subdued for the last five years, largely remaining in a range between
0.3–0.6 per cent. This is significantly lower than the 0.8–1.0 per cent growth
which was experienced between 2008 and 2013 and may reflect the amount of slack
in the labour market. Despite low growth, consumer sentiment remains positive.[4]
There is a general view that wages growth will increase once the economy moves
closer to full employment, but uncertainty around participation makes
forecasting this outcome less certain.[5]
However, increasing competition amongst employers is theoretically likely to
support higher wages and higher income tax receipts for the Commonwealth.
Figure 8: Wage Price Index
Source: ABS, Wage Price Index,
Australia, December 2017, cat. no. 6345.0, ABS, Canberra,
21 February 2018.
Outlook for the global economy
The economies of Australia’s major trading partners have
exhibited stronger than expected performance in the previous twelve months. The
United States economy has grown more quickly than expected and early evidence
suggests that the company tax cuts are driving increased investment, which may
support further growth over the forward estimates.[6]
Chinese growth has also demonstrated resilience, maintaining annual GDP growth
above 6 per cent despite concerns of a slowdown. Indian GDP growth also
rebounded after a slight slowdown in growth in 2017. Japan recently experienced
its strongest GDP growth since 2013 and South Korean growth remains positive.
Figure 9: GDP growth, major trading
partners
Source: Oxford Economics, Global Economic
Databank, 4 April 2018.
Growth in global GDP and global trade has been low but
relatively consistent since the GFC, although conditions have recently shown
signs of improvement. According to data provided by Oxford Economics, global
GDP growth has averaged 2.7% in the last five years, increasing to 3.0% in 2017
and is forecast to rise to 3.2% in 2018. Global trade has grown by 3.6% in the
last five years, rising to 5.1% in 2017 and forecast to grow 5.0% in 2018.
Figure 10: Global GDP growth and
trade growth
Source: Oxford Economics, Global Economic
Databank, 4 April 2018.
Despite the apparent strength in major advanced and
developing economies, significant risks and uncertainties remain. One of the
most prominent concerns is that of an escalation in the trade dispute between
the United States and China, although recent media reports suggest that the
risk of this has diminished. Nonetheless, there is a risk that protectionist
policies may become more widely adopted around the world, impairing the ability
of major trading nations (such as Australia) to export its products.
Another uncertainty is the path of major commodity prices.
Some commodity prices were unexpectedly strong in 2017–18, including prices for
Australia’s major export commodities (including iron ore, metallurgical coal,
thermal coal, and liquefied natural gas (LNG)) which have remained higher than
forecast in the 2017–18 Budget. This has resulted in higher than expected
revenue for the Commonwealth in the form of company tax and mineral royalties.
Recent updates to the RBA Index of Commodity Prices and some private sector
forecasts point to a decline in these commodities over the coming financial
year, though the level of certainty is not high. On the other side of the
ledger, Australia imports significant volumes of crude and refined oil and
prices for these commodities remain higher than forecast.
Figure 11: Prices of major
Australian export commodities
Source: Historical
data (Table 6), Resources
and Energy Quarterly, 8(1), March 2018.
Headline figures
The headline figures are the key forecasts which inform the
Budget’s estimates. Previous Budgets have made upwards revisions to the
headline figures for 2018–19 and, given the stronger than expected performance
of the Australian and global economies in 2017–18, it appears likely that they
will be revised higher in the 2018–19 Federal Budget. This will result in
higher taxation revenue (particularly through company taxes, income taxes, and
the GST) and lower Commonwealth expenditure. However, significant uncertainties
remain about the future level of investment and employment growth, which could
result in economic conditions deviating markedly from the Government’s
expectations.
Figure 12: Gross Domestic Product
(GDP) and Consumer Price Index (CPI).
Source: Oxford Economics, Global Economic
Databank, 4 April 2018.
Figure 13: Historical and forecast
unemployment rate and wage growth
Source: Oxford Economics, Global Economic
Databank, 4 April 2018.
[1].
NAB Group Economics, ‘NAB
Monthly Business Survey: March 2018’, NAB website, 10 April 2018.
[2].
P Lowe Monetary
policy decision, media release, no. 2018-11, Reserve Bank of Australia,
Sydney, 1 May 2018.
[3].
T Cusbert, ‘Estimating
the NAIRU and the unemployment gap’, Reserve Bank of Australia, Bulletin,
June quarter 2017.
[4].
B Evans, ‘Consumer
sentiment stabilises’, Westpac, Bulletin, 11 April 2018.
[5].
For example, I Arsov and R Evans, ‘Wage
growth in advanced economies’, Reserve Bank of Australia, Bulletin,
March 2018.
[6].
L Wang, ‘Trump
tax windfall going to capex way faster than stock buybacks’, Bloomberg
website, 27 April 2018.
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