In terms of the labour market, it’s worth stressing that it always lags the economic cycle. This is because it takes a while for businesses to swing from hiring to fi ring (and vice versa). Thus, the slump in growth over the past year is yet to fully impact employment and this (combined with a contraction in activity in the near term) is likely to push unemployment up to around 7% by year-end and probably up to a peak of 8% next year. While June employment data still indicated a relatively modest rate of deterioration in employment, the 50% slump in ANZ job advertisements over the last year and the sharp fall in business hiring plans point to a sharp fall in employment still to come. Refer to the chart below.
Sharp fall in employment still ahead
… before they get better
While we anticipate a lurch back into negative growth in the June and September quarters, we remain of the view that the economy is on track for a sustained recovery from later this year. Firstly, due to the kick start from the first home owner’s boost and more fundamentally from lower mortgage rates, the housing construction cycle is likely to turn up from later this year. Sure, the first home owner’s boost will tail off as we go through next year. However, with mortgage rates remaining low and with pent up demand having built up after years of housing commencements running below underlying demand, it’s likely that the housing construction upswing will continue through next year and into 2011.
There is a danger in reading too much into the slump in building approvals in May, as it was largely driven by a 43% fall in normally volatile approvals for apartments. Housing finance commitments for the purchase or construction of new homes is still rising solidly and this normally leads housing approvals. See next chart.
The surge in housing finance points to a strong recovery in building approvals
Secondly, a range of business surveys point to a recovery in global economic activity from later this year. At the forefront of this is a solid upswing now getting underway in China. This should help drive a recovery in exports.
Thirdly, stronger public spending (particularly on infrastructure) will start to kick in from later this year, and this will provide an offset to weak business investment. This is all consistent with the rise in business and consumer confidence that we have seen over the last six months, which normally feeds through to growth with a lag.
Business and consumer confidence on the mend
During recessions there is always a concern that any boost provided by fiscal stimulus will be temporary. However, historically it has always been successful, along with low interest rates (which will remain low well into any recovery), in sparking a pick up in private sector demand. This time around the problems of excessive household debt are much greater, but against this the fiscal stimulus has also been greater than normal.
With unemployment likely to rise well into next year and excess capacity in the economy continuing to expand, it’s likely that inflation will fall well below the RBA’s 2% to 3% inflation target over the year ahead. In fact, June quarter inflation data to be published later this month is likely to show inflation at 1.7%. With inflation falling below target, unemployment drifting steadily higher and worries that the fiscal stimulus to consumer spending may wear off, it’s likely that the RBA will want to drip-feed more good news into the economy in the form of further interest rate cuts over the next six months or so. As a consequence, we remain of the view that the cash rate can, and will, fall further, to around 2.25% or 2.50% by year end.
We are now in the stage of the economic cycle where economic indicators paint a confusing picture. Some indicators are still signalling weakness, such as the rise in unemployment, but others are pointing towards an eventual economic recovery from later this year. The cross currents in economic indicators also reflect the constraints around high debt levels on the one hand and massive monetary and fiscal stimulus on the other. Unfortunately, this confused picture is likely to remain for awhile. However, the key is that even though the June and September quarter GDP readings will likely be negative, the economy remains on track for a recovery from later this year.
Dr Shane Oliver is head of investment strategy and chief economist AMP Capital Investors.
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