By Stephen Koukoulas, illion Economic Adviser

The year is ending with a widening divide between a buoyant business sector and ongoing caution from householders and consumers. In a nutshell, it is strong profits versus low wages growth that have been driving this divergence.

For 2018, the themes are likely to centre on a recovery in non-mining business investment, further strong growth in State government infrastructure spending and an ongoing export surge, versus sluggish growth in household spending, which is being held back by weak wages growth and a likely pullback in house prices. New building of dwellings is also likely to turn negative through 2018 as the oversupply of apartments in many cities is unwound.

The latest illion Business Expectations survey confirms an upbeat outlook for profits, sales, capital expenditure and employment in the early part of 2018. It is good news. But within that survey, it is the retail sector that is the weakest link, which is consistent with the official data pointing to a recent decline in retail spending.

Importantly for Australia, the global economic environment is positive. China continues to expand, while the US economy is performing well. The surprise packet of 2017, the Eurozone, continues its path of economic recovery, aided by very stimulatory policy from the European Central Bank.

Back in Australia, the positive tone in the business sector and likely rise in non-mining investment will underpin bottom line GDP growth in 2018. Low interest rates are helping cash flows and encouraging firms to ramp up their investment plans.

For consumers and household spending, the greatest uncertainty is around wages growth and what happens to house prices, which had been an important source of wealth creation in recent years.
Stephen Koukoulas.JPG

Household spending makes up over half of GDP, so the health of consumer finances is a vital element in any assessment of the outlook for the economy.

With wages growth stuck around 2 per cent, the ability of households to lift their spending growth is severely constrained. While spending can be supported by extra borrowing or lowering savings, these sources of funds to support spending are only temporary.

In other words, for a solid and sustained pick up in economic growth, to a pace above 3 per cent, household spending growth needs to accelerate, which in turns requires a pick up in wages growth.

Amid these conflicting forces within the economy, inflation remains very low. The underlying inflation rate has been stuck below 2 per cent for the past two years and on the current RBA forecasts, it is set to remain at or below 2 per cent through to 2019.

The recent illion data on business expectations for selling prices shows that price pressures remain weak. Given this measure has a good record in predicting future trends in inflation, it is likely that inflation through to the middle of 2018 – at least – will remain in check.

In all, 2018 looks to be another year of moderate economic growth, with a solid business sector performance offset to some extent by softness in consumer demand. This means that inflation is set to be well contained at a low level, with the outlook for wages likely to be a highly debated and analysed part of the economy.

December 2017