 Market Update:Economic lessons for 2007
Michael Blythe, Chief Economist for the Commonwealth Bank, asks what lessons we should take from 2006 into 2007*.
Economic commentators are divided on just where the economy is heading. Forecasts for economic growth during 2007 range from 2.3% to 3.8%. The market is similarly divided on interest rates, some predicting a rate rise in early 2007 and some a rate cut by the end of the year.
Economic outcomes generally disappointed in 2006. Despite an extended period of strong capital expenditure, capacity constraints continued to limit Gross Domestic Product (GDP) growth. Productivity growth stopped and unit labour costs lifted. Inflation rates moved above the top end of the Reserve Bank's target range. While these outcomes are disappointing, there were glimpses of better times ahead by year end.
Patience needed as resource production and exports rise and productivity accelerates
High interest rates are restraining spending. The gap between (high) spending and (low) production should narrow. Inflation pressures should abate. More capital per worker should mean that productivity growth accelerates – another inflation friendly result. Export volumes should lift because of the resources boom. Benchmarking this cycle against
previous booms suggest that we are now at the point where the past five years of investment spending should become apparent in rising resource production and exports.
Continue to talk about the weather
The drought will be a significant drag on the economy in 2007. A ‘normal' drought reduces the GDP growth by 1/2 - 3/4 percentage points. A large part of the impact should be evident in the trade numbers – rural export volumes dropped by 15-25%, but the impact is normally short-lived. Food prices will probably rise.
Take note of supply and demand
The unemployment rate is at 32 year lows creating a tight labour market, which means risk to wages remains on the high side, but wage growth remains remarkably well contained. Labour demand is strong, but the supply of labour is also rising. The available indicators suggest that this supply response has further to run. The inflation threat from tight labour markets may remain contained as a result.
* Information sourced from the Commonwealth Bank's Economic Perspective, 15 December 2006 .
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