Australia's short-term growth outlook remains strongly positive, but capacity-related problems and a highly cyclical business environment will present major challenges over the next five years, says economic forecaster BIS Shrapnel.
As reported in the October edition of
QBR magazine, the 30th edition of its flagship economic study,
Long Term Forecasts, 2004 to 2019, concludes that capacity problems will be the key issue for the economy going forward.
Study leader and senior economist Matthew Hassan says that while the current focus may still be stuck on housing markets, consumer debt levels and the prospect of another interest rate rise, Australia's medium-term growth prospects are more closely tied to developments now becoming apparent across the business sector.
"Australia's economic upswing is regaining momentum quickly. In spite of a cooling-off in housing markets, overall growth is continuing to broaden and strengthen. Consumers are still leading the way (helped along by a massive election year fiscal boost), with the export recovery slowly rebalancing growth," he says.
The main problem for Australia over the next few years, says Hassan, will be coping with continued strong growth in a situation of increasingly critical shortages of productive capacity and skilled labour.
"Most Australian businesses have been under-investing for a long time now ... But now the economy is facing a severe deficiency of productive capacity. That means businesses will need to bring new investment through quickly to meet future rises in demand," he says.
Further, Hassan warns that with unemployment already running at 20 year lows, skilled recruits are proving extremely hard to find. With labour demand set to continue rising strongly over the next year, some businesses will inevitably be caught short.
A "rush to invest" is already getting under way, according to BIS Shrapnel. Indeed, the study expects a strong and sustained surge in generalised business investment to take over as the key growth driver from 2005.
"The first stage of this upturn is already becoming apparent. A psychological 'switch' has occurred across key parts of the business sector, with the conservative cost containment approach that has dominated over the last few years finally giving way to a more bullish attitude of gearing up for growth," Hassan says.
BIS Shrapnel says building construction and property market cycles will continue to play a key role.
However, it will be non-residential rather than residential construction that leads the way from here.
Housing markets have cooled off and although BIS Shrapnel believes they do not face an imminent collapse, there is little prospect of further strong rises in activity over the short-term.
In contrast, the boom in minerals-related construction is forecast to continue to lift activity. Meanwhile an upswing in non-residential building is just beginning, with a major office construction cycle waiting in the wings.
A strong and sustained surge in business investment is forecast to push GDP growth from 3.6% in 2003/04, to 4.8% in 2004/05, with growth averaging a robust 4% in the following two years.
Demand-driven surge in inflation to make life difficult for the RBA, however.
Hassan argues that a demand-driven surge in wage and price inflation will force the RBA into a more aggressive round of interest rate rises from 2006.
So far, the RBA has only had modest inflationary pressures to contend with. This has given it plenty of room to manoeuvre and effectively make its interest rate moves conditional on activity in the most interest rate sensitive sectors of the economy (households and housing markets).
Hassan argues that the RBA will face a more challenging environment over the next three years that will force it to raise rates by another 2 to 3%.
"As growth picks up again, the unemployment rate will push into uncharted territory, well below 5% by 2005/06 - providing a key source of inflationary pressure. Widespread labour shortages are expected to push wages growth up sharply, providing the main impetus for a surge in price inflation to well above the 3% ceiling on the RBA's target band by late 2006.
"These two years of inflationary growth will be the trigger for substantial interest rate rises, with the official cash rate expected to peak at around 8% in late 2006," he says.
These rises will clearly have a heavy impact on housing markets and households across Australia's mortgage belt, but will be slower to affect strongly rising business investment.
BIS Shrapnel warns that this cycle will eventually culminate in a sharp investment bust in 2007, sending the economy into a sharp downturn in 2008.
"The tightening in interest rates will only really hit once demand starts to slow and over-investment becomes apparent. But once it does, high rates will trigger a sharp decline in construction and investment, with the cumulative effect sending the economy into recession in 2007/08 - a recession that, given the internal logic of investment cycles and asset price bubbles, will be impossible to avoid," he says.
BIS Shrapnel forecasts GDP to contract 0.1% in 2007/08 and remain subdued in 2008/09.
To read more, see the October edition of QBR magazine. Call 1800 649 578 or email subs@pubserv.com.au to subscribe and secure your copy - as well as the official 2004 Queensland 400 magazine and the 2003/04 and 2004/05 editions of the Book of Lists.