ECONOMIC FORECAST: WHAT'S IN STORE

BIS Shrapnel’s Long Term Forecasts, 2010 – 2025 report predicts economic growth will accelerate an average 3.8 per cent per annum over the next three years. The report also forecasts solid employment growth to push the unemployment rate down to below four per cent by early to-mid 2013.

Senior economist Richard Robinson warns that tightening labour markets and accelerating household spending will lead to higher consumer price inflation (CPI), forcing cash rates up towards 6.5 per cent and housing rates towards 9 per cent.

“We still have a number of critical policy issues which need to be addressed, including a serious housing shortage, ongoing infrastructure deficiencies and bottlenecks and, of course, a skills shortage,” he says.

“These capacity constraints will remain a problem for the economy while the mining investment boom continues. This boom, when it really ramps in one to two years, will leave little room for governments and businesses to address these chronic shortages, and the miners themselves will struggle to get through their projects.”

BIS Shrapnel says an increase in population growth in the three years to 2008/09 played a key role in extending the economy’s long run of growth and dampening wage pressures. However, it also created additional demands on housing and infrastructure which were already stretched.

The combination of significant pent-up demand, strong rents and yields, rising incomes and an easing in funding for property developers, is expected to sustain a recovery in activity over the next two to three years. But Robinson says the housing upswing won’t last.

“Minimal slack in labour markets, a recovery in consumer spending and subsequently, business investment, will quickly see the re-emergence of capacity constraints from 2011/12,” he says.

“Labour shortages and a synchronisation of construction cycles will lead to a build up of inflationary pressures over 2011/12 and 2012/13. The RBA will be forced to respond by raising interest rates to a maximum of 6.5 per cent, which will take mortgage rates back over nine per cent and send housing activity into a controlled downturn over 2013/14.”

BIS Shrapnel says the housing shortage is a major problem because it inflates mortgage debt, which increases household sensitivity to rising interest rates and unemployment and widens the current account deficit. The shortage of housing is also is a major influence on the CPI through its impact on the rental market.

Finance for small businesses is scarce and the cost remains elevated. Changes to the risk weighting of assets by banks for capital requirements as a result of Basel II, and the heightened risk aversion in the wake of the GFC, has disadvantaged small businesses and favoured bank lending to households for the purchase of residential property. Reduced competition from non-bank lenders has exacerbated the problem.

But there’s also some good news ahead.

“The current account deficit is set to improve dramatically over 2010/11 and 2011/12,” says Robinson.

“Firstly as a result of a surge in the terms of trade and higher productive minerals capacity and, subsequently, strengthening world demand for exports. Unfortunately, the strength of commodity demand and the associated strength of minerals investment have, and will continue to have, an adverse effect on non-mining tradeables and import-competing sectors through the impact of high commodity prices on the Australian dollar.”