WestpacBudgetReport2013 (1)

7/30/2019 WestpacBudgetReport2013 (1)

1/16

2013/14

AustralianFederalBudget.


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A report by Westpac Economics

LondonCamomile Court,23 Camomile St,London EC3A 7LLUnited KingdomTelephone (4420) 7621 7061Facsimile (4420) 7621 7527

James Shugg

Senior Economist

Westpac Economics

SydneyLevel 2, 275 Kent StreetSydney NSW 2000AustraliaTelephone (612) 8254 8372Facsimile (612) 8254 6934

Bill Evans

Chief EconomistGlobal Head of Economics & Research

Andrew Hanlan

Senior Economist

Matthew Hassan

Senior Economist

Huw McKay

Senior International Economist

Justin Smirk

Senior Economist

Elliot Clarke

Economist

AucklandTakutai on the SquareLevel 8, 16 Takutai SquareAuckland, New ZealandTelephone (649) 336 5671Facsimile (649) 336 5672

Dominick Stephens

Chief Economist, New Zealand

Michael Gordon

Senior Economist

Felix Delbrck

Senior Economist

Nathan PennyEconomist

Corporate directory

This issue was finalised on 14 May 2013

Publication enquiries, Westpac Economics, Telephone (612) 8254 8720, [email protected]


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Australian Federal Budget 2013/14

Overview

Federal budget: $19.4bn deficit in 2012/13

-3.3

-4.1 -4.2

-60

-40

-20

0

20

40

-6

-4

-2

0

2

4

1981/82 1991/92 2001/02 2011/12

$bn% of GDP

$bn (rhs) % of GDP (lhs)

Sources: Treasury, ABS, Westpac Economics

Govtf/cs to

16/17

Underlying cash balance

Decomposing the 2013/14 deficit

20

15

10

-5

0

5

MYEFO Parameters Net Policy 2013/14

$bn

19.5 0.7

+2.2

18.0

Sources: Budget papers, Westpac Economics

Overview

The Government forecasts that the Budget will be back in balance in 2015/16 and in underly-ing cash surplus in 2016/17, from a weaker than expected 2012/13 starting point of 1.3%of GDP. Revenues are projected to rise by 1.4% of GDP over four years from 2012/13 whileexpenses will decline by 0.4% of GDP. The improvement in the budget position is appropriatelygradual over the four years. Surprisingly for an election year budget, there are few sweetenersbesides the big ticket items in education and disability funding reform that have been in thepublic domain for some time.

The likely deficit for the current financial year of $19bn considerably exceeds the forecast inthe October Mid-Year Economic & Fiscal Outlook (MYEFO) for a surplus of $1.1bn. Receiptshave surprised to the downside, down $16.4bn. New policy decisions cost $2.4bn. A minorpositive was a slight underspend on expenditures, of $1.7bn. A weaker than expected startingpoint for revenue and a downgrading of economic growth prospects for 2013/14 combine tolower expected revenue in 2013/14 by around $17bn. The budget is expected to remain indeficit until 2014/15, which would be the seventh consecutive year of budget deficits. Thebudget was in surplus for each of the eleven years from 1997/98 to 2007/08, with the oneexception of 2001/02. Note that 2015/16 is a slight 'dollar' surplus that fails to register as ashare of GDP (0.0%).

The Government projects that the budget will return to surplus in 2016/17, forecasting asurplus of $6.6bn, representing 0.4% of GDP. Much of the turnaround can be attributed tothe fact that while the funding measures matched to the NDIS and the Gonski reforms arebringing in revenue from 2013/14, substantive outlays on these two very expensive programsare delayed until beyond the traditional four year projection period. Other savings come fromattacking loopholes exploited by large corporations, recalibrating carbon related outlays to thediminished carbon price, rationalising some of the middle class welfare that accumulated inthe pre-GFC boom years, deferring foreign aid spending targets further, and moving to monthly

PAYG instalments for large tax payers.

The economic forecasts underpinning the Budget projections appear to be credible, althoughwe consider the risks to be skewed to the downside. Nominal GDP is projected to expand at5% in 13/14 and 14/15, accelerating to 5% in the following two years. The unemploymentrate is expected to rise to 5% in 13/14, remain there in 15/16, before returning to thevicinity of 'full' employment in the out years, at 5%. We disagree with the sanguine outlookfor the US and Europe embodied in the 4% forecast for world growth in 2014, but given theTreasury is projecting a supply driven decline in the terms of trade regardless, this is not reallya major issue for the plausibility of the projected revenue line.

The Commonwealth Government's net debt position remains extremely manageable. Netdebt is forecast to reach 11.4% of GDP in 2014/15, and fall to 10.0% by 2016/17. Abroader measure of the strength of the Government's balance sheet, net financial worth, was

17.8% of GDP in 2012/13. It is expected to improve to 14.8% by 2016/17. The stock ofCommonwealth Government Securities on issue at 30 June 2013 is expected to be $256bn,of which $233bn are Treasury Bonds, $18bn are Treasury Indexed Bonds and the balanceTreasury Notes. Net issuance of Treasury Bonds is expected to be $27bn in 2013/14, whilefor TIBs the figure is $4bn.

12/13 worse thanexpected ...

... but return to balanceforecast by 15/16 ...

... and surplus by 16/17.

Net debt remainsmanageable.

Outstanding CGS to hit$256bn.

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Budget 2013: the themes


General government, net debt

0

2

4

6

8

1

1

0

20

40

60

80

100

120

Aus

NZ

Canada

Germany

Spain

UK

France

US

Italy

% %

Source: IMF, budget papers, Westpac Economics

Austr alian Governmentincluding2014/15 f/c

% of GDP; 2012

Australia: public net debt remains low

-100

-50

0

50

100

150

200

250

-20

-10

0

10

20

30

40

50

1971/72 1981/82 1991/92 2001/02 2011/12

$bn% of GDP

Net debt, $bn (rhs)

% of GDP (lhs)

Sources: Treasury, ABS, Westpac Economics

Govt

f/cs to16/17Peaks

10.3% 85/8618.1% 95/96

Federal Government

Fiscal policy: the path to surplus

The Government has charted a return to surplus in 2015/16 and 2016/17 with $44bn in savings over four years more thancovering $13bn in major new initiatives over the same period. The Budget is projected to swing from an $18bn deficit in 2013/14to an essentially balanced $0.8bn surplus in 2015/16 and a $6.6bn surplus in 2016/17.

Savings

The largest saving comes from a % increase in the Medicare Levy dedicated to funding the national disability insurance scheme,DisabilityCare Australia. Increased funds from the levy arrive well before the scheme ramps up with $7.3bn raised by 2015-16vs $0.3bn in disability scheme spending. Other major savings come from: tightening up on corporate tax ($4.2bn over 4yrs);scrapping carbon tax compensation ($3.4bn); extracting a 1.5% and 1.25% efficiency dividend out of higher education ($2.6bn);cancelling the family tax benefit part A increase ($2.5bn); tightening eligibility for the baby bonus and halting indexation onfamily payments ($2.4bn). A further 40% of identified major savings comes from deferring a rise in foreign aid, health spendingmeasures, payment changes for large taxpayers, reduced R&D incentives, cost recovery on import processing and other.

Protecting the corporate tax baseThe Government is looking to shore up its revenues by closing a variety of tax loopholes exploited by multinationals and largecorporates. These include: profit shifting structures that load debt onto Australian entities; tightening up on tax concessionsfor exploration; improving the foreign resident capital gains tax regime; closing loopholes around offshore banking units and theconsolidation of business entities; preventing dividend washing or dividend double dipping exploitation of franking credits; andincreasing ATO surveillance. The combined effort is expected to generate a $1.5bn a year uplift in revenues by 2015/16.

Education the Gonski reforms

A new school funding system that will see a $9.8bn boost to education spending over the next 6yrs. The new model aims toensure better funding for schools catering to students from disadvantaged backgrounds. However, the reforms depend on stategovernments opting in so far NSW is the only major state to do so. Within the 4yr fiscal horizon, the new system and continuedsupport of disabled students is forecast to cost $3.1bn. Increases in early childhood education, alternative pathways andadditional places for postgraduate and sub-bachelor courses also total $1.2bn over 4yrs.

DisabilityCare AustraliaThe Governments major social initiative, a national disability insurance scheme, will be phased in from July 2013, with coverageramping up in the last year of the fiscal forecast. Over the 4yr fiscal horizon and the following 3yrs, the combined cost is forecastto be $19.3bn. Again the scheme relies on buy-in from the states/territories. WA and NT are the only states that have signedup at this stage. Support for youth, homelessness and an increase in the income free area for Newstart recipients has also beentargeted with an additional $0.9bn over 4yrs.

InfrastructureThe major projects are rail (Brisbane Cross River Rail; Melbourne Metro), highways (Bruce Highway), motorways (Sydney,Brisbane; Melbourne; and Adelaide) plus regional projects (Swan Valley bypass; Midlands Highway) scoped to be worth $2.9bn intotal over 4yrs. But the major projects are conditional on state funding and a stipulation of no toll roads.

Industry innovationIndustry support via innovation precincts, Australian Industry Participation, Future Fellowships to attract and retain researchers,

and an alternative pathways programme for apprenticeships & trade qualifications, totalling $0.5bn over 4yrs.

DefenceA $0.8bn increase in expenses from 2013/14 over the 4yr projection reflects growth in Defence funding, including support forthe priorities outlined in the 2013 Defence White Paper.

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5/16

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on

which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ

substantially from these forecasts.


Budget 2013: key figures

Major policy initiatives in Budget 2013

AUDbn 13/14 4 yrs Comment

Spending measures

Road & rail infrastructure 0.0 3.1 Bruce Highway, Syd/Bris/Melb motorways, Swan Valley bypass

New school funding model 0.5 3.0 Gonski reforms & support for disabled students

Disability care 0.0 1.9 Central reform of this budget: $19.3bn over 7 years from 2012/13

Early childhood education 0.6 1.2 Early child edu, post-grad, alternative pathways & future fellowships

Youth & homelessness 0.4 1.0 Youth in transition, homelessness, increase income free Newstart

Key health services 0.2 0.9 Changes to PBS new & amended listings, cancer care

Defence 0.6 0.8 Defence operations & procurement

Industry innovation 0.1 0.5 Industry innovation precincts & industry participation

Disaster recovery & farm finance 0.1 0.5 Natural disasters, insurance affordability, drought reform & farm finance

Seniors support 0.0 0.1 Housing, policy research & keeping seniors connected

Total 2.6 13.0

Savings measures

Medicare levy increase for NDIS 0.0 11.6 ppt increase to fund DisabilityCare Australia

Protecting corporate tax base 0.1 4.2 Fundamental reform addressing 'profit shifting', 'dividend washing' etc.

Funding school plan 0.1 2.6 Uni efficiency dividends, scholarships now loans, cap on edu tax deductions

Family payment increase canned 0.6 2.5 Scrapping increase to FTB Part A

Other family payment changes 0.2 2.4 'Baby bonus' reduced and rolled into FTB A, freeze on supplement indexation

Scrapping carbon tax compo 0.2 3.4 Future compensation now contingent on carbon price forecast rising >$25.40

Deferring increased foreign aid 0.0 1.9 Target of 0.5% GDP now to be met in 2017/18 instead of 2016/17

Tightening up on health spend 0.2 1.7 Raise threshold for extended safety net, realign benefits, phase-out tax offset

Other revenue measures 0.1 3.1 PAYG mthly for big taxpayers, R&D incentives cut, import processing charges

Other 0.7 10.7 Accounts for nearly a quarter of total savings measures

Total 2.1 44.2

2011/12(a) 2012/13 2013/14 2014/15 2015/16 2016/17GDP 3.4 3.00 2.75 3.00 3.00 3.00

Nominal GDP 5.0 3.25 5.00 5.00 5.25 5.25

Unemployment (Jun qtr) 5.1 5.50 5.75 5.75 5.00 5.00

Cash balance, $bn * 43.4 19.4 18.0 10.9 0.8 6.6

% of GDP 2.9 1.3 1.1 0.6 0.0 0.4

Revenue, % GDP 22.4 23.0 23.5 23.9 24.3 24.4

Expenses, % GDP 25.2 24.2 24.5 24.4 24.0 23.8

% chg, real#

4.8 3.2 4.3 2.2 1.4 1.9

Net debt, $bn 147.3 161.6 178.1 191.6 191.2 185.7

% of GDP 10.0 10.6 11.1 11.4 10.8 10.0

* Underlying cash balance; # deflated by CPI

Sources: ABS, Budget papers, Westpac Economics

5


6/16


Forecasts: the Government & Westpac

Australian economic conditions

-2

0

2

4

6

8

-2

0

2

4

6

8

Dec-98 Dec-02 Dec-06 Dec-10 Dec-14

% ann% ann

Domestic demand GDPf/csend

'14

Sources: ABS, Westpac Economics

GDP growth, average:3.5%, 1998 to 2007

2.5%, 2008 to 2014

Westpac forecasts

Australian growth mix

-2

-1

0

1

2

3

4

-2

-1

0

1

2

3

4

Consumer* Mining inv. Businessinvestment

Net X GDP

ppts cont'

2012f 2013f 2014f

ppts cont'


contributions to GDP growth

updated: May 13

* includes housing

Westpac forecasts

The Government expects that the Australian economy this year and next will expand at apace a little below trend, that unemployment will move a little higher, and that inflation will bewell contained. In addition, with the terms of trade trending lower, nominal GDP growth willalso be below trend. This is a less upbeat outlook than described by the Government in theOctober Mid-Year Economic & Fiscal Outlook (MYEFO).

Real GDP growth is forecast to be 3.00% in 2012/13, slowing to 2.75% in 2013/14, withtrend growth judged to be around 3.2%. While the growth forecast for this year is as inMYEFO, the figure for 2013/14 has been downgraded by 0.25%, largely reflecting a scalingback of business investment. Nominal GDP growth is forecast to be 3.25% this year, down-graded from 4.0% in MYEFO, and 5.00% in 2013/14, lowered from 5.5%.

A number of headwinds continue to impact the economy, at a time when the mix of growth is

shifting from mining investment towards exports and more robust conditions across the non-mining sectors. This rebalancing of growth will be challenging and the transition is unlikely tobe smooth, notwithstanding a boost from low interest rates. Growth will be constrained by ahigh dollar, households' desire to pay down debt and weak public demand.

The international backdrop remains uncertain. The Government expects world growth tostrengthen to 4.0% in 2014, from 3.25% this year. However, we see the risk that global condi-tions disappoint, forecasting world growth to slow to 3.1% in 2014, from 3.3% this year. Theinternational backdrop remains a key risk to the budget position. The terms of trade is trend-ing lower, declining an estimated 7.50% this year and edging 0.75% lower in 2013/14. Withour weaker world view, we anticipate a somewhat larger fall in the terms of trade next year,down 2.0%

Consumer spending is forecast to expand by 2.5% in 2012/13, constrained by a weak startto the year, improving to a still modest 3.0% in 2013/14. A housing construction recovery is

underway, following a 3.6% contraction in 2011/12. However, this cycle is likely to be mildgiven households' diminished appetite for debt and a scaling back of government incentivesfor first home buyers. Housing is forecast to rise this year and next, by 0.5% and 5.0%.

Business investment is a potential swing factor. Mining investment is set to peak, but remainhigh by historical standards. The timing and strength of an upswing in non-mining invest-ment is particularly uncertain given the high dollar, global fragilities and a lack of businessconfidence. Total business investment is forecast to rise by 10.5% in 2012/13 and by 4.5% in2013/14. We see the risk that overall business investment is broadly flat next year.

Unemployment is expected to move a little higher, with the Government forecasting a risefrom 5.5% in June 2013 to 5.75% by June 2014. This remains relatively low by comparisonwith recent decades.

In summary, the risks to the Government's forecasts are tilted to the downside in our view.International conditions may be more challenging than anticipated, the domestic housingrecovery may disappoint, and non-mining business investment may be slow to improve.Westpac Economics forecasts real GDP growth to be 2.9% in 2012/13 and 2.4% in 2013/14,and nominal GDP growth for the two years to be 3.0% and 4.0% respectively.

Economic growth to besub-trend ...

... slowing to 2.75% in2013/14 ...

... as headwinds persist.

Global outlook a risk.

Housing recovery to bemild ...

... and business outlookuncertain ...

... suggesting risks skewedto the downside.

6


7/16





Macroeconomic variables recent history

2012 2013

Monthly data Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

Employment 000 27.3 16.4 4.5 23.4 0.5 21.5 1.3 12.3 71.7 31.2 50.1

Unemployment rate % 5.3 5.2 5.1 5.5 5.4 5.3 5.4 5.4 5.4 5.6 5.5

WestpacMI Consumer Sentiment 95.6 99.1 96.6 98.2 99.2 104.3 100.0 100.6 108.3 110.5 104.9

Retail Trade %mth 1.1 0.7 0.2 0.5 0.1 0.2 0.5 1.3 1.3 0.4

Dwelling approvals %mth 2.2 22.3 13.4 9.7 3.0 0.0 1.3 2.0 3.0 5.5

Private sector Credit %ann 4.4 4.2 4.1 4.0 3.8 3.5 3.6 3.6 3.4 3.2

Trade balance AUDbn 0.90 1.52 1.99 2.14 1.85 2.29 0.66 1.14 0.11 0.31

Economic forecasts Australia

2012(a) 2013 2014 2012(a) 2013 2014

World growth 3.2 3.25 4.00 3.2 3.3 3.1

Actual Government (year average) Westpac (year average)

2010/11(a) 2011/12(a) 2012/13 2013/14 2012/13 2013/14

Private consumption 3.6 3.2 2.50 3.00 2.6 3.0

Dwelling investment 2.2 3.6 0.50 5.00 0.5 4.7

Business investment* 8.0 20.8 10.50 4.50 10.0 0.0

Private demand* 4.1 6.2 4.00 3.50 4.2 2.4

Government* 1.9 2.1 0.50 0.0 2.5 1.0

Final demand 3.6 5.3 3.00 2.75 2.7 1.7

Stock contribution ppts 0.6 0.1 0.0 0.0 0.1 0.1

GNE 4.3 5.2 3.00 2.75 2.5 1.6

Exports 0.3 4.7 7.00 6.50 6.0 5.7

Imports 9.7 11.8 5.00 6.00 1.7 2.5

Net exports contribution ppts 1.7 1.3 0.50 0.00 0.9 0.8

GDP 2.4 3.4 3.00 2.75 2.9 2.4

Nominal GDP 8.5 5.0 3.25 5.00 3.0 4.0

Employment (Jun qtr) 2.2 1.2 1.25 1.25 1.2 0.9

Unemployment rate (Jun qtr) 5.0 5.1 5.50 5.75 5.6 6.1

Participation rate (Jun qtr) 65.5 65.3 65.0 65.0 65.2 65.0

CPI (Jun qtr) 3.5 1.2 2.50 2.25 2.4 2.9

WPI (Jun qtr) 3.9 3.7 3.50 3.50 3.3 3.3

Terms of trade 20.6 0.5 7.50 0.75 8.5 2.0

Current account, % of GDP 2.4 2.7 3.50 3.75 3.3 2.9

* business investment and government spending adjusted to exclude the effect of private sector purchases of public

sector assets.

7


8/16


Housing sectors sluggish recovery to continue

Australias housing sector will be called on to do much of the heavy lifting through the tran-sition from mining to non-mining led growth particularly during the initial stages. While itsbecoming clearer that a housing upturn is underway, the slow response to rate cuts, an une-ven performance across segments and states, and ongoing headwinds from fragile consumersentiment, soft labour markets and households focus on debt reduction all suggests theupturn will continue to be restrained compared to previous cycles.

The upturn has been very slow to come through. Benchmarking to previous interest ratecycles shows just how disappointing the response to the RBAs policy easing has been. Chart1 shows that up until March, the response from finance approvals had been the worst in 30years and that, despite recent gains, the broader response from dwelling prices continues toundershoot previous cycles by a wide margin.

That said, there are signs that the pick-up has gained more momentum in 2013. Auctionmarkets, the most timely gauge of activity, have sparked into life with clearance rates in thekey Sydney and Melbourne markets surging to over 70% in May. This is a particularly strongperformance for Sydney which historically has seen prices rise at double-digit annual rateswhen when auction clearance rates are sustained at these levels.

The latest pick-up is also starting to show through in housing finance approvals. However, thedetail here and on prices reveals a very uneven performance by segment and state. Segment-wise, approvals are up strongly for upgraders (+27%yr) and investors (+21%yr) but very weakfor first home buyers (FHBs, 5%yr). Some of the weakness in FHB approvals is due to stategovernment policy changes that had seen buyers bring forward purchases. However, evenallowing for this the degree of weakness the number of approvals to FHBs touched recordlows in February is still extreme.

Across the states, NSW and WA are seeing strong gains, particularly for investor financewith rental yields notably firmer in Sydney and Perth. However Vic, Qld and SA are seeingmuch milder upturns. Its a similar story with prices. The positive price momentum is wellestablished in Sydney and Perth, but is patchier (though improving) in Melbourne. Weak pricegrowth in SA and some further slight slippage in prices in Brisbane is a concern.

Looking ahead, we expect this uneven price recovery to continue both this year and next.Sydney and Perth will continue to lead the way although the mining slowdown and a stretchedstarting point for affordability are expected to become more of a constraint in the west.Despite the solid start to 2013, the Melbourne market will tend to under-perform, particularlyas a large pipeline of dwellings currently under construction comes onto the market (including20,000 units approved for inner Melbourne over the last 2yrs). Brisbane, which has been theweakest market over the last 3yrs, is expected to remain soft near term but improve a little in2014. Queensland has seen persistently higher mortgage arrears rates in recent years which

seems to have been a factor in the weakness in some sub-markets including the Gold Coastand Brisbanes southern fringes. Lower rates should see these pressures ease. Meanwhile lowlevels of building will see supply shortages, already apparent in rental markets, put upwardpressure on prices.

Note that while prices may continue to follow a patchy recovery path, gains look wellanchored. The Westpac-Melbourne Institute Consumer House Price Expectations Index hassurged since the start of the year indicating a strong consensus expect prices to rise overthe next year. That points to buyers being unlikely to delay purchase in expectation of lowerprices in the future and sellers being unlikely to accept low ball price offers. Again though,there are significant variations across the states.

Overall, we expect prices nationally to rise about 5% in 2013 with growth slowing to 3% in2014. Construction-wise, we expect dwelling investment to rise 4.4%yr in both years. While

the cumulative 8% gain in prices and 9% rise in construction may look good compared tothe last few years, both are lacklustre compared to previous upturns which would have seendouble-digit annual growth at this stage. A fundamental reluctance on the part of buyers tostretch themselves financially is expected to be the biggest ongoing constraint. Thoughclearly positive, the housing sectors contribution to growth looks unlikely to be vigorousenough to single-handedly sustain momentum in the broader economy as the drag from themining sector starts to come through.

The current recovery ...

... has been slow toform ...

... and despite aquickening in early2013 ...

... is uneven acrosssegments ...

... and states

We expect more of thesame ...

... as price expectationsshow gains well-entrenched ...

... but consumer cautionto remain an ongoing

restraint

Housing outlook

8


9/16

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.

9





Housing outlook

Auction markets spark into life

-3

-2

-1

0

1

2

3

4

-3

-2

-1

0

1

2

3

4

May-03 May-07 May-11 May-03 May-07 May-11

st. devnsst. devns

Sydney (14%) Adelaide (6%)Melbourne (20%) Perth (0.5%)Brisbane (2.5%)

Sources: APM, RP Data-Rismark, Westpac Economics

*seas. adjusted by Westpac, smoothed

figures show avg proportion of propertiessold via auction (i.e. vs private treaty)

auction clearance rates

*standard deviations from long run avg

Housing upturns compared

70

80

90

100

110

120

130

140

150

160

170

70

80

90

100

110

120

130

140

150

160

170

0 3 6 9 12 15 18 0 3 6 9 12 15 18

indexindex2001-02 2008-092011-12 1996-971990-93 1987-881983-84

Sources: ABS, RP Data-Rismark,Westpac Economics

*index based to 100 in monthprior to first mortgage rate decline

months

finance approvals dwelling prices

Consumer house price expectations positive

-60

-40

-20

0

20

40

60

80

100

-60

-40

-20

0

20

40

60

80

100

Dec-04 Dec-07 Dec-10 Dec-04 Dec-07 Dec-10

%%

Australia* NSW Australia* SA Vic Qld WA

Sources: Melbourne Institute, Mortgage Choice

(Australia 2004-08), Westpac Economics

net % expecting house prices to rise

Rental yields close to mortgage rates

3

4

5

6

7

8

9

10

11

12

13

3

4

5

6

7

8

9

10

11

12

13

Mar-93 Mar-99Mar-05 Mar-11 Mar-93Mar-99 Mar-05 Mar-11

%pa%pa

Sydney Adelaide

Melbourne Perth

Brisbane

Sources: RP Data, RE IA, Westpac Economics

*median rent on2bdrm unit as % ofmedian unit price

investor boom

WBCf/c

WBCf/c

Dwelling prices: uneven recovery to continue

60

110

160

210

260

60

110

160

210

260

Dec-02 Dec-07 Dec-12 Dec-02 Dec-07 Dec-12

indexindex

Australia Sydney Australia Adelaide

Melbourne Brisbane Perth

Sources: RP Data-Rismark, Westpac Economics

*all dwellings, Dec 2002 =100

Westpacforecasts

Westpacforecasts

Value of finance approvals by segment, state

0

2

4

6

8

10

12

0

2

4

6

8

10

12

Mar-03Mar-06 Mar-09 Mar-12 Mar-03 Mar-06 Mar-09 Mar-12

$bn$bn

'upgraders'* NSW Vic

investors Qld WA

FHBs SA


*ex refinance

+27%

+21%

5%

year to Mar

by state^

+19%

+15%

+8%

+19%

+5%

incl. investor finance


10/16

Australian interest rates


We expect that the Reserve Bank will complement its May rate cut of 25bps with a follow upcut of 25bps in the near future perhaps as early as June to bring rates down to 2.5%. Rates areexpected to eventually bottom out at 2% by the first quarter of 2014.

In May last year we forecast that the low point in the cash rate cycle would be 2.75%. At thetime the Consensus view was around 3.253.5%. We have held our view consistently since thenwhile emphasising clear downside risks over the last six months. With the Reserve Bank cuttingthe rate to our target level on May 7 it was appropriate to quantify those downside risks.

The Governor gave us clear encouragement that a further move in the near term is likely. Thefinal paragraph of the statement makes the following point: The Board has previously notedthat the inflation outlook would afford scope to ease further, should that be necessary tosupport demand. At todays meeting the Board decided to use some of that scope.

Our interpretation of this wording is that the door has been left open for another move asearly as June. Certainly we expect that over the course of the next month it will becomeclear that business investment intentions are soft, both business and consumer confidenceare fragile and credit growth continues to remain subdued. While we accept that the labourmarket is also a critical influence on Bank thinking, we do not believe that the volatile monthlyemployment reports can totally offset the clear picture that is emerging around the broadereconomy. Indeed, the Reserve Bank opined in its recent Statement on Monetary Policy (SOMP)that the unemployment rate would continue to rise through to mid 2014. The commentary inthe Governors Statement and the SOMP suggests that success in boosting demand so far hasbeen mixed and there is no clear indication that the Bank expects a quick resolution.

Recall that the last time rates were around these levels 2009 monetary policy was beingcomplemented by fiscal policy both domestically and offshore; the exchange rate; and the

upswing in the mining sector all helped to restore demand in the aftermath of the globalfinancial crisis. In the current environment, monetary policy is effectively acting alone.

The really key new development over the last few weeks has been evidence of an even lowerthan expected trajectory for inflation. In its SOMP the Reserve Bank points out that a keyfactor behind the low inflation has been margin pressure for Australian companies partlyassociated with the presence of online vendors. Australian companies have been forced to cutoverheads; contain wage pressures; and negotiate lower rents.

We have also always argued that our assessment of the global economy is more subdued thanthe consensus. The IMF is expecting 4% world growth in 2014 we are at 3.1%. For Australiasterms of trade, the peak to trough decline in the 2011/12 period was 17%, while we forecasta 2013/14 decline in the region of 10%. We have long maintained that from a world growthperspective, 2014 will feel like 2012.

The threat of a disruptive event in Europe remains ever present. The US story does not convinceus. We confidently expect that the US Federal Reserve will persist with its quantitative easingpolicy through most of 2014. China has already begun the process of recalibrating its monetaryand real estate policy settings and the support it received from the export sector in Q1 isalready receding. Indian domestic demand is flagging badly and the required policy supporthas not been adequate. Japan is something of a bright spot, but its gross acceleration will farexceed the net from a global growth perspective as it takes back market share.

After the next cut which we expect in the near future we expect the Bank will be patient andwait to assess the impact on domestic demand of the low rates. However by the end of theyear it will have become clear that further stimulus will be required to offset the impact of asoftening world economy while the response to the low rates in the domestic economy will bedisappointing.

We anticipate that two further rate cuts will be required, one in the December quarter of thisyear and one in the March quarter of next year. That would see the cash rate bottom outat 2.00% from its current 2.75%. Having driven rates down to that level we expect policy toremain on hold through the remainder of 2014.

Our long held target of2.75% ...

... was reached in May ...

... as the RBA rightly sawfit ...

... to use some of thescope ...

... provided by lowinflation.

With our 2.75% targetachieved ...

... we now choose toquantify ...

... the downside risks onrates.

Expect a trough in early2014 ...

... at an even 2%.

10


11/16

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.

11




Australian interest rates


2

3

4

5

6

J an Apr J ul Oct

%

3yr swap

Cash rate

Source: Bloomberg, Westpac Strategy

Fixed Rates turn sharply time to contain risk now

2

3

4

5

6

J an Apr J ul Oct

%

f/cs

2009 2013

2

3

4

5

6

7

8

2

3

4

5

6

7

8

May-02 May-04 May-06 May-08 May-10 May-12

%%

Cash rate

3yr swap

Sources: RBA, Bloomberg, WestpacEconomicsweekly average

updated May 2013

RBA cash rate, 3 year swap

Durables inflation domestic margin pressure

-12 -9 -6 -3 0 3 6

Textiles, clothing & footwear

Furniture

Motor vehicles & parts

Toys, books & leisure goods

Household electrical items

ppts

Consumer prices

Import prices

Source: RBA

average annualised inflation since Q1 2011

World growth WBC forecasts slowdown

2012 (%an n) 2013 (%an n) 2014 (%an n)

World 3.2 3.3 3.1

US 2.2 1.7 1.6

Europe -0.6 -0.5 -0.5

China 7.7 8.0 7.8

Aus tral ia 3.6 2.5 2.3

Underlying inflation to stay low despite carbon tax

0

1

2

3

4

0

1

2

3

4

Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13

%yr%yr

Westpac's estimate of the Carbon Price

RBA core inflation


Forecasts

Target band

Unemployment rate set to peak mid 2014

3

5

7

9

62.5

63.5

64.5

65.5

66.5

Mar-97 Mar-01 Mar-05 Mar-09 Mar-13

% %

unemployment rate (lhs)


Forecaststo Dec 2015

peak6.25%

mid 2014


12/16


Australian dollar

The Reserve Bank lowered interest rates at the May 7 meeting. The Governors statementonce again pointed out the unusual elevated level of the exchange rate given that exportprices and interest rates have fallen markedly over the last 18 months with the exchange rateremaining relatively steady. Unease around the Australian dollar was undoubtedly a key factorbehind the decisions to move Australian rates more into line with global markets.

The detailed arguments behind our decision to forecast a terminal cash rate of 2.00% (or morecorrectly, the fact we have now quantified the downside risks on Australian interest rates wehave been openly discussing for some time) are set out overleaf. With this lower RBA rateprofile there is some modest room for further moderation in the fair value of AUD, which putsdownward pressure on our forecasts. Our June 2014 target has been lowered one cent to 96,and we have decided to treat the current spot (1.011.02) as the likely average for the comingquarters. It is the latter judgement that is most different to the view we put forth a month ago.

The RBA can contribute to the lowering of fair value by delivering on the rate cuts we envisage,while maintaining a credible easing bias throughout, thereby narrowing the 2 year swapspread that has proved to be the most reliable interest rate related predictor of the exchangerate over time. However, the key to a more significant fall in the currency is a more markedreduction in the over valuation premium the degree to which spot exceeds our baselineestimate of fair value which is something that lies essentially outside the RBAs influence.

Our views on advanced country growth indicate that global capital flows, and by extensionforeign exchange markets, will continue to be heavily influenced by aggressive unconventionalmonetary policy in the G4 economies. There is clear evidence that a policy frameworkcharacterised by central bank balance sheet expansion leads to higher exchange rates forthose countries where conventional policy settings are still in place. One such indicator is therising wedge between swap spreads and cross exchange rates where one of the parties is a

QE jurisdiction and the other is a conventional monetary arbiter. While the Australian dollarhas lost a little ground in recent days it is not far removed from the 810 overvaluationrelative to fair value that has opened up since late 2010.

It is our view that the gap will remain substantially in place this year. Next year our forecastsfor the currency envisage the gap between spot and fair value will close gradually, but willremain material at around 56. There is actually nothing new in that assessment. The profilefor the Australian dollar we published last month, which had incorporated a steady cash rate of2.75% (with downside risks reflected in our yield curve forecasts), a softening world economy,periodic financial stress episodes and lower commodity prices, saw AUD back at 97 by Junenext year, partially due to a gradual narrowing of the overvaluation premium.

We have long maintained that from a world growth perspective, 2014 will be reminiscient of2012. For Australias terms of trade, the peak to trough decline in the 2011/12 period was

17%, while we forecast a 2013/14 decline in the region of 10%. Commodity markets havebeen perturbed by the soft data coming out of China in recent times (Chinese Q1 GDP cameout during the gold and base metal selloff of mid April, but it was not the initial catalyst). Weconsider the Chinese outlook on page 20. We are inclined to discount the GDP figures as anerrant reading and maintain our views that a) activity will firm in Q2 and Q3, and b) the cyclewill roll over entering 2014, as tighter policy settings infiltrate more fully. The bulk commodityprice profile we derive from this picture (including a view on the distinct seasonality at play) isa classic year of two halves, with the first half broadly up and the second broadly down. Ergo,commodity price support for fair value, that has been evident since late last year up until a fewweeks ago, will soon be heading more decisively the other way.

A further factor in this story is the financing of the current account. Over the last few years,external financing has been dominated by heavy foreign buying of Australian public debt anddirect equity stakes in resource projects, offset by lower demand for offshore borrowing from

Australian financials. This mixture of flows is higher quality than that of yesteryear. However,public deficits are narrowing and the resource sectors requirement for foreign capital will beconsiderably reduced in coming years. It is arguable whether the high quality financing thesiswas ever truly grasped by the market, so a gradual change may not impact sentiment thatmuch. Even so, if inflows become less stable as private portfolio debt begins to replace directequity and public borrowing, fair value and the gap between spot and fair value would decline,unless the mining export payoff was large enough to cover the difference.

Lower interest rates ...

... will help bring fairvalue down ...

... but while QE persists ...

... so will AUD overvaluation ...

... although we expect thegap ...

... to narrow from 810now ...

... to around 56 in 2014.

12


13/16

Chart 1. Chart 2.

Chart 3. Chart 4.

Chart 5. Chart 6.

13





Australian dollar

Commodity prices will fall through 2014

100

150

200

250

300

350

100

200

300

400

500

600

700

Mar-07 Mar-09 Mar-11 Mar-13

indexindex

Bulks* (lhs)Exchange traded* (rhs)

Sources: Westpac Economics, Bloomberg, ABS.Bulks includes iron ore and coal. Exchange traded includesrural, crudeoil, base metals and gold.

Australian dollar to fall but retain QE premium

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

1.20

J an-91 J an-95 J an-99 J an-03 J an-07 J an-11

USDUSD

Fair value band

AUD/USD actual & forecast

Sources: RBA, Westpac Economics

Includes WCF I+BI commodities index, 2 year swap spread, and NFD to GDP .

Europe: Unemployment continues to rise

0

5

10

15

20

25

30

0

5

10

15

20

25

30

1995 1997 1999 2001 2003 2005 2007 2009 2011

%

France SpainItaly Netherlands

Source: Eurostat

%unemployment rate

Major central banks are committed to QE

0

10

20

30

40

50

0

10

20

30

40

50

J an-08 J an-09 J an-10 J an-11 J an-12 J an-13

%GDP

ECB Fed BOJ

Sources: Ecowin, Bloomberg, CEIC, Westpac Economics

%GDP

Indicativeforecasts

US unemployment falls due to part. rate, not jobs

54

56

58

60

62

64

66

68

0

2

4

6

8

10

12

1970 1980 1990 2000 2010

%%

Unemploment rate (lhs)

Participation rate (rhs)

Employment-population ratio (rhs)Sources: Ecowin, Westpac Economics

Chinese construction cycle slowdown coming

0

10

20

30

40

J an 05 J ul 06 J an 08 J ul 09 J an 11 J ul 12 J an 14

%yr %yr 3mma

%yr 3mma

Sources: CEIC,Westpac Economics.


14/16


Financial forecasts Australia

Currency forecasts

Latest (14 May) Jun13 Sep13 Dec13 Mar14 Jun14

AUD vs

AUD index* 100 100.0 98.7 97.8 95.8 94.6

USD 0.9966 1.01 1.00 0.99 0.97 0.96

USD forward^ na 0.99 0.99 0.98 0.98 0.97

JPY 101.36 99 97 95 92 90

EUR 0.7674 0.78 0.78 0.78 0.79 0.79

NZD 1.2071 1.22 1.19 1.16 1.14 1.14

CAD 1.0069 1.02 1.02 1.02 1.02 1.01

GBP 0.6511 0.67 0.66 0.65 0.64 0.63

CHF 0.9532 0.95 0.95 0.95 0.94 0.95

DKK 5.7197 5.80 5.82 5.83 5.86 5.86

SEK 6.5807 6.76 6.79 6.81 6.84 6.85

NOK 5.7772 5.90 5.94 5.95 6.05 6.06

ZAR 9.1367 9.19 9.17 9.15 9.12 9.10

SGD 1.2364 1.24 1.22 1.21 1.18 1.16

HKD 7.7346 7.84 7.76 7.69 7.53 7.45

PHP 41.02 41.21 40.45 40.21 39.21 38.63

THB 29.57 29.80 29.18 29.06 28.30 27.84

MYR 2.9869 3.01 2.95 2.94 2.86 2.82

CNY 6.1254 6.22 6.13 6.07 5.92 5.83

IDR 9708 9827 9652 9571 9336 9199

TWD 29.72 29.88 29.35 29.11 28.37 27.92

KRW 1108 1106 1090 1083 1053 1035

INR 54.41 54.65 53.51 53.09 51.70 50.86

*Nominal trade weighted index, with latest data compiling the base. Weights from Reserve Bank of Australia. A reading above (below) 100 indicates a rise (fall) in the AUD.

^Approximate market forward price for AUD/USD, not a forecast. Sources: Bloomberg, Westpac Economics.

Interest rate forecasts

Latest (14 May) Jun13 Sep13 Dec13 Mar14 Jun14

Cash 2.75 2.50 2.50 2.25 2.00 2.00

90 Day Bill 2.81 2.55 2.55 2.30 2.10 2.10

3 Year Swap 2.89 2.80 2.80 2.75 2.65 2.75

10 Year Bond 3.21 3.20 3.40 3.25 3.10 2.85

10 Year Spread to US (bps) 129 120 120 115 110 105

Sources: Bloomberg, Westpac Strategy.

14


15/16

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