Economy faces some testing weather

11 October 2004

Some huge commitments have been made and the revenue projections may prove to be optimistic.

The buoyant economy underpinned the Howard Government's triumph but its economic management credentials are likely to be tested during the next parliamentary term.

The economy is in its 14th year of expansion and it may be difficult to sustain another three years of strong growth.

While the economic fundamentals are good, with unemployment low, inflation in check and interest rates relatively low, there are several domestic and global risks.

On the home front, the behaviour of house prices after the recent boom remains the biggest threat, economists say.

The housing market has cooled this year but a prolonged price slump, coupled with any moderation in economic conditions, is likely to hurt many highly indebted households.

Economists say spending has recently been driven more by rising house prices and increased debt than rising incomes and the Reserve Bank says the level of indebtedness has made families more vulnerable to economic shocks.

If house prices fall, families may slash spending, taking a toll on the whole economy. Alternatively, a re-acceleration in house price growth could pave the way for a sharp downturn in future, with damaging consequences.

The Reserve has warned it is watching developments in the housing market closely.

Interest rates will also be crucial, with some economists tipping an increase before Christmas.

The unprecedented level of household debt - which doubled to $700 billion in the past five years - has left consumers more sensitive to interest rates than ever. However, even if rates do rise, most economists believe there are only one or two modest increases in store.

Some analysts are concerned about the economic fallout from the Government's pre-poll spending spree, and its impact on public finances.

Since the federal budget in May, the Coalition has made commitments worth about $65 billion over five years.

This has the potential to boost economic activity, fuel inflation and put upward pressure on interest rates, according to some analysts.

Despite the pre-poll largesse, Treasury figures show the budget should remain in surplus, although HSBC chief economist John Edwards has questioned these forecasts. "Some huge commitments have been made and the revenue projections may prove to be optimistic," he said.

Access Economics also says the federal coffers may not be in as good shape as the figures suggest. "We've spent public money all too fast, wasting a lot of it, and we're nearer the bottom of that barrel than we think," it said. The soaring international oil price, which reached a record $US53.31 last week, has clouded the economic outlook.

In Australia, high petrol prices continue to eat into family budgets and crimp consumer spending. The petrol price surge also adds to business costs and puts upward pressure on inflation.

This combination - weaker economic activity and upward pressure on inflation - makes the management of interest rates more difficult.  The oil price also threatens to dampen global growth, and could hurt exports.

Australia's trade performance has been below par for some time and forecasters are counting on global growth to boost exports and help offset an anticipated fall in consumer spending.

For this reason Australia's economic prospects rely on the strength of the world economy and any global slowdown will take a toll on local growth. Some economists have expressed concern about Australia's gaping current account deficit, which has been stuck at 6 per cent of GDP.

There is concern this imbalance may cause problems if it does not start to improve soon.

Treasury has also warned massive budget and current account deficits in the United States also have the potential to destabilise the world economy in the years ahead, with inevitable consequences for the Australian economy.