2010 and 2011 will likely shape up as strong economic growth, albeit with weak US growth. Global economic growth is expected to be 4.4 per cent for 2010 (3.5 per cent in Australia). Excess liquidity in key Asian trading partners, in concert with loose monetary settings in major Western nations, suggest that favourable monetary conditions will continue to support global economic growth via an emerging market recovery.

From a starting position of still high underlying inflation and the lack of spare capacity in product and labour markets, inflationary pressures and set to re-emerge through 2010 and gain momentum in 2011. Headline inflation is likely to move beyond the top of the RBA’s 2-3 per cent target band through the second half of 2010.

Financial conditions are set to tighten further. Although financial conditions were loose eight months ago, it is also clear that financial conditions have tightened appreciably over the final months of 2009, suggesting that the recovery will enjoy a relatively brief period of strong growth. Nevertheless, the degree of interest rate rises the RBA may implement, combined with a rising A$, suggest financial conditions will merely be close to neutral by mid-2010. The economic growth prospects for 2011 will hinge closely on how emboldened the RBA and Treasury are in removing the stimulus, and the ultimate path of the A$. Nevertheless, based on the current A$, interest rate, equity market and credit market forecasts, financial conditions are unlikely to prove sufficiently restrictive to deliver anything more than a mid-cycle economic slowdown before recovering again in 2011. Exceptionally strong population growth, a likely recovery in productivity growth and a rise in Australia’s terms of trade should also help underwrite the medium term recovery.

The threats to consumption from weak credit growth, prior wealth destruction and the threat of an ongoing rise in precautionary household savings are low. It is hard to ignore consumption per capita having already retreated to a pace consistent with the depths of the early-80s recession, the adjustment in the saving ratio is far more advanced in comparison to the wealth declines relative to other western nations, and that household income growth in Australia will be sustained by unprecedented monetary and fiscal stimulus in 2009 and into 2010 sufficient to underwrite a sustainable recovery for consumption growth. With the starting point being household consumption at a record low as a percentage of GDP, and population expanding at a record 2.1 per cent, it appears that a durable recovery for consumption will unfold through 2009 and 2010.

The main sources of risk to our Australian economic view are:

• An aggressive tightening in liquidity in emerging markets as central banks begin to fear the inflation consequences of excess liquidity.
• A stronger rise in the A$ than we expect. An A$ above 1.05 would begin to cause substantial economic damage (assuming no compensating commodity price rises) as financial conditions tighten meaningfully.
• The undersupply of housing, low real interest rates and renewed investor demand prompt a sharp reaccelerating in housing prices. The consequence would be materially higher interest rates than currently envisioned and an earlier end to Australia’s nascent economic recovery.
• The linkage between LNG prices and the oil price breaks, threatening the economics of a series of large investment projects.
• The combination of the Henry Taxation Review, the Superannuation Review, the uncertainties surrounding the Emission Trading Scheme and holding of the Federal election provide a sufficient trigger for a sharp drop in consumer and business sentiment.

The forecasts for 2010 for share markets by Goldman Sachs are as follows:


Goldman Sachs estimate that ten year Aust bond rates for 2010 are likely to be 5.75 per cent.

Significant valuation discount for listed property has gone. There is limited growth for listed property over next two to three years while yields are unlikely to offset lack of growth options for sector. There is potential for M&A cycle to increase as sector consolidates. Historically, listed property has lagged in interest rate tightening cycle.

What does this mean for investors?

Certainly, 2008 and 2009 were disastrous years for investors. 2010 and 2011, by comparison, look a lot brighter but there are still risks. Our approach would still be that of diversification (based on objectives and personal situation) rather than trying to pick a winning sector.


David Martin, Queensland
dmartin@moorestephens.com.au