1

Where is the economic growth coming from?

Saul Eslake

Refer to important disclosures and disclaimer on page 17

Hobart, 28th November 2013

Presentation to the Private Health Care Australia conference

2

Sources: Australian Bureau of Statistics; US Bureau of Economic Analysis; Japan Economic &Social Research Institute; Eurostat; UK Office of National Statistics; Statistics Canada; US Bureau of Labor Statistics; Japan Home Ministry; Statistics New Zealand.

Real gross domestic product

Australia’s economy has been doing better than its peers

90

92

94

96

98

100

102

104

106

108

110

112

114

116

08 09 10 11 12 13

Dec qtr 2007 = 100Australia

Japan

US

UK

Canada

NZ

Unemployment rate

3

4

5

6

7

8

9

10

11

12

13

08 09 10 11 12 13

% of the labour force

Australia

Japan

US

UK

Euro area

CanadaNZEuro area

3

Having risen more than most other countries, Australia’s “terms of trade” are now falling by more

Note: ‘Terms of trade’ is the ratio of export to import prices derived from the national accounts. Sources: National statistical agencies, Eurostat, OECD.

Australia’s terms of trade

80

100

120

140

160

180

200

01 02 03 04 05 06 07 08 09 10 11 12 13

2003 = 100

Australia

OECD average

Canada

Norway

NZ

80

100

120

140

160

180

200

01 02 03 04 05 06 07 08 09 10 11 12 13

2003 = 100Australia

Brazil

South Africa

Chile

Compared with other ‘advanced’ economies

Compared with selected commodity-producing ‘emerging’ economies

4

Falling terms of trade are now detracting from income growth –the opposite of what happened over the past decade

Sources: ABS.

Real gross domestic product (GDP) and gross domestic income (GDI) growth

-4

-2

0

2

4

6

8

10

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

Real gross domestic product (GDP)

Real gross domestic income (GDI)

� Over the decade ended 2012, gains in Australia’s “terms of trade” boosted the growth rate of real incomes (GDI) by 1.1% pa above the growth rate of real output (GDI)

5

The ‘resources boom’ is passing its second major turning point

Minerals and energy export commodity prices

Note: ‘Mining investment’ excludes intangibles such as exploration and R&D expenditure. Sources: RBA; ABS.

0

20

40

60

80

100

120

01 02 03 04 05 06 07 08 09 10 11 12 13

Index - 2011-12 = 100

Mining investment as a pc of GDP

0

1

2

3

4

5

6

7

01 02 03 04 05 06 07 08 09 10 11 12 13

%

6

Some pieces of evidence that the resources investment boom is peaking

0

20

40

60

80

100

120

02 03 04 05 06 07 08 09 10 11 12 13

$bn

Construction work

yet to be done

Commence-

ments (4-qtr

rolling total)

Source: ABS.

Engineering construction work –oil & gas fields and mines

-2

0

2

4

6

8

02 03 04 05 06 07 08 09 10 11 12 13

% ch from year earlier

Seas. adj.

Trend

Employment - WA

-5

0

5

10

15

02 03 04 05 06 07 08 09 10 11 12 13

% ch from year earlier

Seas. adj.

Trend

Retail sales - WA

7

Iron ore and coal export volumes are now ramping up

Iron ore

Sources: Bloomberg; ABS.

Coal

Bulk commodity export volumes

8

LNG exports will rise sharply but employment will fall from 2015 on

Source: Bureau of Resources & Energy Economics.

0

10

20

30

40

50

60

70

80

90

100

2011 2012 2013 2014 2015 2016 2017 2018

0

10

20

30

40

50

60

Volume (left scale)

Value (right scale)

Financial years ended 30 June

Mt 2012-13 $ bn

Australian LNG exports

0

2

4

6

8

10

12

Gorgon Ichthys Wheat-

stone

A-PLNG Qld Curtis GLNG

Capex phase

Opex phase

'000s

Project

Employment directly associated with major LNG projects

9

Interest rates

Note: Dotted lines indicate 15-year average of each interest rate shown.Source: RBA.

Lower interest rates are yet to stimulate faster growth in borrowing

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

01 02 03 04 05 06 07 08 09 10 11 12 13

% pa

RBA cash rate

Standard variable

mortgage rate

Weighted average

rate paid by

small businesses

-10

-5

0

5

10

15

20

25

01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

Housing

Business

Credit growth

10

Non-mining business investment still looks very weak

Source: ABS.

Non-mining business investment as a pc of GDP

3.0

3.5

4.0

4.5

5.0

5.5

6.0

01 02 03 04 05 06 07 08 09 10 11 12 13

%

50

55

60

65

70

75

80

05 06 07 08 09 10 11 12 13 14

A$bn

Actuals

Successive ABS capex intentions

survey estimates

Actual and intended non-mining business investment

11

-3

-2

-1

0

1

2

3

4

5

6

7

01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

'Tradeable' goods

& services

'Non-tradeable'

services

'Underlying'

inflation

The strong A$ helped keep inflation under control during the ‘boom’

A$ vs US$

Sources: RBA; ABS.

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1.10

89 92 95 98 01 04 07 10 13

US$ per A$

Rolling post-float

(Dec 1983) average

Consumer prices

12

But now, foreign capital inflows into mining are keeping the A$ at levels above ‘fundamentals’

Sources: ABS (balance of payments data).

Net capital inflows by sector

-20

-10

0

10

20

30

40

50

60

70

80

07 08 09 10 11 12 13

Mining All other Current account deficit

A$ bn (4-qtr moving total)

2030405060708090100110120

01 02 03 04 05 06 07 08 09 10 11 12 13

0.50

0.60

0.70

0.80

0.90

1.00

1.102011-12 = 100

A$ vs US$

(right scale)

US$

RBA commodity price index

(left scale)

Commodity prices and the A$

Interest rate spreads and the A$

0

50

100

150

200

250

300

350

400

450

500

01 02 03 04 05 06 07 08 09 10 11 12 13

0.50

0.60

0.70

0.80

0.90

1.00

1.10Basis points

A$ vs US$(right scale)

US$

Australia-US 2 yr bond

yield spread (left scale)

13

Business confidence is picking up – but hiring and capex plans aren’t

-30

-20

-10

0

10

20

01 02 03 04 05 06 07 08 09 10 11 12 13

Net balance (%)

Seas. adj.

Trend

Business confidence

Sources: NAB monthly and quarterly business surveys.

-30

-20

-10

0

10

20

01 02 03 04 05 06 07 08 09 10 11 12 13

Net balance (%)

Seas. adj.

Trend

Business conditions

-30

-20

-10

0

10

20

01 02 03 04 05 06 07 08 09 10 11 12 13

Net balance (%)

Seas. adj.

Trend

Employment intentions

-20

-10

0

10

20

30

40

01 02 03 04 05 06 07 08 09 10 11 12 13

Net balance planning increase (%)

Capital expenditure intentions

14

A spike in gas prices may also be a deterrent to higher investment

Source: Australian Industry Group, Energy Shock: The ‘Gas Crunch’ is Here, July 2013.

Historic and offered gas prices

Historic and offered gas prices

Impact of gas prices on investment

15

The housing market does seem to be springing to life again …

Source: RP Data – Rismark.

Capital city dwelling prices

200

250

300

350

400

450

500

550

600

650

01 02 03 04 05 06 07 08 09 10 11 12 13

A$000

Houses

Apartments

Capital city auction clearance rates

16

… but the upswing in demand is being driven mainly by investors

Sources: ABS; RBA

Housing finance commitments

-40

-30

-20

-10

0

10

20

30

40

50

60

04 05 06 07 08 09 10 11 12 13

% change from year earlier

(by value)

Owner-occupiers

Investors

Housing debt outstanding

0

5

10

15

20

25

30

35

04 05 06 07 08 09 10 11 12 13

% change from year earlier

Owner-occupiers

Investors

� 60% of the increase in total housing finance commitments since 2011 have been to investors (cf. their 40-45% share of total housing finance commitments over the past decade

17

… and overwhelmingly in Sydney

Sources: ABS; RP Data Rismark.

Housing finance commitments to investors

-40

-30

-20

-10

0

10

20

30

40

50

04 05 06 07 08 09 10 11 12 13

% change from year earlier

(by value) (3-mth moving average)

New South Wales

Rest of Australia

Capital city dwelling prices

� More than two-thirds of the increase in total housing finance commitments to investors so far this year have been in New South Wales

-20

-15

-10

-5

0

5

10

15

SYD MEL BNE ADL PER HBA DRW CBR

Late 2010 peak - 2012 trough Since 2012 trough

% change

18

First home buyers have been conspicuous by their absence from the housing market

Sources: ABS; Westpac-Melbourne Institute.

Housing finance commitments to first-time buyers

Consumer sentiment about home-buying conditions

10

15

20

25

30

35

40

45

01 02 03 04 05 06 07 08 09 10 11 12 13

% of total commitments to

owner-occupiers (excl. refi)

68

70

72

74

76

78

80

01 02 03 04 05 06 07 08 09 10 11 12 13

% of civilian working age population

(12-mth moving avge) 20-34 year olds

35-64 year olds

Employment-population ratios

60

80

100

120

140

160

01 02 03 04 05 06 07 08 09 10 11 12 13

Ratio saying 'good' to 'not good' (%) Trend

Actual

19

Investors are much less likely to buy a new dwelling –and especially a house

Source: ABS.

5.0

7.5

10.0

12.5

15.0

17.5

20.0

22.5

25.0

01 02 03 04 05 06 07 08 09 10 11 12 13

% of total

Owner-occupiers

Investors

Lending for new housing as a pc of total, by type of borrower

Private residential building approvals

70

80

90

100

110

120

130

140

01 02 03 04 05 06 07 08 09 10 11 12 13

'000s (annual rate)

Trend

Actual

Houses

20

30

40

50

60

70

80

90

100

01 02 03 04 05 06 07 08 09 10 11 12 13

'000s (annual rate)

Trend

Actual

Other (apartments, etc.)

20

House prices are usually co-incident with starts – they don’t lead starts

Sources: ABS; RP Data-Rismark.

Residential property prices and residential building commencements

-10

-5

0

5

10

15

20

25

91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

-60

-40

-20

0

20

40

60% change from year earlier

Private dwelling commencements

(right scale)

Dwelling prices

(left scale)

% change from year earlier

21

Higher house prices don’t directly spur faster growth in retail sales

Sources: ABS; RP Data-Rismark.

Property prices and retail sales of household goods

-10

-5

0

5

10

15

20

25

01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

Retail sales of

household goods

(3-mth mvg avge)

Dwelling prices

Residential building approvals and retail sales of household goods

-5

0

5

10

15

20

01 02 03 04 05 06 07 08 09 10 11 12 13

-60

-40

-20

0

20

40

60

80% change from year earlier

(3-mth moving average)

Retail sales of

household goods

(left scale)

Private residential

building approvals

(right scale)

22

Consumer confidence has improved but retail sales still remain weak

Sources: Westpac-Melbourne Institute; ABS.

Consumer confidence

0

2

4

6

8

10

12

01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

Seas. adj.

Trend

*

*

*

*

Government

'cash splashes'

*

80

85

90

95

100

105

110

115

120

125

130

01 02 03 04 05 06 07 08 09 10 11 12 13

Ratio of optimists to pessimists (%)

Seas. adj.

Trend

Retail sales

23

The jump in consumer confidence is wholly due to Coalition voters

Sources: Westpac-Melbourne Institute.

Coalition voters

70

80

90

100

110

120

130

140

150

01 02 03 04 05 06 07 08 09 10 11 12 13

Ratio of optimists to pessimists (%)

Seas. adj.

Trend

Labor voters

70

80

90

100

110

120

130

140

01 02 03 04 05 06 07 08 09 10 11 12 13

Ratio of optimists to pessimists (%)

Seas. adj.

Trend

Consumer confidence by voting intention

24

Consumer spending isn’t likely to pick up while income growth is weak

Source: ABS.

Real household disposable income

-4

-2

0

2

4

6

8

10

12

01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

Actual

Trend

Employment growth

0

1

2

3

4

5

01 02 03 04 05 06 07 08 09 10 11 12 13

'000s (annual rate)

Trend

Actual

0

1

2

3

4

5

6

01 02 03 04 05 06 07 08 09 10 11 12 13

% change from year earlier

Wages growth

25

No compelling reason to think households are about to save less

80

100

120

140

160

180

200

90 92 94 96 98 00 02 04 06 08 10 12

-4

-2

0

2

4

6

8

10

12

14Ratio of pessimists to optimists (%)

Saving rate (right scale)

% of HDI

Households expecting higher

unemployment (left scale)

Sources: Westpac-Melbourne Institute; RBA; ABS.

Unemployment expectations and household saving

Household net worth and household saving

-4

-2

0

2

4

6

8

10

12

14350

400

450

500

550

600

650

700

75090 92 94 96 98 00 02 04 06 08 10 12

% of HDI

Net worth (left scale, inverted)

Saving rate(right scale)

% of HDI

26

There is a risk Australia could experience recession around 2015-16

-3

-2

-1

0

1

2

3

4

5

6

07 08 09 10 11 12 13 14 15 16

Real % change from year earlier

Forecast

'Base case'

'Recession'

4

5

6

7

8

07 08 09 10 11 12 13 14 15 16

% of the labour force

Forecast

'Base case'

'Recession'

Real GDP growth Unemployment rate

Sources: ABS; Bank of America Merrill Lynch Global Research.

27

0

1

2

3

4

5

6

7

01 02 03 04 05 06 07 08 09 10 11 12 13

Health care & social assistance Other

% change from year earlier

Financial years ended 30 June

The health care sector is expanding rapidly

Employment

Source: ABS.

-20

-15

-10

-5

0

5

10

15

20

25

01 02 03 04 05 06 07 08 09 10 11 12 13

Health care & social assistance Other

% change from year earlier

Financial years ended 30 June

Capital investment

(excl. mining)

28

There’s plenty of scope to borrow more to fund infrastructure spending

-100

-80

-60

-40

-20

0

20

40

Canada

Switzerland

AustraliaDenmark

Sweden

Finland

Singapore*

Norw

ay

% of GDP, 2013

-183.2%

Sources: IMF World Economic Outlook October 2013 database; S&P; ABS; BofA Merrill Lynch Global Research.

AAA-rated sovereigns – net public debt to GDP ratios, 2013

0

5

10

15

20

25

30

35

40

45

50

00 01 02 03 04 05 06 07 08 09 10 11 12 13

By public sector

By private sector

Work yet to be done

A$bn (2011-12

chain volumes)

Financial years ended 30 June

Engineering construction work done for the public sector

29

Declining work force participation is obscuring the rise in unemployment

Labour force participation rate

Source: ABS.

63.0

63.5

64.0

64.5

65.0

65.5

66.0

01 02 03 04 05 06 07 08 09 10 11 12 13

% of civilian working

age population

Seas. adj.

Trend

Unemployment rate

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

01 02 03 04 05 06 07 08 09 10 11 12 13

% of labour force

Seas. adj.

Trend

� If the labour force participation rate had remained at its 2011 average (not its peak), the unemployment rate would now be 6.8%, not 5.7%

30

The falls in participation have been among young people, not retirees

Employment-population ratios

Source: ABS.

58

60

62

64

66

68

70

01 02 03 04 05 06 07 08 09 10 11 12 13

% of civilian working

age population

� Since September 2008, the proportion of 15-24 year olds in employment has dropped by 5¾ pc pts, but the proportion attending full-time education has only risen by 3 ¾ pc pts

15-24 year olds

76

78

80

82

84

01 02 03 04 05 06 07 08 09 10 11 12 13

% of civilian working

age population

25-44 year olds

76

77

78

79

80

81

82

01 02 03 04 05 06 07 08 09 10 11 12 13

% of civilian working

age population

45-59 year olds

12

14

16

18

20

22

24

26

01 02 03 04 05 06 07 08 09 10 11 12 13

% of civilian working

age population

60 year olds and over

31

The market is no longer expecting any further rate cut from the RBA

Sources: Thomson Reuters Datastream ; BofA Merrill Lynch Global Research.

RBA cash rate and OIS pricing

2.0

2.5

3.0

3.5

4.0

4.5

12 13 14

% pa

31 Dec 12

29 Mar 13

30 Jun 13

30 Sep 13

15 Nov 13

-175

-150

-125

-100

-75

-50

-25

0

25

50

12 13 14

Actual

10-day moving average

Basis points

2-year bond yield – cash spread

32

Rising unemployment will force further declines in the cash rate

Sources: ABS, RBA; BofA Merrill Lynch Global Research.

Unemployment, participation and the cash rate

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

04 05 06 07 08 09 10 11 12 13

1

2

3

4

5

6

7

8

% of labour force

Unemployment

rate

(left scale)

% pa

Unemployment rate assuming constant

2009-11 participation rate (left scale)

RBA cash rate

(right scale,

inverted)

33

Important Disclosures

This document has been prepared by Saul Eslake (the author), solely for use at the annual conference hosted of Private Health Care Australia (the organizers) in Hobart on 28th November 2013. No part of the document is to be reproduced, made available online, circulated or otherwise distributed without permission of the author, or of the organizers of the event.

This document does not purport to constitute investment or business strategy advice. It should not be used or interpreted as an invitation or offer to engage in any kind of financial or other transaction, nor relied upon in order to undertake, or in the course of undertaking, any such transaction. No representations of any kind are made, nor are to be inferred, about any securities or financial instruments whatsoever based on anything in or inferred from this document.

The information herein has been obtained from, and any opinions herein are based upon, sources believed reliable. The views expressed in this document are those of the author. None of the author, Bank of America Corporation, Merrill Lynch Equities (Australia) Limited (ABN 65 006 276 795, AFS License 235132), nor any of their affiliates or subsidiary or related entities however makes any representation as to their accuracy or completeness and the information should not be relied upon as such.

All views, opinions and estimates herein reflect the author's judgement on the date of this document and are subject to change without notice. Each of the author, Bank of America Corporation, Merrill Lynch Equities (Australia) Limited and their affiliated and subsidiary entities expressly disclaims any responsibility, and none of them shall be liable for any loss, damage, claim, liability, proceedings, cost or expense (Liability) arising directly or indirectly (and whether in tort (including negligence), contract, equity or otherwise) out of or in connection with the views, opinions and contents of and/or any omissions from this document except to the extent that a Liability is made non-excludable by legislation.