September 2011

Construction forecasts are always subject to substantial uncertainty, being sensitive to a wide range of underlying assumptions. For example, construction forecasts are sensitive to the underlying assumptions made about interest rates, which have a wide variety of flow-on effects in the economy.

Underlying these construction forecasts are our whole-of-economy forecasts. The Reserve Bank of Australia (RBA) began to tighten monetary policy in late 2009. However, since November 2010, the RBA has kept rates at 4.75% p.a., as a series of natural disasters and economic events destabilised both the domestic and international economies. Despite these setbacks, the bank has maintained a bullish outlook on the Australian economy over 2011, and until very recently, market expectations for the next rate movement were weighted towards a rise. Over the past few months however, renewed concerns have arisen around the possibility of a further downturn in global growth, sparking speculation that the bank may be forced reduce rates in the near future, or at least keep them on hold for a sustained period.

Despite heightened downside risks, our economic forecast takes a relatively optimistic view on growth prospects, based on an expected boom in resource related investment and export activity. Accordingly, our forecast takes a hawkish view on rates and assumes the official cash rate will reach 5.25% p.a. over the next 12 months.

Given the current uncertainty around interest rates, an alternative scenario has been prepared to estimate the effect of keeping interest rates on hold, rather than at around 5.25% p.a. as currently forecast by our macroeconomic model. Interest rates could be left at 4.75% p.a. if global growth prospects are further weakened by adverse economic events in the US or Eurozone. The impact that lower interest rates will have on construction activity for 2013/14 is shown in Table 1 below.

Table 1 - Change in Construction Activity, 2013/14 (Nominal terms)

Note: increases shown as deviations from the baseline scenario.

As might be expected, the largest impact in the short term is in residential construction. This is because owner occupiers are particularly sensitive to interest rates. As such, lower interest rates encourage greater dwelling investment and hence boost activity in residential construction. The impact on non-residential and engineering construction is similar (i.e. lower rates encourage greater investment), however, the impact in 2013/14 is not as large.

Table 2 shows the estimated impact in 2014/15. Interestingly, by this stage the boost to residential activity has begun to subside, whilst the impact on engineering construction has strengthened. This change in the pattern of impacts reflects the longer lead times needed for engineering projects to move from planning to construction.

Table 2 - Change in Construction Activity, 2014/15 (Nominal terms)

Note: alternative scenarios are shown as deviations from the baseline scenario.

ACIF Forecasts are produced in nominal terms, i.e. in the dollars of the day. Where we occasionally quote real values, we indicate the base year. Generally speaking, we assume inflation of between 2% and 3% per annum, and take in to account current period ABS price adjustment indices, in calculating real values.