The international economy is expected to remain supportive of solid growth in the domestic economy, with growth in Australia’s MTP of 4¼ per cent expected in 1996-97, broadly similar to 1995-96.
Growth in the United States, while strong in the first half of 1996, is expected to slow to a trend rate of around 2 to 2½ per cent. Past increases in long-term interest rates and the appreciation of the US dollar should work to that end. In Japan, factors such as accommodative macroeconomic policies and the sharp depreciation of the yen against the US dollar over the past year should support a gradual recovery over the course of 1996, with growth returning to a medium-term trend rate in 1997. Structural factors will be important in constraining the speed of recovery and the longer-term sustainable growth rate, and recovery is likely to be at a more gradual pace than in the past.
Although the economic outlook for Continental Europe continues to be subdued, a gradual pick-up in GDP growth is expected through 1996-97. The German economy will be aided by the favourable impact on trade of the depreciation of the deutschmark against the US dollar since the middle of 1995 and the accommodative stance of monetary policy.
Growth in Australia’s East Asian MTP (excluding Japan) is expected to ease in 1996-97, although remain high.
MTP inflation is expected to rise slightly to 3¼ per cent in 1996-97 from 3 per cent in 1995-96. East Asian MTP inflation is expected to continue at the same rate, but a slight pick-up is likely in Australia’s OECD MTP. Crude oil prices are expected to ease in 1996-97 as the significant price rises which occurred in late 1995-96 are unwound.
In the short term, a key uncertainty in the international outlook relates to the pace of economic growth in the United States. While the strong growth in the first half of 1996 is expected to slow, there are uncertainties about the timing and magnitude of the slowdown. The strength of the economy is reflected in emerging labour market cost pressures. Although these have not yet been reflected in higher rates of inflation, the margin before price increases intensify is small.
In Japan, while there is no question that fiscal and monetary policy will need to be tightened, difficult judgements have to be made about the balance, timing and magnitudes of the tightening. How deftly those adjustments are made — in the face of considerable uncertainty about the strength of private demand and continued pressure on the financial sector — will determine the pace of recovery.
In Continental Europe, with the major economies coming out of a period of negative growth, achieving the right balance of macroeconomic policies and meeting the Maastricht objectives will be a continuing challenge.
The difficulties facing the G3 economies in making the appropriate policy choices are not unusual, happening at a time when two of the economies are at turning points. However, the balance of risks points to the possibility of stronger growth in the world economy, at least over the remainder of 1996. Further out, the expected convergence to growth rates in the range of 2 to 3 per cent in the United States, Japan and Germany will be beneficial for world activity but could lead to heightened inflationary and associated interest rate pressures.
Policy reactions in the major economies to any signs of such pressures building will be important. The longer-term effects of the late cycle surge in growth and inflation experienced in the most recent period of growth synchronisation in the late 1980s have made policy makers more alert to the dangers of underestimating reinforcement effects. There are grounds for confidence that any signs of overheating will attract a policy reaction more quickly than in the past in order that the hard won gains on inflation can be retained. More generally, economies are in better shape now than in the late 1980s, with imbalances lower and/or abating and with widespread commitments to fiscal consolidation.