Lewes, DE -- (SBWIRE) -- 06/01/2016 -- Real GDP growth is highly likely to slow over the coming years owing to a number of factors: slowing growth in the working age population; a high share of government spending relative to GDP; a reversal in the country's terms of trade; and the growing risk of deflation. These impediments will result in real GDP growth averaging 2.3% over the next decade, down from 2.7% over the past decade.

Australia's federal elections are widely expected to be held on July 2, and we believe that the lack of policy certainty, as the elections will be a close fight between the ruling Liberal-National coalition and the opposition Australian Labour Party (ALP), will be negative for investment and act as a drag on economic growth. In the event that the coalition secures a victory in the elections, the inability to reduce expenditures when revenue growth is weak will divert scarce resources from the productive sector of the economy and crowd out the private sector to the detriment of the business environment. We remain bearish on the Australian dollar despite the large fall we have already seen in the currency. While valuations are no longer a headwind to the currency, the trend remains very bearish. Weak economic growth owing to falling investment and correction in the property market amid elevated indebtedness does not bode well for the AUD.

The Liberal-National coalition government led by Prime Minister Malcolm Turnbull presented its FY2016/17 (July-June) budget on May 3, and maintained its goal of a balanced budget by FY2020/21. We believe that the administration's target is ambitious, and Australia's fiscal accounts are unlikely to return to a surplus any time soon, given downside risks to revenue collection and a lack of expenditure cutbacks. While there is currently no danger of a fiscal crisis, our core view is that this growing burden of the government will undermine the productivity of the private sector and take its toll on economic growth over the medium term.

Following the Reserve Bank of Australia (RBA)'s 25 basis point (bps) cut to its cash rate to a fresh historical low of 1.75% at its May monetary policy statement, we forecast the central bank to reduce its benchmark policy rate by another 25bps to 1.50% in by the first quarter of 2017. The central bank will ease its monetary policy further as overall economic growth deteriorates and as the unwinding investment boom is compounded by a weakening housing market amid a subdued inflationary environment.

Major Forecast Changes

We downgraded our 2016 and 2017 real GDP growth forecasts to 2.1% and 2.2%, respectively (from 2.3% and 2.5% previously), as investment in the mining sector continues to contract, and this will be compounded by weakness in the housing market.

We revised our average 2016 Australian dollar forecast stronger to USD0.7300/AUD (versus USD0.7000/AUD previously) owing to the AUD's strength since the start of the year. However, we remain bearish on the currency over the medium term as the country's still-elevated indebtedness leaves the currency exposed to capital outflows amid an economy that is suffering from an unwinding investment boom and a correction in the property market.

We revised our FY2016/17 federal budget deficit forecast to 2.5% of GDP from 2.1% previously as the ruling Liberal-National coalition focuses on supporting economic growth, particularly as it announces new spending initiatives, hoping to return the coalition to power.

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