Key influences on the financial markets outlook for 2007

The first is the re-leveraging of the Australian business sector. During 2006, for the first time in over a decade, borrowing by Australian businesses grew more rapidly than borrowing by households. For the moment, this presents little cause for concern, because the financial position of Australian businesses is, at least in aggregate, stronger than it has been for more than two decades. But that would change if business borrowing continued to grow at in excess of 16 per cent per annum (as it did in 2006) for, say, another five years (as it did over the second half of the 1980s).

The Australian economy would be much less resilient to external financial shocks by the end of this decade if both the corporate and household sectors were heavily geared.

The second key trend is the slowdown in productivity growth. Over the past four years, trend growth in output per hour worked in the “market sector” of the Australian economy has averaged just 1.2 per cent per annum, the slowest over any four year period since the latter part of the 1980s and less than half the rate attained during the 1990s. All of the improvement in Australian productivity relative to the US during the 1990s has now been lost.

The productivity slowdown - which was quietly acknowledged in the form of another downward revision to the Government’s longer-term economic growth projections in the pre-Christmas Mid-Year Economic and Fiscal Outlook - reflects the deluge of productivity-stifling legislation and regulation which has been imposed in the name of “national security” and corporate governance since the early years of this decade.

Ideally, the 2007 election will provide those seeking high office with an opportunity to demonstrate to investors as well as voters how they propose to reverse this trend.

With so much “good news” already factored into Australian asset prices it’s difficult to see how 2007 could provide share investors with returns as spectacular as those of recent years. That’s not to say that 2007 will be a “bad” year either. But there won’t be many easy pickings.