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Hold on to your hats – the economy is starting to improve

The central business district/finance district of Sydney/NSW, Australia. Aerial view during golden hour. Source: Getty Images

We heard recently that the labour market was a lagging indicator on the economy and that the unemployment rate would be the wrong thing to look at when hunting for clues about the economic outlook.

But forward looking economists are starting to factor in better economic conditions into their forecasts for 2020 because the leading indicators are starting to show some signs of life.

Why?

After many years of economic disappointment, there are signs the economy is poised to pick up pace, delivering faster economic growth, a lower unemployment rate (with a lag) and a welcome lift in wages and inflation.

We are not quite there yet and it might take six months or so for these positive signs to show up in the hard data, but 2020 looks increasingly likely to be the year where, finally, the economy registers genuine strength.

Positive signs for our economy

In no particular order, the positive signs are most obvious in the Australian stock market, which has hit fresh record highs, a boom in exports, buoyant commodity prices, decent levels of consumer sentiment and business conditions plus a little appreciated surge in expected levels of private sector business investment in 2019-20.

Add to this the housing market turn and it is not fanciful to expect that by this time next year, annual GDP growth will be near 3 per cent and inflation will be on track to rise above 2 per cent.

While the RBA does not target house prices, the housing sector plays a vital role feeding into forecasts for growth, employment and inflation.

One vital factor dragging the economy lower from late 2017 and through to the middle of 2019 was the wealth destruction for householders from the slump in house prices.

From the peak in 2017, house prices fell by more than 10 per cent, wiping out well over half a trillion dollars of wealth.

It was no wonder that consumer spending remained in the doldrums, dragging the whole economy lower.

This in turn saw the RBA cutting interest rates to record lows and the regulators relaxed otherwise strict restrictions of lending.

If, as appears close to certain, house prices are in the early stage of a consolidation before a pick up in 2020, the negative wealth effect that has dogged the economy will be replaced by at least a neutral contribution and, at best, a solidly positive effect.

If house prices were to rise by 5 per cent over the next year, the impact on wealth and spending would be material.

And then there is the positive, but yet to be felt, effect of the income tax cuts and the impact of the recent RBA interest rate cuts on business investment. Even before those cuts, the Capex outlook was positive.

There is growing evidence of better times in retailing which, if sustained, will underpin larger contribution to the economy from the consumer than was feared at the start of the year.

Are we over the low point?

While it is unlikely that the economy will suddenly leap to a strong growth path with a quick lift in wages growth and inflation, the low point in the economy cycle is passing.

It is not quite the time to break out a bottle of sparkling wine, but better economic times look to be ahead.

For the gloom merchants out there, those who continually forecast recessions, housing crashes and more general economic malaise, this will come as bad news. They will be wrong yet again as they have been for the past few decades.

The trick in economic forecasting, remember, is not to be perpetually optimistic or pessimistic, it is to forecast a cycle in economic activity. After the slump of the last few years, it’s time to get set for a recovery in 2020.

Stephen Koukoulas will come together with the best minds in business, government, academia and entrepreneurship to examine the most critical issues facing Australia at Yahoo Finance's All Markets Summit event.