Is the Aussie economy back on track for growth?

The interest rate cutting cycle appears to be over. This is not because inflation is accelerating – on the contrary, inflation remains low and looks like staying low for some time. Rather, interest rates are on hold is because the RBA is looking at a range of indicators that are suggesting the economy will be stronger over the next year and that, in time, inflation will eventually lift and return to the target band.

In other words, in not cutting interest rates now, the RBA is speculating that the economy will be strong enough to drive inflation higher during 2017 and beyond.

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The growth pick up scenario has some strong points behind it. Importantly, commodity prices are moving higher which, if sustained, will give a substantial income boost to the Australian economy over the next few years. The unrelenting strength in house prices, particularly in Sydney and Melbourne, is not cooling to any significant extent, which is boosting wealth and posing a threat to financial stability. The RBA would prefer to see house price growth weaken and an interest rate cut does not fit with that wish. It does not want yet lower rates to underpin further house price growth.

At the same time, business confidence and sentiment is rising strongly. The Dun & Bradstreet survey of business expectations is pointing to upbeat conditions into the first quarter of 2017. Expected sales, profits and employment are at multi-year highs which, if correct, will underpin the strongest economic conditions since the GFC.

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The construction sector is poised for a strong 2017. Not only is dwelling construction running at record highs with a huge pipeline of work still to be done, but infrastructure and non-residential construction is also surging. New transport facilities, hotels, office blocks, schools and university campuses are being built at a rapid pace and it will take some time to build them. The construction sector itself looks like adding close to 1 per cent overall GDP in 2017 and probably into 2018, even if housing investment falls away.

If consumer demand can recover from the post-election doldrums, a scenario where GDP growth stays above 3 per cent is a distinct probability. If that is the case, there is scope for an improvement in the labour market and for the unemployment rate to edge lower. By this time next year, the unemployment rate is likely to be around 5 per cent.

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There are still risks, as always. The US Presidential election, Chinese property and debt issues, Brexit and any number of global events could derail this path to stronger growth. But for now, the lift in commodity prices, a more optimistic business sector and generally favourable conditions will see the RBA sit on the side line for many months to come.

There is a growing possibility that the next move in interest rates will be up. It would be prudent for mortgage holders and the business sector to factor in the possibility of higher interest rates and not get too used to interest rates at these record low levels.

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks and as economic advisor to the Prime Minister of Australia.