Australian Markets Weekly

A light period for new data is an appropriate time to take stock of where the economy is at. Short answer is that the pace appears to be coming out of the interest rate sensitive consumer


Where are we?

The broader economy remains mixed and the outlook similarly so. Our best judgement is still that the RBA will leave the cash rate steady at 2½% for a long time, although the risk remains that they may still need to cut again in the next 12 months.

Against a mixed economy, one area of strength is a strong rebound in residential construction. Some worry there might be too much. We’re not. While there’s every chance supply/demand won’t perfectly match by location, there are several reasons not to worry about oversupply. For one, residential construction was around 6-6½% in the mid 2000s, slipping to under 5% of GDP in recent years. Second, Australian population continues to grow at a smart rate, up 1.7% in the year to Q3 2013; the latest arrivals/departure card data show ABS net migration has turned up again more sharply, outstripping building approvals – see chart.

Despite positive residential construction, recent data suggest the positive of low interest rates may be running out of juice. House prices have been flat to falling in recent months. Even aside from the fall around the Federal Budget induced fall, consumer confidence peaked in early 2014 and has been falling for some months now. Employment and wages are subdued, so with house prices subdued, so has confidence. Retail sales growth has also slowed recently. We expect modest growth to continue in the months/quarters ahead.

The known negatives continue

The headwinds for the economy are well known and by and large haven’t changed recently. Mining investment has started to fall and we expect it will end up subtracting around 3½% from GDP through 2014 and 2015. The recent Federal Budget left fiscal policy as a ½% of GDP headwind for the economy in the next few years. Moreover, the $A remains too high for many businesses and of course it has risen recently. With a high $A, Australian businesses remain uncompetitive relative to businesses they compete with in export markets or foreign importing firms who compete in Australia.

If we don’t get a lower $A – and for now the world is not gifting us this – businesses becomes more competitive through productivity gains. Productivity gains means doing more with less and we are seeing this in the national statistics where 1) while indicators of labour demand have bottomed they do not point to strong jobs growth ahead and 2) wage cost growth has fallen to its lowest level in the 17 year history of the series labour market indicators.

In the absence of a large fall in the $A this trend of modest employment and wage growth looks set to continue – in turn this will leave household income growth fairly modest.

In last week’s Minutes from their June Board meeting, the RBA commented that “it was difficult to judge” whether the positive of low interest rates were offsetting the negatives of the mining investment slump and fiscal consolidation.

For some time NAB economists have been concerned that it wouldn’t be. The $A pushing higher recently and low interest rates looking like they’ve lost some of their potency justify this concern. Unemployment rate looks set to remain 5¾- 6¼% and inflation will be benign. The RBA is clearly reluctant to cut what they already think is a super low 2½% cash rate. Most likely this leaves them on hold at 2½% for a long time, although they risk remains they may still need to cut again later this year.

Week Ahead

A quiet week in Australia, with the main interest Skilled Vacancies and Job Vacancies reports Wednesday and Thursday, respectively, where softness won’t surprise.