Has the Australian economy reached a turning point

Drew Klease, Principal Economist

The economic transition underway in the Australian economy appears to have strengthened over recent months. After a surprisingly soft March quarter, due partly to adverse weather conditions, incoming data suggests a noticeable improvement in activity during the June quarter. In our view, the National Accounts next week should reveal economic growth of around 0.7% over the quarter; a solid result considering that the aftermath of Cyclone Debbie continued to restrict coal exports during April.  

Even more promising than the headline result, is the composition of growth. Despite the record low wage growth and below-average consumer confidence, consumer spending is expected to be solid. Real retail sales rose a strong 1.5% over the quarter, boosted by increased discounting, a pick-up in employment growth and ongoing gains in household wealth. 

Furthermore, business investment is expected to advance for the second consecutive quarter. This is a marked turnaround from the ongoing declines seen over the previous 2½ years. The downturn in mining investment is nearing an end, while non-mining investment is showing signs of improvement. During the June quarter, total real private capital expenditure rose 0.8%, boosted by a solid 2.6% gain in non-mining investment.

Promisingly, capital expenditure intentions for 2017/18 also improved considerably in the most recent ABS survey released this week. Utilising long-run average realisation rates implies a fall in capital expenditure of only 1.7% in 2017/18, compared to an implied drop of 7.1% from the previous survey released three months ago. The improvement has been driven by the services sector, where surveyed intentions now imply an increase in capital expenditure of 10% in 2017/18 (compared to 2.4% three months ago). 

Residential investment is expected to be unchanged in the June quarter, due primarily to a pull-back in construction in Western Australia and to a lesser extent Victoria over the quarter. Although building approvals have turned lower, the amount of work still in the pipeline suggests that the impending slowdown in housing activity is likely to be seen more in 2018 than 2017.     

The external sector is likely to be broadly neutral to GDP growth during the June quarter. While Cyclone Debbie disrupted coal exports at the start of the quarter, coal exports rebounded quickly in May and the ongoing ramp up in LNG shipments also helped support exports. Nonetheless, lower commodity prices during the quarter will cause a drop in the terms of trade and lower company profits.  
 
Growth in the Australian economy has also been supported by firmer public demand over recent quarters, with governments focussed on delivering increased infrastructure spending. Given the projects under construction in Sydney and Melbourne, this trend likely continued in the June quarter, although further details on government spending will be released next Tuesday ahead of the National Accounts.
Overall, next week’s National Accounts are likely to mark a turning point for the Australian economy. Growth in 2016/17 is likely to be the cyclical trough, and we expect real GDP growth to firm from just below 2% in 2016/17 to between 2.5%-3.0% in 2017/18 and 2018/19. 

Despite the turnaround in economic conditions, we continue to expect the RBA will keep the cash rate unchanged at 1.5% throughout 2017/18. The inflation outlook remains subdued, despite the recent increase in electricity prices, and monetary policy will need to remain accommodative to continue to promote the recovery in non-mining investment. Any move towards higher rates, and the appreciation in the Australian dollar that would accompany it, would at this juncture threaten to kill-off the green shoots in the economy that are starting to appear.  

Table 1: Financial market movements, 24 - 31 August 2017

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,471.7

1.3%

US

2.12%

-7.7 bps

US Dollar Index (DXY)

92.67

-0.7%

Nikkei 225

19,646.2

1.5%

Japan

0.01%

-1.8 bps

USD-JPY

109.98

0.4%

FTSE 100

7,430.6

0.3%

UK

1.03%

-1.9 bps

GBP-USD

1.293

1.0%

DAX

12,055.8

-1.0%

Germany

0.36%

-1.5 bps

EUR-USD

1.191

0.9%

S&P/ASX 200

5,714.5

-0.5%

Australia

2.71%

8.0 bps

AUD-USD

0.795

0.5%

Source: Bloomberg


Economic Update


United States

US economic growth continues to improve
  • Real GDP growth for the June quarter was revised upwards to an annualised rate of 3.0% from the preliminary 2.6% estimate. Both consumer spending and non-residential investment were revised upwards, more than offsetting the downward revisions to state and local government spending.  
  • Personal consumption continues to improve in the US, growing by 0.3% over July (+0.2% in real terms), while the previous month’s estimate was also revised upwards. Consumer spending in the US remains underpinned by solid growth in real disposable incomes.
  • Despite the uptick in consumption, headline inflation measured by the PCE price index remained unchanged at 1.4% over July. Meanwhile core inflation, which excludes volatile items such as food and energy, fell to 1.4% from 1.5% in June. This continues the recent trend of soft inflation prints and may complicate the Fed’s plan of a December rate hike. 
  • Business investment continues trend higher, with core non-defence capital goods shipments rising 1% in July, the strongest monthly outturn in five months. 


Euro area / United Kingdom

Inflation in the euro area edges higher, while UK house prices stall
  • Inflation in the euro area continues to edge higher, with headline inflation rising to 1.5% in August, up from 1.3% in July. Meanwhile, core inflation (excluding food, energy, alcohol and tobacco) remained unchanged at 1.2% over the month. 
  • Conditions within the euro area labour market remain strong, with unemployment rate remaining stable at 9.1% over the month of July, its lowest level since 2009. Relative to July last year, virtually all countries within the area have experienced a decrease in their unemployment rates.
  • Building on the recent stream of data pointing towards a slowdown of conditions in the UK, house prices declined by 0.1% in August according to the Nationwide Index. Overall, UK house prices have been broadly stagnant over the past six months.



China / Japan

Manufacturing activity in China continues to improve
  • Business conditions in the Chinese manufacturing sector continue to improve, with the NBS manufacturing PMI index rising to 51.7 in August, up from 51.4 in July and above the market forecast of 51.3. This was driven by a rise in production as well as a rebound in new orders. Meanwhile, the non-manufacturing index declined to 53.4 over August, down from 53.1 in July.
  • Industrial production in Japan fell 0.8% over July, falling short of market expectations following a strong gain in June. 
  • The Japan labour market remains strong, with unemployment remaining unchanged at an over 20 year low of 2.8% over July, while the jobs/applications ratio edged higher to 1.52%, up from 1.51% in June. 
  • Retail sales remained solid in Japan during July, with annual growth in sales at 1.9%, well above the -0.6% gain seen on average during 2016.  




Australia / New Zealand

Conditions in the Australian housing market continue to slow
  • Dwelling approvals continue to trend lower in Australia, falling 1.7% in July after a surprise 11.7% spike in June. While volatile on a month to month basis, approvals have fallen almost 16% from their peak in August 2016.
  • In addition to the slowdown in approvals, CoreLogic data showed that house prices are also cooling. National house prices were flat in August, with softening evident across all markets. Prices were flat in Sydney and Adelaide over the month, continued to fall in Perth (-0.8%) and Darwin (-2.2%) and edged up in Melbourne (+0.5%) and Brisbane (0.2%). In annual terms, house price growth slowed to 8.9% nationally, with the pace of appreciation moderating in Sydney (13.0%), Melbourne (12.7%) and Brisbane (3.0%).     





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