Daily Commentary BY THE CURVE TEAM –

Australian Economy’s Next Big Challenge

17th of May, 2017

In the minutes from the May Board meeting that were released yesterday, the RBA re-affirmed much of what we already knew. Inflation and growth are both expected to track in line with expectations over the forecast period with the usual quantifiers about upside and downside risks. However one comment did stand out and it highlights the next big challenge that the Australia economy will likely face.

It is now safe to say that the Australian economy successfully made the transition away from the mining investment led growth that threatened to derail our run at the world record for the longest run of uninterrupted growth. Mining investment was replaced by the final phase of the mining boom, the growth in exports, thanks in part to the new supply now available. The other driver of growth to fill the gap left by mining was construction, aided by further monetary support that saw the cash rate hit a record low.

The Australia economy will soon face another transition challenge. The contribution of exports is largely at the mercy of demand from China and the price of commodities. Meanwhile the peak in construction’s contribution to growth is quickly passing us by. Recent building approvals data saw total approval fall 13.4% in a month, leaving them nearly 24% below their 2015/16 peak. Additional lending restrictions announced by the banking regulator are only likely to further curtail appetite.

That begs the question: what driver of growth will the Australian economy transition to next?

The RBA has long hoped that non-mining investment would step up to fill the void. The data and surveys of capital expenditure suggest this is still very much a pipe dream. Consumption remains the single largest sector in Australia’s growth profile, even if spending patterns continue to shift from retail to service spending.

Low wage growth has acted like a handbrake in recent times and the outlook suggests that this is unlikely to change materially any time soon. There is a bigger risk however. This brings me to the comment that jumped out to me in the minutes. Speaking about downside risks, the RBA said that:

“If households were becoming more focused on paying down debt, this would imply some downside risks to the outlook for household consumption growth. A fall in housing prices could also weigh on consumption growth.”

For me, this risk is more about ‘when’ and not ‘if’ the huge build up in debt will eventually hit consumption.

Consumer sentiment is already tepid according to both the weekly and monthly surveys. The question from the monthly survey over the wisest place for savings has already seen the response of ‘pay down debt’ increase.

Which brings me back to the question: what driver of growth will the Australian economy transition to next?

David Flanagan

Director - Interest Rate Markets