–  NOVEMBER 2017 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA once again elected to leave the cash rate on hold at a record low 1.50% following their November Board meeting.
  • Governor Lowe remained optimistic in the accompanying statement as data largely continues to support the RBA’s central forecasts.
  • Inflation continues to miss the mark domestically and this looks to delay any change in policy by the RBA.
  • The consumer continues to be a cause for concern for the RBA following yet another poor retail sales number.

Rates Recap

  • The RBA left the cash rate on hold yet again in November with the cash rate remaining at 1.50%.
  • In the post meeting statement Governor Lowe maintained his optimistic outlook on growth and inflation over the medium term, whilst citing increased uncertainty around the consumer.
  • This dovish sentiment has seen the curve flatten across the board with market pricing for an August 2018 rate hike at around 50%.
  • To contrast, increasingly hawkish commentary and positive data out of the US has seen yields drift higher.
  • Equities markets both domestically and in the US have continued to gather momentum over the month.

RBA Forecasts Walking Fine Line With Outlook

It has been evident for quite some time now the Australian economy looks to be tracking along steadily, particularly in regards to strength in employment conditions and business investment. Nonetheless, over the course of this year there have been a number of factors that continue to cast a sense of doubt over the hardiness of the domestic economy. While the RBA has been consistently optimistic on the outlook of the economy, the release of this quarter’s Statement on Monetary Policy reiterates some key uncertainties that continue to loom over the state of the economy.

Before we go into the details, let’s paint a current picture of the global economy. While inflation and wage growth continues to be a conundrum for central bankers around the world, the tide looks to be turning particularly from a growth standpoint. This is starting to prompt a change in rhetoric amongst central banks and in a couple of cases we have seen adjustments to policy.

That being said, contrary to Australia’s ability to withstand the effects of the GFC, we look to now be lagging a bit behind. Looking forward, unless there is a sharp reversal of some current trends, we might not see a change any time soon.

While the overarching theme that remains is around persistently low inflation levels, looking deeper there are a couple of issues that look to be complicating things further. The first of which is around the degree of slack in the labour market.

Australia is currently experiencing a robust period of hiring with unemployment falling to 5.5% from 5.9% over the last 6 months. That being said, while there has been noteworthy employment growth of late, there is still a large degree of underutilisation in the labour force. Guy Debelle highlighted this in a speech he made earlier in October citing that:

“There still remains a sizeable degree of spare capacity in the labor market.”

What this then translates to is uncertainty around the outlook for wages. Wage growth remains steady at 1.9% and has been around that mark over the course of 2017, implying that it is tracking largely in line with inflation. Despite the strength in employment conditions, things are yet to tighten enough to translate into an uplift in wages.

One of the key factors behind this is in regards to how Australia is continuing to transition away from a mining centric economy post-GFC. While this has been a very necessary structural change, we have seen a shift in the employment dynamics within the economy. Employment has shifted away from high paying resource roles to the services industry in which the contracts are traditionally not as lucrative. Couple this with a decline in the amount of skilled labour available to businesses and therefore wages are unable to lift as swiftly.

On the other side, we continue to see the level of household indebtedness at record highs. This is a trend that we have watched carefully following the GFC, where an extended period of cheap capital has encouraged borrowing to a point now where debt accounts for nearly 200% of household disposable income. This quarter’s Statement on Monetary Policy highlighted this concern for the RBA, citing that:

“Household indebtedness is high and debt levels relative to income have continued to edge higher.

While measures have been put in place to abate lending and we are starting to see the effects come into fruition in the economy, some risks still remain.

The inability for the labour market to tighten restricts the ability of firms to lift prices in a normal fashion. In conjunction with high levels of household debt, this will continue to cast doubt over the outlook for the economy despite strong business conditions.

Outlook for Interest Rates

A theme that has carried on over the course of this year by the RBA has been around patience, and with another month passing this theme looks to be continuing forward. Data coupled with sentiment out of both this month’s meeting as well as the recent Statement on Monetary Policy indicate that any adjustment to the monetary policy setting is some time away. Nevertheless, the tones are looking to be increasingly bearish and hence market pricing for an August 2018 hike has fallen to around 50%.

As widely expected, the RBA opted to leave rates on hold for another month in their November meeting. Optimism continues to ensue particularly around business investment. This has been a talking point that has continued to gather traction over the course of 2017 as the economy transitions away from a mining focused economy. Deputy Governor Guy Debelle was quick to highlight this, speaking on “Business Investment In Australia” he cited:

“It now appears that there has been a solid upward trajectory in non-mining business investment over the past couple of years.

The uplift in non-mining activity looks to be one of the cornerstones for the progression of the Australian economy by the RBA, providing what is being described as much needed “signs of life.

While optimism around business conditions continues to gather strength, on the other hand we have the growing threat around households that continue to cast doubt on the outlook. Burdened by indebtedness growing at a faster rate than wages, has meant that consumers have been spooked and subsequently spending habits have been drawn down. A worrying trend considering consumer spending accounts for more than two thirds of GDP.

This was very evident in the recent retail sales figures for September, coming in flat following a 0.5% slump in August and 0.3% in July. What we are gathering from this is that any additional income earned, rather than being spent on discretionary items is being focused towards paying down debt. Following the RBA meeting last week, Governor Lowe voiced these concerns highlighting that “one continuing source of uncertainty is the outlook for household consumption.

Lowe looks to have found himself in a bit of a predicament. Inflation looks to be going nowhere fast and a lack of consumer spending and wage growth only adds to this.

With low rates already stoking high household debt levels, it is unlikely that Governor Lowe will want to push rates down any further. Nevertheless, increasingly skittish behaviour from the consumer means the RBA has to be patient and as a result will assess the data as it comes in, and hence could be sitting on their hands for some time.

Australian Economic Highlights

  • Following a weather effected slowdown in Q1, Growth improved in the second quarter with the economy expanding by 0.8%. The Australian economy now holds the record outright for the longest run of growth without a recession at 104 quarters.
  • CPI continued to disappoint,  the headline figure only lifting 0.6% for Q3 with falls in fruit and vegetable and telecommunications prices contributing largely to the weakness. The RBA’s preferred measure, core inflation also remained below the band at 1.88% after a quarterly increase of only 0.35%.
  • Employment data continued to reflect strong labour market conditions with total job growth of 54,200 for August, coming in well above expectations. The unemployment rate remained unchanged at 5.6% coinciding with a 0.2% lift in the participation rate.
  • Following September’s flat print, ANZ job ads rebounded this month with the number of advertisements lifting 1.4%. Employment conditions continue to show strength.
  • The NAB business conditions index hit a record high in October, touching 21 driven by improved trading conditions and profitability. Business confidence remained steady at 8 as uncertainty around margins causing the disparity. Interestingly forward orders eased this month painting a more accurate picture of the strength in the non-mining sector.
  • Consumer confidence continues to languish as weak wages growth and tightening credit standards continue to impact family finances. The ongoing weakness is starting to show up to a greater degree in consumption data.
  • Retail sales continue to be a cause for concern, printing flat for September following a 0.5% slump in August and 0.3% in July.
  • Housing finance continues to be impacted by the macro prudential restrictions imposed by the council of financial regulators. The downward trend in dwelling finance commitments continued, falling 3.6% on seasonally adjusted terms with investment housing also dipping 0.5%. 
  • A lift in iron ore prices month helped lift Australia’s trade surplus for September, the surplus lifted to $1745m in seasonally adjusted terms. The uplift was also assisted by an increase in goods exports with non-rural goods exports lifting $600m. 
  • Building approvals continue to trend upwards. Following the 0.4% uplift in August, the number of buildings approved rose 1.8% in September. The lift looks like it is largely attributed to the 2.6% increase in private sector dwellings (excluding houses). 
  • Motor vehicle sales dipped following a 0.3% increase in August, falling 0.5% for September. 
Oliver Parsons

Oliver Parsons

Client Relationship Manager