Australia’s economic outlook looks set to become harder to forecast with any confidence. Past economic performance, especially before the turn of the year, was stronger than widely expected, providing hope of an improving economy this year. However, economic readings over the most recent past – January and February – are much less promising and seem to point to a weaker patch developing. Governments around the world seem much less able than usual to deliver policies capable of fostering stronger economic growth. Central banks seem to be increasingly in two minds about what they can do with monetary policy that may help to promote sustainable economic growth.
It is still possible that growth globally and in Australia may improve in 2016. The tax-cut like legacy of low oil prices is still in play in much of the developed world. Despite uncertainty about how to progress, central bank policy settings are still very accommodating although there has been some tightening of conditions in the United States and only partly because of the single 25bps hike in the Federal funds rate back in December. The stronger US dollar over the past 12 months has also tightened US monetary conditions the equivalent of at least another couple of 25bps hikes.
In Australia too there has been the equivalent of a “Clayton’s” tightening of monetary policy occurring since late 2015. Despite the cash rate being held unchanged at 2.00%, bank lending interest rates have moved up around 15bps on average since October 2015 and a new cost-of-funding inspired round of rate increases seems to be starting again around now. The Australian dollar has appreciated since the end of 2015 and by more than might be expected on the basis of somewhat better export prices. If the RBA continues to leave the cash rate unchanged it is presiding over an unwarranted de facto tightening of monetary policy.
A tightening of Australian monetary policy by RBA design or otherwise is clearly not what the economy needs at present. The mainstay of Australia’s better-than-expected GDP growth readings in the second half of 2015 was robust growth in household spending both on housing and consumer goods. Spending on housing is clearly past its best early in 2016. There are still pockets of strength in some housing locations but there are also important and widening areas of weakness developing. Home building approvals peaked in late 2015 and are now trending downwards.
There are also signs developing that retail spending may be past its best too. The latest retail sales report for February was disappointing showing a flat result. Over the three months ending February retail sales rose by only 0.4% compared with 1.3% for the three months ending November 2015 and 1.0% for the three months ending August. The deceleration in growth in retail sales seems to have been pronounced and barring an extraordinarily strong March retail sales result household spending will make a noticeably weaker contribution to Q1 GDP growth than it did back in Q4 2015 and Q3.
There is a strong likelihood that GDP growth started to lose momentum in Q1. We will have to wait for the GDP report due in early June to confirm whether it did, but there appears to be corroborating evidence in the slower pace of employment growth too. The March labour force report is due this coming Thursday, but the two previous reports for January and February showed employment respectively falling by 7,300 and then rising by 300. The market consensus forecast is that employment rose by 20,000 in March. If it did, the cumulative employment gain for the three months ending March would be only 13,000 set against gains respectively in the three months ending December 2015 and the three months ending September of 120,800 and 59,700.
It is of course entirely possible that employment rose by more than the market expects in March or was weaker. What seems highly unlikely is that employment rose enough in March for the three-month total to rival the very strong readings for the previous two three-month periods. It was the big increases in employment in both those quarters that countered the impact of very weak wages growth and allowed total household disposable income to rise reasonably strongly – a key influence permitting stronger household spending. Almost certainly total household disposable income grew much less strongly in Q1 in turn restraining growth in household spending.
Of course the domestic economy is not just about the spending of households but also about the spending by Government at all levels and importantly the spending of businesses too. It is unrealistic in our view expect the likely softer growth in household spending to have been offset by a strong rise in government spending suddenly abandoning restraint or businesses which would require miners to stop running down investment spending.
Offshore demand is unlikely to help much either. Our biggest trading partner by far, China, is still going through a growth basing phase (Q1 GDP is due on Friday and is expected to come in around 6.7% y-o-y in Q1 2016 from 6.8% y-o-y in Q4 2015). More importantly, the parts of China’s economy that directly feed Australian mineral exports are growing at a significantly slower pace than general GDP. There is hope that China’s growth rate will pick up some pace later in the year on the back of earlier policy easing moves by the Government and the Peoples’ Bank of China, but the precise timing, impact and extent of the improvement in growth is peculiarly hard to assess because China’s economy is undergoing a significant rebalancing creating big political issues along the way.
There may be a white knight charging in from China to help lift Australian growth later in the year, but it is also possible there may not be. What we are doing under our own devices to help lift domestic spending seemed to be working for a while back in 2015 but may be faltering early in 2016. What does seem clearer is that the RBA is slowly giving more recognition to the case to lower the cash rate further. There are some important data readings ahead including the March labour force reading later this week and the Q1 CPI later this month, but our sense is that both of these data points will reinforce the case for a cash rate cut. We expect the RBA to cut the cash rate by 25bps to 1.75% in May and with a strong likelihood that it will follow up with another 25bps cut to 1.50% either in June or July.