Global economic growth seems to be gathering pace in the second half of 2017, one factor helping to lift Australian economic growth. Also, the stiff head-winds retarding Australian economic growth, falling business investment spending and the beginnings of a decline in home building activity seem to have calmed. In the case of business investment spending there is a reasonable chance that calm may turn to modest improvement later this year and in 2018. As far as the calm in home building activity is concerned that is more likely to return to renewed decline before long. All told, however, Australian economic growth looks better placed to accelerate over the remainder of this year and running in to 2018.
Another factor that is starting to provide growth momentum to the local economy is the strengthening employment market. Employment growth has been noticeably stronger through 2017 so far than through 2016 and has been particularly strong over recent months, rising more than 100,000 in the three months ending June with full-time employment up more than 110,000. Growth in household disposable income is driven predominantly by change in paid hours worked – a combination of employment and wages paid. While wages growth continues to languish at the lowest pace in at least half a century (the latest reading for Q2 2017 is out on Wednesday), employment growth has accelerated sharply.
Household disposable income probably rose in Q2 at the fastest pace in at least three years – we estimate by around 1.5% q-o-q. That likely lift in household disposable income helps to explain several economic developments including a surprisingly strong lift in the volume of retail sales in Q2, up 1.5%, still very low levels of household sector non-performing loans even though the dizzyingly high and record household debt to disposable income ratio has stretched even higher towards 190%. In short, the household sector is still up to its neck in debt but is still holding above water and seems no nearer to the point of trying to reduce its debt burden because income is lifting.
This dynamic of rising income allowing households to borrow even more is adding to near-term growth prospects but is also adding to the risk that at some point in the future households need to make a balance sheet adjustment containing or reducing debt burden and at the same time reducing spending. The larger the retrenchment in household spending the greater the risk and scale of recession that may follow.
There is no doubt that for the time being policymakers are likely to welcome the near-term signs of improvement in Australian economic growth. There is not yet any need to take policy action to repress growth because there are not yet any signs that stronger growth is promoting unacceptably strong growth in wages and inflation. Indeed, the RBA is on record saying that it would prefer higher wages growth. If annual wages growth over the next year or so were to accelerate gently from the current 1.9% y-o-y say to around 3% y-o-y in 2018 and then stabilise between say 3% to 4% y-o-y beyond 2018, the RBA would probably regard that as a positive development allowing the economy to grow around potential with annual inflation steady within 2% to 3% band. This “ideal” outcome would not stop the RBA from lifting its cash rate, but it would mean it could take its time getting the cash rate up very slowly from the current very growth accommodating 1.50% to a rate that is nearer to the theoretical neutral cash rate nearer to 3.50%. There would not be any real urgency for the RBA to start the process of lifting the cash rate before early 2018 in our view.
There are also two possible scenarios in our view where the RBA could act to lift the cash rate later in 2017. The first scenario is if lenders and borrowers for housing show signs of throwing caution to the wind – a sharp lift in lending for housing especially if in worrying categories such as interest-only to investors and accompanied by an evident decline in lending standards. Given the concern that too high household debt is a big medium-to-longer term risk to economic growth, the RBA would be likely to reinforce the efforts of APRA to batten down growth in lending by lifting interest rates.
The second scenario runs along the lines of careful what you wish for. There is a possibility that if the labour market continues to tighten that wages growth when it starts to lift, jumps sharply. If this started to show signs of occurring, the RBA would lift its inflation forecasts for 2018 and 2019 and would promptly start the process of hiking interest rates.
We do not assign a high probability to either the housing lenders and borrowers go crazy scenario or the wages break out scenario, so we still view a first rate hike later this year as being very unlikely. Early 2018 remains our call for the first RBA rate hike.