For a more comprehensive round up of the week, listen to Stephen’s full report here.
The Budget delivered last week presented no real surprises and in essence means that if all the measures are legislated the Federal Government’s net spending position moves from presenting a headwind to growth in spending in the economy in 2014-15 to a slight tailwind in 2015-16. Large as some of the centerpieces of the Budget seem, such as the $A5.5 billion small business spending package over four years, they pale against the hole developing in mining investment spending. It is the spending growth required in other parts of the economy to fill the gap left as mining investment spending falls that is still likely to need further assistance from the RBA cutting interest rates further.
Like the RBA, Commonwealth Treasury in its economic forecasts underpinning the budget sees Australian real economic growth lodged below 3% (the level needed to stabilise the unemployment rate) throughout 2015-16 and extending in to 2016-17. The most disturbing part of Treasury’s economic forecasts are the size of the decline in real mining investment spending, down by 15.5% in 2014-15 and then a further 25.5% in 2015-16 and down another 30.5% in 2016-17. Real new capital expenditure by the mining sector totaled nearly $A89 billion in 2013-14. That number reduces on Treasury estimates by around $A13.8 billion in 2014-15 and on Treasury forecasts falls another $A19 billion in 2015-16 and another $A17.0 billion in 2016-17.
This huge reduction in mining investment spending needs to be more than compensated by growth in spending in other parts of the economy. The heavy lifting needs to be done by growth in household consumption expenditure, investment in housing and non-mining sector business investment spending. Housing investment in a broad economic sense means mostly spending on adding to the stock of homes in Australia, plus renovation spending on the existing stock. That type of spending on housing is lifting well, up in real terms by 5.1% in 2013-14 and expected on Treasury’s forecasts to lift by 6.5% in both 2014-15 and 2015-16 and a further 4.5% in 2016-17. In short, Treasury expects and needs the housing boom to continue.
Household consumption spending is by far the biggest component of spending in the economy, more than 55% of total spending, and is what really needs to grow more strongly if the economy is to grow sufficiently strongly in the face of the mining investment downturn. Treasury forecasts that growth in household consumption spending will lift from 2.2% real growth in 2013-14 to 2.75% in 2014-15, 3.00% in 2015-16 and 3.25% in 2016-17. It is fair to say that accelerating growth in real household consumption is the key to whether the entire economy can accelerate the way that Treasury is forecasting over the next three years and to whether the budget deficit falls from an expected $A41.1 billion, or 2.6% of GDP in 2014-15 $A6.9 billion, or 0.4% of GDP out in 2018-19.
Treasury’s household consumption expenditure growth forecasts are possibly too optimistic. Households face constraints on how freely they may spend. The first constraint is an enduring cautiousness in the wake of the global financial crisis and a higher preference to save rather than spend. A second constraint is that wages growth remains persistently weak. The Q1 wage price index was released the day after the Budget and showed a weaker-than-expected lift in wages of only 0.5% q-o-q, 2.3% y-o-y – the weakest annual growth in wages in the history of the survey going back to 1998. The bigger problem is that wages growth is showing no signs of improvement for quite some time. Lifting household consumption spending will be an uphill battle and will rely on lifting confidence in the household sector. The Budget may have temporarily boosted consumer confidence, but the lift in confidence needs to be persistent and it is doubtful whether the positive reaction to the budget will be more than a temporary phenomenon.
Turning to non-mining business investment spending, it is probably fair to say that businesses are watching spending developments in the household sector to see whether lifting investment spending makes sense. Those Australian businesses more dependent upon overseas sales are probably watching the Australian dollar exchange rate too and the rebound in the Australian dollar over the past month or two is the exact opposite of what is needed to lift business confidence.
Treasury is looking for quite a revival in non-mining business investment spending in its forecasts, a lift of 4.0% in 2015-16 after an expected lift of 2.0% in 2014-15 and an even stronger 7.5% gain in 2016-17. These forecasts allow for the small business initiatives in the budget, but the issue is whether in the face of still quite lack-luster spending in the economy small businesses have the confidence to take up the initiatives in the budget.
Our view remains that RBA will still need to reduce the cash rate further to increase the likelihood that growth can return eventually to nearer to 3%. The Budget lifts very slightly the prospect of better growth, but not enough to materially change the interest rate outlook. We see the RBA cutting the cash rate by 25bps to 1.75% in early August (after the Q2 CPI releases in late July). There is a chance that even more rate cutting will be required beyond August. At this stage we are forecasting a prolonged floor for the cash rate at 1.75%, but the risk is that another cut to 1.50% could occur late in 2015.