Australia’s economic outlook is hanging in the balance between forces supporting stronger economic growth and those suppressing growth. Forces helping the economy to grow include rising employment, a low unemployment rate, the first signs of accelerating wages growth, rising export volumes and double-digit annual growth in export prices, improving non-residential investment spending by the public and private sector and growth accommodating monetary conditions (low interest rates and an under-valued Australian dollar exchange rate). The forces suppressing growth include the worsening downturn in housing on some measures and evidence that growth in retail spending is fading in response.
We have held a view that the stronger parts of the economy would more than offset the weaker parts and promote above trend economic growth later in 2019 and in 2020. Key assumptions underpinning this view are that employment growth stays strong; wages growth accelerates; housing activity finds a base later in 2019 and slowly improves in 2020; and crucially household consumption spending grows at moderate pace (2.5% y-o-y or better in real terms in 2019 and 2020).
Recent economic readings have been softer on balance and inconsistent with our economic view. The sharp decline in home building approvals in November, -9.8% m-o-m, and December, -8.4% m-o-m, point to a deepening downturn in home building activity later in 2019. While a cut in the supply of new homes is a necessary condition allowing housing supply and demand to find balance, the problem is that continuing house price falls in most major Australian cities still speak of weak housing demand running below housing supply.
The most recent weekend house auctions in Melbourne and Sydney were a little better in terms of number of homes offered and clearance rates than those immediately before the Christmas/ New Year pause, but mainstream indicators of the health of the housing market such as monthly housing finance commitments; home building approvals; and house prices are still falling. It is also becoming harder to see how housing can start to recover in the near-term beset by uncertainties related to availability of housing finance post the Hayne Banking Report and with a Federal election in May where the tax benefits relating to investment in housing may become less generous in future.
The negative wealth effect from falling house prices may have already started to become a factor suppressing growth in retail trade. December retail sales released last week were disappointingly soft, down 0.4% m-o-m, and almost cancelling the 0.5% gain in November. In Q4 2018 retail sales rose only 0.1% q-o-q in volume terms less than the 0.2% gain in Q3, which was also a disappointingly weak result. Growth in household consumption spending, a mainstay of GDP growth, was soft in Q3 and may have stayed soft in Q4.
Nevertheless, household consumption spending is still growing and making a small contribution to GDP growth. Providing other contributors to GDP such has net exports, government spending and business investment spending provide some positive contribution, GDP can still grow although not as fast as it did through the first half of 2018.
GDP growth prospects, however, would be much softer if household consumption spending starts to provide no contribution to growth, or worse a negative growth contribution. Even with a weak housing market, household consumption is unlikely to flatline or fall while strong labour market conditions persist.
At present, there are no signs of weakness in the labour market – rather the opposite. Already strong employment growth has accelerated over the past three months. The unemployment rate was a six-year low 5.0% nationally in December and was near 40-year lows in New South Wales (4.3%) and Victoria (4.2%). The latest quarterly wages report is due next week and is likely to show further minor acceleration in annual wages growth to around 2.4% y-o-y (a year earlier it was 1.9%).
It is probably fair to say that over the next 3 to 6 months the labour force and wage reports will hold the key to the economic growth outlook. If the labour market stays firm and wages growth continues to gather pace slowly, housing activity is likely to improve later in the year and growth in household consumption spending should lift.
If the labour market starts to weaken then Australia’s growth outlook will be much softer leading to the RBA cutting the cash rate at some point.
It is has become a much closer call on Australia’s growth outlook over the past month or two reflected in the RBA’s latest quarterly Monetary Policy Statement released last week. What is clear is that it will require a lot more information on the areas of strength and weakness in the economy before it becomes clear whether an RBA interest rate hike or cut is needed. The cash rate will be on hold for several more months possibly extending to another year or two while the RBA gathers that information.
We still suspect that labour market strength will continue helping the housing market to start recovering later this year and underpinning household consumption spending. Our view remains that an RBA interest rate hike is more likely than a cut at some point in 2020. We will be watching the labour market data and wages data for confirmation of our view or any signs that we are wrong