A combination of slowing employment growth and the long election campaign plus its difficult conclusion have placed Australia’s economic growth prospects on a path of fading strength. The fade is starting to show in monthly readings of retail sales, credit growth and home building approvals. In the absence of an economic factor capable of reversing the fade – a marked lift in economic growth among Australia’s major trading partners or a lift in domestic spending from some source – annual real GDP growth looks set to slide from 3.1% y-o-y in Q1 2016 to below 2% by Q1 2017, possibly well below 2%. The RBA will need to respond to weakening growth and very low inflation.
Before looking at possible influences that may reverse the growth fade, it is worth examining the evidence that it is actually starting to occur. The biggest change has been in the relative strength of employment growth. Monthly employment growth has averaged 7,000 a month in the first five months of 2016, compared with 30,200 a month over the second half of 2015. Moreover, much of the employment growth in the second half of 2015 was full-time, averaging 17,800 a month whereas in the first five months of 2016 full-time positions have shown an average monthly fall of 12,100 a month.
Average monthly growth in retail sales has faded too from 0.3% per month in the second half of 2015 to 0.2% a month in the first five months of 2016. Annual growth in retail sales has slowed from 4.9% y-o-y in mid-2015 to 3.4% y-o-y in May 2016. In the case of monthly private sector credit growth, the fade is a little less pronounced averaging 0.5% a month in the first five months of 2016 compared with an average 0.6% a month in the second half of 2015.
Home building approvals are the odd man out, showing better monthly average growth in the first five months of 2016 at 0.2% a month, compared with -0.2% for the second half of 2015. However, annual growth in home building was -9.1% y-o-y in May and stories of substantial over-supply of new home units in Melbourne and parts of Sydney and reports that residential property developers are experiencing greater difficulty obtaining bank finance for new unit developments all point to a pronounced fade in home building approvals before long.
Key parts of Australian domestic spending are starting to struggle. It seems unlikely that the election result where the government is both soul-searching why it performed so poorly and needs to negotiate with an even more mixed group of cross benchers in the Senate to pass legislation will provide any boost to either business or consumer sentiment. Indeed, there is a strong possibility that the opposite may occur and businesses and consumers turn even more cautious.
The chances of a big boost to Australian demand coming from overseas are comparatively limited too. Australia’s biggest export market by far is China. China’s GDP growth is languishing for the time being in mid-to-high 6% y-o-y territory. The Q2 GDP report is due this coming Friday and the consensus forecast is minor slippage to 6.6% y-o-y from 6.7% y-o-y in Q1. While Australian exports to China are changing, by far the biggest part is still bulk commodities. The part of China’s GDP that influences demand for bulk commodities is growing far more slowly than total GDP and looks set to grow slowly for some time to come as China seeks to continue to rebalance its growth drivers in favour of services sector activity and consumer spending. China’s growth rebalancing efforts are also adding to problems associated with burgeoning corporate debt and ballooning potential bad and doubtful debts for China’s banks. It is unlikely that China will provide a major boost to Australian growth prospects over the next year or so.
The next set of big league export markets for Australia – Japan, South Korea, India and Indonesia – are also facing moderate economic growth prospects at best. Australian exports can continue to rise on the additional capacity coming on stream, but are unlikely to rise at a pace that can hold up total GDP growth as growth in domestic spending weakens.
As has been the case over the past year or two, the only Australian agency in a position to try and withstand the fade in growth prospects is the RBA. Q2 CPI inflation out later this month will very likely be low enough to give the RBA the reason it needs to cut the cash rate again at its August policy meeting. Low inflation, however, is not the only reason why the RBA is likely to be cutting the cash rate over coming months, the growth fade is another. We expect the RBA to recognize how much growth prospects have faded in its August Monetary Policy Statement due the first Friday of August.
Growth fade plus very low inflation implies that the RBA may cut the cash rate at least twice in the second half of 2016, probably 25bps cash rate cuts in August and November. There is also an increasing risk that the RBA may need to cut the cash rate even more. Our base case is that the cash rate will fall to 1.25% by the end of 2016 where it will stay throughout 2017. Our main risk case is that the cash rate is cut further in 2017 to 0.75%.