By BOQ Chief Economist, Peter Munckton.
- The cash rate remained unchanged at 1.5%;
- The accompanying Statement was largely unchanged from the previous month;
- The economy is picking up, and is doing at least as well as the RBA’s forecast;
- The consumer has been the missing piece of the economic puzzle.
Recent economic information
This week two of the biggest pieces of economic information was released. One was the RBA decision to keep rates unchanged for the 20th consecutive meeting. The accompanying statement was essentially unchanged from the previous month. The RBA appears comfortable that their forecast of an above-trend domestic and global economy is running to script. But inflation is below target, and the unemployment rate is only around its decade-average. The RBA expects further economic improvement. But that improvement is expected to be only gradual.
The Q1 GDP numbers give the RBA no reason to change their mind. Indeed, if anything they might have to revise up their view on how well the economy is doing. According to the Government statisticians, the economy grew by 1.0% in the March quarter and increased by around 3% over the past year. Exports are doing well, non-mining investment is improving. Infrastructure spending is helping. Government spending has been rising. The mining, manufacturing and health sectors have done well. But growth of consumer spending is modest. The national accounts measures of inflation remain muted. And productivity growth is too low. So the story from the Q1 GDP numbers are that the economy is improving but further strength is needed. And for the economy to sustainably improve, better productivity growth is required.
The missing economic link
Our language is full of idioms (or sayings). If it ain’t over until its over, its adding insult to injury. Over the past couple of years the export sector has been firing on all cylinders and the construction sector has been kicking goals. Infrastructure spending has been doing some of the economic heavy lifting. The missing piece of the puzzle has been consumer spending. Until last year that reflected household concerns about unemployment. But the big jump in jobs growth has seen confidence in the labour market leap. In turn, consumers are starting to see some rays of economic sunshine.
But households remain less happy about the state of their own finances. Growth in retail sales has been picking up in recent months, although remain below that recorded in the pre-GFC days. The reason why consumers have been more pessimistic about their own finances is they have (in effect) been facing an income recession. Disposable income growth (after allowing for the impact of inflation) has grown at around the same rate in recent years as during the 1990s recession.
This has mainly reflected low wages growth. The RBA believes that wages growth has bottomed, although they also think that the pickup will only be gradual. The GDP data indicates that growth in employee compensation (essentially firms’ wages bill) is increasing at its rising at its fastest pace in over 5 years. This is consistent with surveys that indicate firms are facing increasing labour costs (mainly through employing more people). But the growth rate of employee compensation remains below the 6-8% rate more typical of the pre-GFC days.
Another factor keeping a lid on consumer incomes has been reduced returns on financial assets. The low level of interest rates is providing a very low return on cash. Dividends are still providing decent return to shareholders, although below the peak seen during the mining boom salad days. Rental yields are also low. And in some cities (such as Perth), rents have been falling.
Household incomes have also been crimped over recent years by the increased amount of income that has been paid in tax. But this did follow a period when disposable incomes gained a significant boost from changes to tax rates. At one point in 2010 the amount of household income paid in tax fell to the lowest point in around 40 years. The proportion of income paid in tax has now moved back to around the average level paid since the mid-1980s. The recent tax cuts will help boost consumer disposable income growth, although how much will depend upon the extent to which the Government’s tax policy is implemented.
The Australian economic issue that gets the most attention is the high level of household debt relative to income. But most households are currently servicing that debt relatively comfortably, as interest payments as a proportion of income is near its lowest level in around 15 years. This in turn reflects the very low level of mortgage rates.
Nonetheless, the high level of debt is constraining households in other ways. Consumers are very aware of their high level of borrowing and are choosing to pay down debt with excess funds. This reduces household saving, and means there is less money available for discretionary spending. It is also possible that households with high debt levels will feel the need to keep a job and this might make them less inclined to demand higher wages.
The other factor eating into consumer incomes has been a rise of insurance premiums (although partly offset by a rise in claims). More generally, discretionary spending has been hit by price rises for other essential goods and services (such as utility bills).
All up, the economy is improving but not all shoulders are hitting the economic wheel with the same vigour. Similarly, not all regions or industries have felt the warm glow of a firing up economy. In short, the economy needs to stay stronger for longer. This view is consistent with current financial market pricing and economist forecasts. At the time of writing, financial markets have a negligible chance of a rate move in 2018. With decent pace of global and domestic economic growth projected to continue, the next rate change is projected to be up. Investors are not fully pricing one rate rise until Q3 2019. This is broadly consistent with economist forecasts.
Economists have pushed out their view on rate hikes reflecting some uncertainty in global financial markets, some slowing in the global economy in Q1 (which looks like being reversed), moderate domestic economic growth and an unemployment rate stuck at around 5.5%. The RBA has also made it clear that they are in no hurry to change interest rates.
But the economy is running at least as fast as RBA economic growth forecasts. A rate hike by the RBA becomes more likely once inflation enters the 2-3% inflation target and the unemployment rate starts to decline towards 5-5.25%. Ideally, a rate rise would also not occur unless the $A is trading under 0.75c.
Getting everyone rowing in the same direction is another saying idiom commonly used. Until recently, the consumer oar has only been lightly dipped in the water. Hopefully the consumer will become a bigger part of the economic growth effort in coming quarters.
We live in interesting times.