• The GDP numbers say the economy is moving at its slowest pace since the GFC;
• But other indicators are a little more rosy;
• There are some sectors doing pretty well;
• Stronger growth in consumer disposable incomes would be welcome;
• We are unlikely to have seen the last interest rate cut in this cycle;
• It would be helpful if fiscal policy was doing more.
‘One step forward two steps back
Nobody gets too far like that’
‘One Step Forward ‘
The Desert Rose Band
The Desert Rose Band (at least according to Wikipedia) was a country rock band of the 1980s and 90s. The band had a couple of hits that reached number one on the country charts. And ‘One Step Forward’ reached number two. It would be wrong to say that the economy has taken too many steps back. Despite the recent tickup, the unemployment rate is still around one percentage point below where it was three years ago. But the one-step two-step is a more accurate description of interest rate movements over the past couple of decades where every move up has been followed by a bigger shift down.
But right now the economy and interest rates are dancing to the same tune. It has been clear travelling around Australia over recent months the strong consensus is that the economy has lost some of its sting. This consensus is very much in line with the recent GDP numbers. Slower growth is also consistent with the other statistical evidence (weaker business and consumer confidence, flattening yield curve, some rise in the unemployment rate). But the degree of weakness suggested by the GDP data is more aggressive than that suggested by the other evidence.
Annual % GDP Change
GDP & Business Sentiment
(standardised relative to trend)
GDP Per Capita Growth & Change Unemployment Rate
(2 quarter average)
While the aggregate economy is currently moving at a slow waltz, there are sectors that are pumping it up. Oil and gas is booming (with the big gas projects coming on line), as is areas of IT (firms boosting software investment in the drive to digitise). The Health/social sector are doing OK. So (interestingly) is the Metal Products sector. But heavy engineering firms are finding the going tougher (the flip side of the end of the gas projects), as are many farmers (reflecting the drought on the East Coast although the news on the West Coast is better). The slowing in residential construction is starting to hurt.
For some sectors the period of weak activity is likely to be temporary. With the big mining projects now at an end, it will be hard for heavy engineering activity to continue to decline as aggressively as it has been. Indeed, with exploration activity picking up heavy engineering firms will start to find work a little easier to find. A bit of luck with the weather will see better times in agri. Better weather will also help iron ore and coal miners. But for some sectors the tougher times will last longer. The decline in residential construction activity has only started. More substantial falls are likely over the next 1-2 years. And this will have a flow on impact for other sectors (manufacturing and home retailors).
(annual % change year to March 2019, real terms)
Selected Types Of Investment
(% of GDP)
More generally, sluggish consumer spending continues to hurt retailors. In recent times households have also been spending less on tobacco, cars and petrol (lower oil prices). The recreation sector is doing Ok but it is no thanks to the consumer. Households have been happier to shell out on health (the result of an aging population) and communications (IPhones, Netflix).
Leaving aside the bumps and grinds of the quarterly numbers, the shuffling pace of consumer spending has been an issue for some time. Post the GFC consumer spending averaged around 2.5% (after adjusting for inflation), well below the 4%-pace typically seen in the 15 years before the GFC (and below the 3%-average recorded between 1975-1995). One positive is that while the average annual growth in spending has been low, the variability of consumer spending year-to-year has also been very low.
Annual Household Consumption Growth
(year to % change March 2019)
It is widely recognized that the main reason consumers have not been spending is the scarcity of spare dollars in bank accounts. Disposable income growth (after allowing for price rises) has been growing at less than a 1%-pace over recent years, a speed historically seen during recessions. Weak income growth has meant that consumers have less to tuck away for a rainy day. The risk is that when disposable income growth does rise again some of it will be used to restock the (bank account) larder.
Annual Growth In Consumers Real Disposable Incomes
(disposable income after inflation, 3 year average)
Net Household Saving Ratio
(gross saving less depreciation as proportion of disposable income)
The consumer has benefitted from lower interest rates as interest payments have fallen to their lowest level (relative to disposable incomes) in about 15 years (and will decline further after the recent cut). But lower interest rates also means lower deposit rates. In aggregate households benefit from low interest rates as the amount spent on interest payments is greater than the amount received. And interest receipts will understate the returns that householders get from their saving as low rates encourages consumers to shift funds into assets offering better returns (such as shares or the tax benefits provided by Super). A negative for consumer incomes is that a bigger slice of their income pie has been taken in income taxes. So the proposed tax reductions for low- and middle-income earners will provide a welcome boost to disposable incomes (particularly as low and middle-income earners are more likely to spend).
Impact Of Interest Cash Flows On Household Incomes
(proportion of gross disposable incomes)
Tax As Proportion Household Income
While the consumer has taken step back, the government has leapt onto the economic dance floor. Federal government consumption spending has been rising faster than the economy for much of the past 20 years, and particularly over the past three or four (reflecting higher NDIS spending). State Governments have been more cautious, although they look to have become more generous more recently.
Government Consumption Spending
(% of GDP)
A widely discussed feature of the economy over recent years has been the big boost to infrastructure spending. Importantly, there is plenty of work in the pipeline. Infrastructure should be a prominent part of the economy right now given the obvious need, the very low level of interest rates (making it cheap for the government to borrow) and sluggish rate of economic growth. While there are plenty of hard hats around, investment on R&D has become a smaller part of the economy (only partly because of government cutbacks). This is a worry as R&D spending is an important driver of long-term productivity and innovation.
Investment As A Proportion Of The Economy
The slowing economy has had an impact on firms’ profit outlook. But there has been a rise in the company profit share over recent quarters. A big part of that has been miners benefitting from higher commodity prices, their work to improve cost efficiency and increased production (as gas projects have been finalised). Falling interest rates have benefitted most firms. But the taxman is also getting a bigger cut (an important reason why the budget is returning back to surplus).
Private Non Financial Company Profit Share
(% of gross national income)
Ratio Of Interest Payments To Gross Profit
Tax As Proportion Of Gross Income For Private Non-Financial Firms
Firms have been increasing their dividend payout ratio over recent years. For mining companies this reflects their lower capex requirements (although that looks to be changing). Very low interest rates also means that investors are more likely to demand higher dividend payments. The proportion of profits kept as retained earnings is also relatively high. This might reflect the intention of firms (notably miners) to increase their capex spending (a large part of capex is funded from retained earnings). High level of retained earnings is also consistent with surveys suggesting that the proportion of firms indicating they have no borrowing requirements remains high.
Implied Dividend Payout Ratio
Retained Earning Ratio
Proportion Of Firms Saying No Borrowing Required
(3 month average)
A disappointing feature of the economy over recent times is the very low rate of productivity growth. Partly that is the result of good news (jobs growth has been strong despite the so-so economy). But over the long term the rate of productivity growth determines the growth of living standards. One indication is that the low productivity of recent years has coincided with low wages growth.
(GDP per hour worked, 5 year average, trend)
(annual % change)
All up, it was an ordinary GDP report. The GDP numbers do seem weaker than some of the other evidence. And parts of the economy (such as oil and gas) are doing better than others (retailors). But in aggregate the economy is moving to a beat that is too slow. Some of the negatives will be temporary. But not all of them. The outlook for the global economy is mixed at best. Lower interest rates will provide some help (although could be offset if the $A increases) but fiscal policy should be doing more. The good news is that it can. At the moment the economy is doing just enough to get a pass mark. But ‘needs to do much better’ is very much the summary comment.
We live in interesting times!
Peter Munckton - Chief Economist