Maxim Market Insights by Greg McKenna

• Australia’s economy grew 1% in the March quarter and 3.1% for the year to March 2018. Respectively, that’s the best quarterly growth rate since 2011 and best year on year rate since June 2016. That rate of growth was better than economist or the RBA forecast.
• So, you’d be forgiven for wondering why many in the press and in the economics fraternity are talking as though the economy is weak. It’s all about consumers and the dichotomy between aggregate and business growth against consumers in the Australian economy
• Put simply as the economy grows the pie is growing faster than what consumers and households are feeling because population growth is driving a significant part of that growth.


BIG PIE, SMALL SLICE - Explaining the dichotomy between economic growth and consumer caution


Australia’s run of record growth continued for another quarter in the first three months of 2018 with GDP printing a better than expected 1% in the March quarter which saw the year on year growth rate accelerate to 3.1%. By historical standards that’s still relatively weak growth, that’s why the RBA still has the official cash rate at 1.5%.

But the improvement in the quarterly and yearly growth rates to 7 year and 2 year highs respectively, highlights that the RBA’s positive outlook appears to be justified. (For the moment at least anyway given the headwinds facing households from weak wages growth, high debt levels, and falling house prices). 

The simplest explanation for the divergence between the overall level of Australian growth and what households feel is summarised in this chart from Westpac’s economics team.


Sure jobs are plentiful in the economy at the moment, 2017 saw record employment growth and a surge in workforce participation, but households feel like they are missing out because their slice of the pie is getting smaller.

Consumers can feel that real and nominal growth rates have taken a step lower since the GFC, but the gap between the red and grey lines since 2008 highlights that GDP per-capita is underperforming the overall rate of growth. In layman’s terms, it suggests while the economy is still growing, and in some sectors strongly, the overall standard of living Australian households feel is growing more slowly. 

Put simply overall GDP growth is in a very large part, being driven by population growth. That means the growth is spread across a bigger population which in term means that GDP per capita growth is down.

Put another way the pie is getting bigger but each Australian's slice is smaller.


So, what does that mean for business?


There is very much a multi speed economy happening in Australia at the moment. B2B sales, outside retail, are likely to have been solid over recent quarters but may be slowing as Q2 progresses, and as the NAB business survey shows, business confidence and conditions slip a little from their recent highs.

At a consumer facing level though, what the ABS reported and the data shows, is that the growth in Q1 2018 was driven by increased spending on non-discretionary items like utilities and communications. What the data also showed, is that spending on discretionary items like hotels, cafes, and restaurants fell 1.8% over the course of the March quarter. Alcohol too was down substantially.

When you overlay this with low wages and a fall in the savings rate to 2.1% (the lowest level since the December quarter of 2007 before the GFC really hit), we see a household sector which is under some stress. 

So while at an aggregate level (the Pie) the economy is growing and offering more opportunities for business, the reality is that Australian households are not feeling that same level of growth (smaller Slice). In other words, because of population growth, individuals and household level Australians, don’t feel they are getting the full benefit of Australia’s growth.


But the next big question is what happens now that Australian housing is falling and especially now that Sydney, in particular, and Melbourne property prices are falling as well.

Behavioural economics will tell us that the endowment effect (the value people place on things they own) would suggest that households will genuinely feel the loss associated with the fall in property prices. This is where the “wealth” effect, that more traditional economists talk about, kicks in.

Consumers feel wealthier and are thus prone to spend more as property prices rise and are thus likely to fell less wealthy as prices fall.

Behaviourally, this means Australians are being circumspect with their purchases and non-discretionary items are eating into overall consumption. Small luxuries, cheaper offerings (or those that offer better VALUE) seem likely to do best in this environment.

For the moment, the overall health of the economy should forestall any real reduction in consumption, but the risks are rising! As falling house prices continue, the overall health in other sectors of the economy will not be able to forestall a period a economic weakness driven by household retrenchment.


What does the RBA do? 


The RBA has to manage the aggregate economy but pay attention to specific sectors. In Mining Boom Part 1, the then governor Stevens said expressly he was raising rates to reduce household spending and make way for the mining. This was done so as not to push inflation sharply higher.

As Mining Boom Part 2 ended, the RBA lowered rates to facilitate a transfer of workers from the mining investment boom to a housing construction boom. What it didn’t expect was the associated surge in house prices which then needed to be reined in by APRA clamping down on investment and interest only lending.

As we head toward the second half of 2018 then, the RBA has to set rates for an economy which has a relatively robust outlook, but which is burdened with households worried about falling house prices, low wages growth, and debt.

At the end of the day, it means rates at 1.5% for another 6-12 months at least until the outlook becomes clearer.


This article has been provided by Greg McKenna, Behavioural Economist 

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