Maxim Monthly Insights - July 2017

• The RBA remains cautiously upbeat about the Australian economy at the present time and into the future. It held rates at 1.5% again in July with the governor’s statement reflecting this optimism
• Global growth has picked up to the level where central banks from London, to Brussels, Washington, and Stockholm are now able to contemplate the removal of the emergency stimulus measure which have been in place for the best part of a decade.
• That’s a good backdrop for Australia but it could pose challenges for financial markets – bonds, stock, and currency traders – in the months ahead.  


The Australian economy is getting its mojo back


Back in April and May it seemed like the Australian economy was starting to splutter.

Jobs growth didn’t appear very strong, retail sales felt like they were dragging, and there was a general sense that with house price appreciation moderating, and with APRA and the RBA’s efforts to rein in spending likely to provide a further negative shock that the domestic economy faced some serious headwinds.

It caused ratings agencies Standard and Poor’s, as well as Moody’s, to downgrade Australian banks and give a warning about the outlook for growth in the economy given the high level of household debt that has built up in the economy.

Moody’s warned (my emphasis) “Australia … exhibits very high levels of household debt, with the ratio of household debt to disposable income rising to 188.7% at the end of 2016. This situation is particularly concerning, against the backdrop of low nominal income growth experienced in Australia over the past few years…The household sector’s resilience to weaker employment levels and/or rising interest rates has materially reduced. Any increase in household sector stress would have the potential to weaken consumer confidence and consumption, creating negative second and third order impacts on overall economic activity and, accordingly, bank balance sheets…The resilience of household balance sheets and, consequently, bank portfolios to a serious economic downturn has not been tested at these levels of private sector indebtedness.”


Yes it’s true. If Australian’s focus on debt reduction, or if rates rise then cash will be diverted from consumption and into debt repayment and servicing.

But that’s a conditional probability, not a certain outcome.

And at present what we’ve seen in the past 6 week’s is a strengthening of the Australian economy. Business conditions are strong, business confidence is high, and the recent dip in employment has given way to better job creation over recent months. Consumer confidence has bounced back, perhaps a coincident with the recovery in house prices, and the strength of motor vehicle sales suggests households were never as worried as they reported anyway.

That’s a solid environment for business even though their will naturally always be pockets of weakness and headwinds for growth.


A deeper dive into business conditions


Anyone who has read my column and outlooks for the Australian economy over the years, or seen me present at the Maxim breakfast knows there are two enduring themes.

The first is that the glass is always half full. The second is that if there was only one data release each month I could view to judge the Australian economy it would be the NAB business survey.

In many ways it’s been the performance of this survey and what it tells me about business conditions, confidence, and then the sub-indexes of trading, profitability, and employment which have helped me have this glass half full approach.

At present conditions and confidence remain solid and above long run averages. Trading, profitability, and employment sub-indexes are also showing strength as well.

Summing up the most recent release NAB chief economist Alan Oster said:

“The strength looks to be quite broad-based, with all industries recording positive business conditions for only the second time since 2010 – although conditions are only neutral for retail in trend terms, weighed down by the softer trends in the household sector.”


The divergence between business and households the survey needs to be watched but recent retail sales data suggests its being resolved in Business favour.

Indeed a flat, and then negative growth in February and May retail sales grew 1% in April and 0.6% in May. Couple that with new motor vehicle sales hitting a new record of 100,476 units in May and there seems to be clear evidence that consumers are back and spending once again.

That’s exactly what the economy needs at this difficult period of transition and with the end of the housing construction boom looming.

How that can continue given the acute levels of housing debt held across the nation is difficult to fathom. But the RBA retains an upbeat outlook for the economy expecting growth to accelerate toward potential and into a 2.75% to 3.75% range for this, and the next two, financial years.

Given that’s associated with an expectation that inflation will accelerate into the 2-3% target range that implies nominal growth above 5% for Australia.

That’s a good environment for business.   


If things are looking good why is the RBA holding rates at record lows of 1.5%


The easy answer to that question is uncertainty. RBA Governor Lowe has on many occasions in the past 2 months highlighted the risk the economy faces if households focus on the repayment of debt.

Indeed, in the May minutes the RBA board said, “If households were becoming more focused on paying down debt, this would imply some downside risks to the outlook for household consumption growth. A fall in housing prices could also weigh on consumption growth”.

Jobs growth in Australia has recently been strong with the 2017 average more than 30,000 jobs per month. That is an important salve to the emergence of household concerns.

But the RBA is playing it cautiously. Offshore evidence shows it’s easier to restrain an overheating economy than it is to pull one out of an acute weak spot.

Article provided by Greg McKenna, Economist 

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