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Positive signs for economy: forget rate cuts in 2017?

David Bassanese
Wednesday, February 15, 2017

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By David Bassanese

Despite the shenanigans in Canberra, corporate Australia seems to be getting on with the job.

After I suggested just last week that the economy may be experiencing its own version of the “Trump bump”, we got more positive signs on the outlook in the past week. Business sentiment has gone through the roof, and the RBA has backed up its recent optimistic statements on the economy with a detailed justification of its views in the latest quarterly Statement on Monetary Policy. 

Of course, it’s important not to get too carried away, but parts of the economy appear to be stirring. The hope is that this will eventually translate into stronger corporate earnings, especially in the non-mining sectors. That said, if the economy is really picking up, we can forget about rate cuts this year, and there’s even a chance of rate hike by Melbourne Cup day. Under such a scenario, the $A could also conceivably re-test US80c, especially if coal and iron ore prices also defiantly remain firm.

Last Friday in its statement, the RBA doubled down on its optimistic outlook for the economy by dismissing the negative September quarter GDP result as largely reflecting “temporary factors”. Bad weather delayed some high-rise residential construction projects, and ever-volatile public investment saw fit to decline in the quarter. More seriously, consumer spending was also soft in the quarter, but already retail sales volumes, at least, did bounce back nicely in the December quarter.

That said, even allowing for a reasonable bounce back in growth last quarter, the RBA concedes growth through 2016 was likely only around 2%. But this disappointment has done nothing to shake the RBA’s faith that growth will lift to a 3% pace in 2017.

Why the optimism? For starters, business surveys suggest the decline in mining investment is close to bottoming out, meaning it will be less of a drag on growth. What’s more, LNG exports volumes are slated to pick up nicely, contributing an extra 0.5% to growth both this year and next year.  

Critically, however, the RBA is also counting on residential construction staying at a relatively high level despite the clear downtrend in new home building approvals that is now evident. Its confidence is based on the fact that much of the lift in home approvals in this cycle has been for high-rise apartment blocks, which take around three times longer (a year and half) to build than more traditional stand-alone homes – meaning there’s a lot more work still in the pipeline than is usual when building approvals start to turn down. Most of this work is slated to take place in Sydney, Melbourne and Brisbane. 

Of course, this longer-than-usual lag between home building approvals and actual construction leaves us with two risks down the track: some current plans might still be mothballed if conditions change, and there’s a greater risk of an eventual supply-demand mismatch (most likely over supply) later. But for now at least, new supply is being absorbed reasonably well in the hot markets of Sydney and Melbourne, though new apartment prices have already started to decline in the less buoyant market of Brisbane.

Elsewhere in the economy, the RBA is also counting on household spending remaining reasonably steady, and the long-awaited recovery in non-mining investment finally gathers steam just as the home building boom eventually fades. Even public infrastructure projects are contributing to growth.

The great immediate test of this optimism will be the labour market.

Reflecting improved economic growth this year, the RBA is counting on some lift in employment growth in coming months after moderation through 2016 - and it expects the unemployment rate to “edge lower” over the next year or so. But while continued gains in job ads and a firming in corporate hiring intentions points in this direction, the RBA did note these lead indicators have proven overly optimistic on the labour market over the past year. 

Of course, whether the RBA is right or not remains to be seen. But this week’s National Australian Business survey for January certainly counts in its favour. The NAB’s measure of business conditions shot up from +10 to +16 last month – or equal to levels seen in the pre-financial crisis boom period. While conditions in the consumer and business service sectors remain steady at a high level, driving the improvement in recent months has been decent recoveries in the mining, manufacturing, transport and wholesale sectors. To my mind, that suggests rising commodity prices and the cranking up in export volumes are making conditions at least “less bad” in these still relatively soft sectors. 

Of course, we might still worry about what may happen when the housing sector eventually turns down if non-mining investment remains missing in action. But then again, one of lessons of recent years is that our remarkably resilient economy in recent decades has always seemed to find a growth driver to latch onto.

Published: Wednesday, February 15, 2017

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