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[FIXED INCOME] Mixed signals from the Australian economy

Jehan Konesan is an investment analyst with UBS. 

Recent Australian economic data releases contained some mixed signals—with some positive signs from the national accounts data, but historically weak numbers from the inflation, capital expenditure and wages data. The RBA continues to convey a reluctant easing bias, despite the outlook for continued low inflation, recent moderation in the employment numbers and global financial market turbulence increasing the market's pricing of the probability of a cut in rates. Specifically at the start of January, the market priced in 19 basis points of rate cuts over the next year, with this increasing to 31 basis points of rate cuts on 3rd March. 

Nearly 8,700 jobs have been shed over the two months to January, driving the unemployment rate back up to 6.0%. The strength in the labour market before that overstated the reality, reflecting issues with the ABS sampling rotation. Wage price inflation in Australia remains soft, with the Q4 wages printing at 2.2% year-on-year (yoy) and private sector wages growth slowing further to 2.0% yoy—the weakest result in over a decade. Australia’s NAB business indicators survey also remains soft and is pointing to weaker business and employment conditions in February. 

Real GDP growth reached 3.0% yoy growth, driven by a solid lift in consumer spending, a strong rise in dwelling construction and a spike in public sector capex. Consumers have been decreasing their savings ratios in the presence of weak wages growth. Net exports were flat after a big increase in Q3 and unsurprisingly business investment contracted, driven by large declines in mining-related engineering construction. Capital expenditure surveys showed expected capital spending for 2015/16 was down 17.8% compared to 2014/15, and it was even less positive for 2016/17. Mining investment intentions were down heavily and non-mining investment intentions were also weaker.

Real income growth, which is the purchasing power of total incomes generated by domestic production, was virtually flat at 0.3% annual growth, driven by significant declines in commodity prices. This has softened wages and inflation and also contributed to the depreciation of the AUD, improving the competitiveness of the non-mining trade exposed sectors, especially services. 

The RBA still remains reluctant to ease, however a number of factors continue to support a rate cut in 2016. It is the desire of the RBA to keep the currency in the low US$0.70 range or even lower to aid the economic transition to the non-mining sectors. However the currency's appreciation from US$0.69 in the middle of January back to $US0.73 on the 3rd March, driven by a recovery in iron ore prices, will test the RBA.

Furthermore, a very gradual Fed funds path will also restrict the potential depreciation in the currency. Current global developments such as the fears of Chinese contagion and higher volatility in oil and equity markets will not help consumer and business confidence. Business and mortgage lending rate premiums over the RBA cash rate have also widened, causing a further tightening in financial conditions.

Additionally, in a weak wage growth environment, a future increase in demand fundamentals for the non-mining sector will need to be driven by consumers maintaining low savings ratios, or by cutting cash rates to increase left over income to spend, or by further improvements in global conditions—of which the latter cannot be guaranteed.







Published on: Friday, March 04, 2016

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