Maxim Monthly Insights - September 2017

• The Australian economy is showing signs of strength with solid economic growth in Q2 and continued solid prints for the NAB’s business survey pointing to a continuation of this economic strength.
• Consumers have been a big part of this strength despite their pessimism. That appears to be driven by strong employment and is despite low wages growth. It’s concerning many economists but household consumption may be more sustainable than they believe
• There are risks from a higher Australian dollar, and potential RBA rate rises. But overall the outlook is very positive.  

 

Australian growth - driven by business conditions & consumption

 

Since our last update in July the evidence has continued to build that the RBA’s hitherto, seemingly, optimistic outlook for the Australian economy is in fact closer to the mark than many forecasters and economists thought possible.

Naturally readers of these updates and attendees at Maxim presentations would have had the benefit of the “glass half full” analysis driven by strong business conditions and the faith that given that’s where most Australian work they would feel confident to continue spending – even with low wages growth.

And data received this month showed the Australian economy grew 0.8% in the second quarter of 2017 to continue its record breaking run of growth without a recession. That was a big improvement on the March quarter’s 0.3%. 

 

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And once Q3 2016 negative growth washes out at the end of this month its expected growth will be back above 2% on a year on year basis from Q2’s 1.8%. That’s a solid base for the economy to accelerate toward the RBA’s growth target around 3% by the end of the current financial year.

What we have also seen is the latest release of the NAB’s business survey showed that business conditions, trading, profitability, and employment indexes are all still strong. Yet business confidence has slipped this month. On the consumer side of the equation the pessimists continue to outweigh the optimists Westpac’s consumer sentiment index shows.

So, as with concerns expressed by many earlier this year economists, even RBA board members, are wondering how long households will continue to run down their savings rate in the face of high debt and low wages growth.  

As I noted in July, 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.

Overall however business conditions and the RBA’s economic projections suggest that the Australian economy will continue to grow back toward potential and that wages growth, and inflation, will eventually lift. 

 

A look at Australian households and what that means for growth

 

Households contributed 0.4ppts to the growth rate of the economy in Q2 driven by a falling savings ratio which dropped to a post GFC low of 4.6%.

The RBA is forecasting growth to be closer to 3% by the end of the current financial year.

Economists wonder whether faced with low wages growth and high debt Australian households will continue to save less and spend more.

Yet the simple question is what really is the relevant “savings rate” benchmark. It sat in the mid 4% region on average during the 1990’s and just 1% at the start of this century until June 2008.

So there is room for further reductions while the economy remains strong and the jobs market hot. 

But what worries economists is with households contributing so much to the growth rate of the economy in Q2 can this level of consumption be kept up given relative pessimistic consumer confidence and around 50% or respondents saying the wisest place of saving is either paying down debt or putting money in the bank.

Deutsche Bank says it just can’t get the consumption number high enough to generate the type of growth the RBA says is coming in the economy.

 

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So there is a clear risk to the domestic outlook. But one likely to need a trigger to crystallise into lower consumption and more saving and debt reduction.

That’s something that RBA board member Ian Harper highlighted this month when he said “Consumption is two-thirds of gross domestic product…If households as a group were suddenly to decide that we really can’t afford this now, we’re going to start to slow up consumption to keep ourselves on an even keel, then that will certainly pull GDP growth away from where we want it to be”.

But the Australian economy has created 268,300 jobs this year at an average of 33,500 per month. That’s well above the 5 year average of 15,300. And it is an unequivocally strong performance of the labour market. 

RBA governor Lowe this month said that strength is already causing wages to rise in pockets and that the “Reserve Bank's central scenario is that, over time, this will become a more general story”. If he’s as right as the RBA has been on growth in the economy then Australian consumers can look forward to a positive outlook. And then so too can the economy.

 

Economic strength means the RBA may hike rates in 2018

 

The NAB’s economics team  believes the strength of the economy will see the RBA raise rates twice in 2018 and twice in 2019.

Likewise the ANZ’s “RBA Bias Index” - which seeks to track the RBA’s words as a method to predict rate hikes - is pointing to two upward moves in the official cash rate – and thus mortgage rates – in 2018.

With high debt and low wages growth that could put pressure on households and the companies and industries which compete for the 40% of income spent on discretionary items. But the RBA knows that, meaning the rate hike cycle will be muted.

That said though, such moves would likely also put upward pressure on the Aussie dollar.

Content provided by Maxim's "Economic Expert", Greg McKenna of Business Insider.

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