Economic Insider: Subdued income growth a challenge in new financial year
18 July 2015
- Robust dwelling construction activity in all states is filling a significant proportion of the void left by the end of the construction phase of the resources boom.
- The dwelling construction cycle still has some way to run in most states, but it will turn down eventually, which will be a challenge in the face of falling commodity prices.
- The dwelling construction cycle has sustained total employment in the construction industry as a whole, but it is unlikely that a new phase of resource construction will have commenced when the dwelling cycle turns down.
- Although the unemployment rate might have peaked, underemployment is at a historical high. Moreover, wages growth is subdued, so households are maintaining consumption by running down the savings they had built up in the aftermath of the GFC.
- Traditional retailers already challenged by online shopping and households’ growing appetite to consume services rather than goods may find the going tough once again in the new financial year.
- Low interest rates are helping to sustain household consumption, which accounts for more than half of gross domestic product (GDP). The RBA stands ready to lower rates even further, but would prefer not to, lest it fuel even stronger growth in Sydney house prices.
- A lower Australian dollar would do the RBA’s work for it without necessarily putting another rocket under Sydney house prices.
- The RBA, and exporters, would be delighted if the Australian dollar were to shed at least another 5-10 US cents and stay at the lower level for at least a year or more. As the first increase in the federal funds rate in the US gets closer, we expect the currency to ‘do the right thing’, but quiet confidence falls well short of certainty.
- A more competitive currency would boost the tourism, education and rural sectors, amongst others; while as Australia’s population ages, it is all but certain that the health and social assistance category will maintain its number one spot as the largest employer in the nation.
Robust dwelling construction activity in all states is filling a significant proportion of the void left by the end of the construction phase of the resources boom (Figure 1). Nevertheless, while a drop off in dwelling construction is not imminent in most states, activity in a highly cyclical industry will begin to wane eventually, although earlier and more quickly in some states than others.
Although dwelling investment is well and truly pulling its weight, business investment other than mining/oil and gas has not yet stepped up to the plate. And until it does, there is no guarantee that the unemployment will not track back up. Moreover, underemployment rose to yet another historical high in the final quarter of 2014-15 (Figure 2), and until it peaks, businesses relying on strong household consumption might be disappointed again in the new financial year.
Consumption of goods and services by households is the bread and butter of most advanced economies, and Australia is no exception. Household consumption’s share of gross domestic product (GDP) averaged 56 per cent in 2014, just a touch below its 50-year average (Figure 3). Nevertheless, while it is up from its GFC trough of 53.5 per cent, it is well below the 58 per cent it averaged in the 15 years leading up to the collapse of the sub-prime mortgage market in the US in August 2007, which became the GFC a year later.
The trough in household consumption’s share of GDP in the wake of the financial crisis was even deeper than during the recession of the early 1990s, because households were furiously repairing balances sheets damaged by the GFC, including falling house prices and especially the 50 per cent peak to trough decline in global equity (share) prices.
That reparation, then subsequent nursing of balance sheets pushed total national saving and the household saving ratio up sharply (Figure 4), after both had languished for a quarter of a century. But households are once again running down savings to finance consumption in the face of modest income growth and a soft labour market in general.
Traditional retailers battling with consumers’ growing preference for online purchases of goods, but in particular services, are once again faced with a modest capacity and appetite by households to consume.
The retail sector overtook manufacturing as the nation’s biggest employer in late 2001, but it in turn was displaced by health care and social assistance employment in mid-2009 (Figure 5). The retail sector still accounts for just over 10 per cent of total employment, but in the face of an ageing population, the health and social assistance sector is almost guaranteed to maintain the number one spot, and indeed continue to increase its share.
The maintenance of exceptionally low interest rates has to some extent offset the impact of sluggish income growth on household consumption. Nevertheless, there is only so much monetary policy can do when rates are already closer to their ‘zero lower bound’. Moreover, while the RBA stands ready to cut the cash rate again if need be, it would prefer not to, in case it puts home ownership out of the reach of even more households in Sydney, and to some extent Melbourne also.
In sharp contrast to Sydney, house prices on the other side of the continent are flat in the face of a sharp slowing in WA’s population growth and the end of the high wage growth that goes with the construction phase of resources booms. Prices in Perth rose by almost 50 per cent in the year September 2006, but less than 2½ years later they were falling by more than 7 per cent per annum (Figure 6).
While the challenge posed by falling commodity prices is much greater in Western Australia and Queensland than it is in other states, they nevertheless have broad implications across the nation, just as house price growth during the resources booms that straddled the GFC was not confined to Perth and Brisbane.
The multi-currency denominated RBA index of commodity prices has fallen by around 45 per cent since it peaked in July 2011, but the Australian dollar has only lost 25 per cent of its value for the US dollar (Figure 7), and just 15 per cent on its trade-weighted index. So a more competitive currency is not coming to the rescue this time, as it did in 2001, when it dipped below 50 US cents in the face of low commodity prices.
Nevertheless, the currency did not rise anywhere near as far as commodity prices did during the resources boom, and even though the RBA and exporters would prefer a lower dollar, it is a lot more competitive than it was when it tracked above parity with the US dollar for most of 2011 and 2012. The rural, tourism and education sectors stand to gain substantially if the currency falls by at least another 5 US cents and stays at the lower level for at least a year.
The timing and speed of the impending rise in the federal funds rate - the US equivalent of the RBA’s cash rate target - is the key to whether, and if so when and how far, the Australian dollar falls. The first couple of increases are already priced into the Australian dollar, but we are quietly confident that it will shed more than just a couple of extra US cents sometime in the new 2015-16 financial year.
However, there is no certainty in foreign exchange markets, which is why neither the RBA nor federal treasury attempt to forecast where the currency will go. Rather, than just assume it will remain unchanged throughout the duration of their forecasting horizons.
The RBA has never had to resort to unconventional monetary policy to underpin an Australian economy that slowed, but did not slide into recession in the wake of the GFC. So high interest rates down under compared to most other advanced economies for more than five years has attracted lots of capital flows from offshore, which has sustained the local currency’s value. As the US Federal Reserve prepares to usher American interest rates higher, interest rate differentials in favour of the Australian dollar are likely to narrow - perhaps markedly - so one of the Australian dollar’s key props is about to be taken away.
Which will please the RBA - because it is less likely to be forced to lower the cash rate even further - and will please exporters even more.
A more competitive Australian dollar would provide a buffer against the risk of widespread contagion from the Greek debt crisis, although the downside is that it would increase the cost in local currency of borrowing overseas. Moreover, it would put a floor under the benign inflation that has allowed the RBA to lower the cash rate to a succession of historical lows. While there are losers as well as winners from a lower Australian dollar, as a big exporting nation, Australia has many more winners than losers when its currency is at competitive levels.
Chief Economist, Bankwest