Week beginning 11 March 2019
- RBA’s likely rate cut strategy.
- Australia: Westpac–MI Consumer Sentiment, housing finance, NAB business survey, RBA Deputy Governor Debelle speaks.
- NZ: retail card spending.
- China: fixed asset investment, retail sales, foreign direct investment.
- Europe: CPI, industrial production.
- US: CPI, retail sales.
- Key economic & financial forecasts.
Information contained in this report current as at 8 March 2019.
RBA’s Likely Rate Cut Strategy
This GDP print for the December quarter of 2018 shows the Australian economy having slowed in the second half of 2018 from a 4% annualised pace in the first half to a 1% annualised pace in the second half.
The challenge for the Reserve Bank will be to credibly maintain its GDP growth forecasts at 3% in 2019 and 2.75% in 2020. Expecting a lift in the growth momentum from 1% to 3% could only really be justified if the economy was expecting to benefit from a significant stimulus. But global growth is slowing; the residential construction cycle has clearly turned; the AUD remains in a stable range; monetary policy is on hold and fiscal policy will continue to be constrained by the perceived need of both political parties to predict a surplus in 2019/2020.
Consequently the Reserve Bank is likely to see the need to further revise down its growth forecasts when it announces its revised forecasts in the May Statement on Monetary Policy.
Those are likely to have an upper bound of 2.75% in 2019 and 2.5% in 2020. That is a “trend” forecast for 2019 and slightly below trend in 2020. Such forecasts are likely to still be assessed as consistent with steady policy with a clear “easing” bias.
With the residential construction cycle now turning down; business investment mixed; the savings rate now edging up; and house prices and new lending contracting, prospects for being able to maintain those forecasts in August look bleak. We expect by the August Statement on Monetary Policy, the growth forecasts for both 2019 and 2020 will have both fallen below potential (2.75%), probably not to Westpac’s current forecasts of 2.2% in both years but sufficiently below trend to invalidate any forecast of a falling unemployment rate and solid wages growth.
In such circumstances, with 150 basis points of “flexibility”, the RBA is expected to cut the cash rate by 25 basis points to 1.25% and follow that up with a second cut of 25 basis points in November recognising confirmation of persistent below trend growth. Under such a benign growth outlook it will also be necessary to further push back on the expected timing of the return of underlying inflation into the 2–3% target band.
This expected scenario is consistent with Westpac’s forecast for two rate cuts in August and November.
There were a number of significant developments in the GDP report.
Firstly we saw an extension of the contraction in new dwelling construction from the September quarter following a particularly strong first half. Westpac expects this is the start of a long run of falls in residential construction reflecting the downturn in dwelling approvals and an expected further contraction as tight funding conditions and falling house price expectations deter both demand and supply of new construction.
Secondly, we saw a second particularly weak print on consumer spending (0.4% following 0.3%) reflecting weak income growth and some early signs of a negative wealth effect as the savings rate lifted from 2.3% to 2.5%. Wages growth is lifting only very slowly while employment growth is expected to slow in 2019 as political uncertainty, global tensions around trade and softening demand weigh on business employment and investment intentions. There are lags but the tepid growth in the second half of 2018 is likely to weigh on employment growth in 2019.
There is also likely to be a further wealth effect on consumption as the impact of falling house prices on household balance sheets plays out. Evidence of a wealth effect during the boom period for house prices is apparent in the 1.7–1.9 ppt fall in the savings rate in NSW and Victoria. We expect this to gradually unwind over 2019 and 2020 restraining annual consumption growth to around 2.0% in both 2019 and 2020 with an expected lift in the savings rate from 2.5% to near 5% by end 2020. That rise in the savings rate and associated low consumption growth is the main factor behind the expected soft GDP growth outlook.
House prices will be important in 2019. Even though prices have fallen by 13% from their peak in Sydney and 10% in Melbourne, these adjustments follow cumulative increases of 60% and 44% respectively over the previous four years. Affordability is still stretched in both cities.
Unlike previous cycles where affordability was improved through sharp reductions in interest rates and relatively firm income growth, the necessary restoration of affordability in this cycle will need to come from prices. We estimate that further falls of 10% or more in these cities (over 2019 and 2020) will be required to restore affordability given limited interest rate flexibility and a restrictive credit environment. In previous housing downturns interest rates played a critical role in restoring affordability. With the RBA cash rate already down at 1.5%, there is very limited scope for interest rate cuts to perform that traditional role.
As we have recently seen in Perth, affordability can be restored but prices can still fall further if credit is tightened. While there is some unease in official circles around a possible credit squeeze we expect that the regulators will be comfortable to maintain greater scrutiny on lending practices. This is despite decisions by the regulator to release previous policies to limit investor and interest only loans.
There are also challenges with an entrenched low inflationary environment. On a calendar year basis headline inflation has been below the RBA’s 2–3% target range since 2013. The concern is that such a protracted period of low inflation is impacting expectations. Our forecasts indicate that headline and core inflation will not reach 2% until June 2021. The RBA recently pushed back its forecast for underlying inflation to reach 2.25% from 2019 to 2020.
On the positive side, government infrastructure spending, continues to lift with overall government spending up 6% in 2018. The mining investment contraction has bottomed out and there is some evidence of a likely modest lift in new mining investment largely focussed on iron ore and lithium.
Services exports are booming. Education spending rose 15% in 2018 while total services exports lifted 9.7%. Overall net services exports contributed nearly 0.5 percentage points to GDP growth. Importantly, this is not specifically a China story, with China explaining around 20% of total services exports, including 33% of education exports. The China story remains vulnerable to any policies aimed at boosting China’s shrinking trade surplus.
Household income growth is expected to slow. We expect employment growth to slow to 0.6% in 2019 down from 2.2% in 2018, pushing the unemployment rate up to 5.5% by years end. Wages growth is also lacklustre, partly because considerable slack remains in the labour market. The underemployment rate is forecast at 8.5% by end 2019, largely unchanged since December 2014 despite a drop in the unemployment rate from 6.1% to 5.0%. Accordingly wages growth is expected to remain sluggish – this has been the case even in NSW where the unemployment rate has fallen just below 4.0%.
The week that was
Ahead of the release of the December quarter National Accounts, we had been anticipating a particularly downbeat update. This expectation proved prescient, as the Q4 outturn of 0.2% left annualised GDP growth in the second half of 2018 near 1.0% – a fraction of the first–half’s 4.0% gain, and also well below potential at 2.75%.
In terms of the detail, government spending was the sole positive, adding 0.3ppts to growth in Q4. In stark contrast however, private demand flat–lined. Within the private sector, information on the consumer was particularly concerning: annual consumption growth slowed to 2.0%yr in Q4 – just ahead of population growth at 1.6%yr – and the decline in residential construction gathered pace. Business investment growth was also subdued in Q4: equipment investment remained sub–par, affected by both mining and the consumer; while non–residential construction consolidated at a high level.
On the heels of Q4 GDP, January’s below–expectation retail sales gain of 0.1% gave further cause to be concerned over economic momentum come 2019, particularly given it followed a 0.4% decline in December and as gains in January were confined to food sub–categories – non–food retail was down 0.1%. Clear here is a hesitancy on the part of the consumer to spend on discretionary items, one that is expected to linger as house prices fall further and income growth remains weak.
The above outcomes strongly support our view that aggregate activity growth will be materially below trend in 2019, circa 2.2%yr. While the RBA held an above–trend growth view ahead of this data, in coming months they will have to revise their expectations lower. This sets the scene for two cuts in the cash rate, in August then November – as per Westpac’s view.
Offshore, the March ECB policy meeting marked a significant dovish shift in the policy stance. While before, the ECB held steady in their confidence that the growth slowdown would be temporary, in March they factored in weakness persisting through the first half of 2019.
All up, this saw large downward revisions in the economic projections, the extension of interest rate policy forward guidance to rates expected to be on hold at least through the end of 2019 (previously the summer of 2019), and the announcement of a new Targeted Long–Term Refinancing Operations (TLTRO) package in response to the upcoming maturities.
Prior to the meeting, Q4 GDP was confirmed at 0.2% while Q3 was revised lower to 0.1%. Through the year growth for 2018 was below trend at 1.1%, with a marginally lower 1.4ppt contribution from domestic demand offset by a 0.3ppt reduction from net exports (down from a 1.4ppt contribution last year).
Compared to 2018’s annual average growth of 1.8%, the ECB now expects 2019 growth of just 1.1%, a sharp revision from their December forecast of 1.7%. With that below trend pace, the unemployment rate is expected to edge up to 7.9% from 7.8%, and inflation is expected to remain subdued.
Amidst the pervasive uncertainty on the economic outlook, policy has now become proactive to get “ahead of the curve”. Accordingly, our previous call for a hike in the deposit rate in December 2019 has been pushed out to March 2020, with growth expected to stabilise in the second half of 2019.
Regarding TLTRO policy, today’s announcement was broadly in line with our expectation, maintaining liquidity for longer and incentivising lending to the real economy – the full detail of the incentives are to be announced in due course.
Chart of the week: Q4 GDP – soft private sector
Output grew by only 0.2% in the December quarter, meeting our expectations.
Private sector demand flat–lined over the second half of 2018, declining by 0.1% in Q3 followed by a flat Q4. Against this, government spending, in the form of public demand, continues to expand at a brisk pace, up 6.2% over the year and directly adding 0.3ppts to activity in the final quarter of 2018.
The December quarter was another soft one for the Australian consumer. Incomes posted a better quarter but were coming off a very weak run, and still not strong overall. The flow through to spending was also muted by an uptick in savings. The update confirmed a material slowing in consumer spending over the second half of the year and underscored risks of a further wealth effect driven rise in savings rates undermining demand going forward.
New Zealand: week ahead & data wrap
A Narrowing Gap
Our latest Regional Roundup suggests that growth in regional activity in New Zealand has begun to converge.
Economic activity in the central and southern parts of the North Island and the most southern regions of the South Island remains strong, although momentum is starting to flag in some places. Meanwhile, activity in northern parts has been weaker, but signs of an improvement have become increasingly more evident. A further narrowing of the activity gap is likely as slow population growth and house price inflation in overheating regions begins to cool.
For some time now, New Zealand has been an economy of two halves. The central and southern parts of the North Island and the most southern regions in the South Island have been running hot, propelled by the success of exports, notably those relating to agriculture and tourism, population–induced building booms and healthy house price gains.
However, activity elsewhere has been less impressive. Flat to falling house prices in Auckland have weighed heavily on activity in the upper North Island with contagion effects resulting in a spill–over into neighbouring regions. Meanwhile, Canterbury, struggling to come to grips with life post–quake rebuild, has remained in the doldrums.
This still remains the case today, although the gap between strongly performing regions and the rest of the pack has begun to close.
That’s not to say that traditional outperformers such as Gisborne/Hawke’s Bay, Otago, and Southland, are not performing well. Thanks to some eye–popping house price gains and export successes, they still are, but momentum has been lost.
At the same time, erstwhile laggards like Northland, Waikato, and Nelson/Marlborough/West Coast, have all picked up pace, bolstered by a combination of supportive agricultural conditions, rising house prices, and improving labour markets. Auckland too has shown signs of picking up, with a sharp lift in regional confidence, retail spending and house sales volumes. Mid–table performer, Taranaki/Whanganui–Manawatu also seems to have a gained a second wind, in part because of strong house price growth, but also raised crude oil prices.
At the national level, the economy lost some impetus in late 2018, but we expect it to regain momentum in 2019. The main reason for this is a large increase in government transfers and spending, which should be felt across the whole country. Added to this the possibility of weaker fuel prices and the outlook for most regions is quite positive.
The three main population centres are likely to stand out from this trend, albeit for different reasons. Wellington is expected to benefit from spending by the Government on the public sector, so the outlook there is particularly strong. In Auckland there has been a very large rise in consents for new dwellings, signalling a lift in construction activity that should boost the local economy over 2019. On the other side of the ledger, activity in Canterbury will remain hampered by a further cooling in reconstruction work.
There are a number of rural regions of New Zealand currently doing very well, and we expect that to continue in 2019. Some are already losing momentum and that may continue this year. Others, such as the Bay of Plenty, have built quite a head of steam and are expected to roll through 2019 in fine form. Many of these rural regions are overheating, and we expect they will cool in time.
Their success has been driven by a combination of factors. The performance of export orientated industries has been key. So too above trend population growth, raised construction activity and rapidly growing house prices.
Some of these factors are likely to further support rural activity over the course of 2019. Others not so much.
A key driver of rural fortunes is likely to be the ongoing success of export orientated industries, such as tourism and agriculture. Despite slowing growth, we expect a record number of tourists from abroad to support spending in tourism dependent regions such as Otago, Southland, and the Bay of Plenty. Even Auckland, which is our largest tourist destination, should benefit.
So too agriculture, although the picture here is a little more complicated. In general, supply and demand fundamentals suggest a pretty positive outlook for most commodities in 2019. How positive, will depend on prevailing weather conditions. As mentioned in our recent Fortnightly Agri Update1, concerns about the impact of recent dry weather are likely to have been a key factor leading to a downgraded forecast for milk production as well as a lift in milk prices. We expect that prices will unwind somewhat when the weather begins to normalise, but still maintain a slightly higher milk price forecast $6.40 for this season.
Other factors, such as population growth, construction activity and rising house prices are not likely to be quite as supportive. Population growth is already slowing in many rural regions, and as it continues to cool the construction booms currently under way will wane. Meanwhile, double–digit house price inflation is currently stimulating strong consumer spending in many regions, but this will not last. When house price inflation slows or goes into reverse as we expect, consumer spending in many regions will slow from the current helter–skelter rates of growth.
Aus Jan housing finance (no.)
- Mar 12, Last: –6.1%, WBC f/c: –2.5%
- Mkt f/c: –2.0%, Range: –3.0% to 2.1%
Housing finance approvals posted a very weak finish to 2018 with sizeable declines across all components. The headline number of owner occupier loans fell 6.1%, down a hefty 8.2% ex–refi, and –14.4% for the year. Notably, what was initially an investor–led cycle is now seeing clear weakness in owner occupier activity – both the value and number of loans.
The slide is expected to carry into January with industry data covering the major banks pointing to a further 2.5% decline. The value of investor loans is expected to see a similar fall. As always, the low activity over the holiday season means January reads are less reliable than usual.
Aus Mar Westpac–MI Consumer Sentiment
- Mar 13 Last: 103.8
The Westpac Melbourne Institute Index rose 4.3% to 103.8 in Feb, recovering from a dip into slightly pessimistic territory in Jan (a reading of 99.6). The RBA’s shift to a more neutral stance on the outlook for interest rates in early Feb appeared to give a modest boost to confidence after a shaky start to the year.
This month’s survey is in the field from March 4–9. The main development over the last month has been another run of weak economic data culminating in the soft December quarter national accounts showing annual GDP growth slowed to 2.3%, with press coverage emphasising the weakness of the second half of 2018. Financial markets have remained quite buoyant, the ASX up a further 3% since the last survey, but housing market conditions remained soft.
NZ Feb REINZ house sales and prices
- Mar 11-15 (tbc), Sales last: +6.7%, Prices last: 3.1%yr
Nationwide house sales picked up in January after an unusually weak December. The foreign buyer ban, which took effect in October, probably accounts for some of the recent volatility in monthly sales. Annual house price inflation has slowed, albeit marginally, in that time.
We expect a modest upturn in the housing market in the early part of this year. The RBNZ’s restrictions on high-LVR lending were eased in January, while mortgage rates have been pushing down from their already low levels.
Regional differences in price growth are likely to persist, with many areas outside of Auckland and Canterbury likely to see continued strong house price growth. Foreign buyers play little role in many regional centres, and the combination of lower mortgage rates and lending restrictions will give demand a further shot in the arm.
NZ Jan retail card spending
- March 11, Last: 1.8%, WBC : +0.3%, Mkt: + 0.3%
Retail spending rose by 1.8% in January. That large rise was centred on durables spending and followed an unusually large drop in spending through the Christmas shopping that may have been related to processing delays. Looking at spending more generally, household’s spending was up in most categories in January. That was likely supported by the fall in petrol prices that put money back in to households’ wallets. Over the past year as a whole, core (ex-fuel spending) was up 5.3%.
Following December and January’s sharp swings, we expect to see spending returning to trend in February. We’re forecasting a 0.3% gain in retail spending over the month, underpinned by a 0.4% lift in core (ex-fuel) categories.
UK Meaningful Brexit votes
- March 12 to 14
On 12 March, the House of Commons will vote on PM May’s proposed exit agreement for a second time, and it’s likely to be defeated again.
The PM has stated that should her agreement be voted down at its second reading, she would table motions on two pivotal issues on the following days. First, MPs would be asked to vote on whether they support leaving the EU without a withdrawal agreement (i.e. a ‘no-deal’ Brexit). We expect this motion will be defeated.
Second, assuming MPs reject a ‘no-deal’ Brexit, they will be asked on whether to seek a short extension to the negotiation period with the EU. We expect that this motion will be approved. EU agreement would still be required, but this would pave the way for Brexit to be delayed beyond the current 29 March deadline.
US Jan retail sales and Feb CPI
- Mar 11, retail sales, Last: –1.2%, WBC f/c: 0.2%
- Mar 12, CPI, Last: 0.0%, WBC f/c: 0.1%
December US retail sales was a significant disappointment to the market, registering a 1.2% decline. Notably, this was not the result of price volatility, with the control group (which excludes volatile items) down 1.7%.
Based on anecdotes of sales into year-end, a positive revision seems a high probability, but presumably, the decline won’t be wiped away entirely. If, as we and the market expect, the January retail number is broadly flat, then it will set GDP up for a weak Q1, limiting 2019 growth to nearer 2.0%yr than the 3.1%yr pace of 2018.
For the CPI, there are two key stories. In terms of momentum, energy price volatility remains key. For core prices, inflation looks very sticky around the 2.0%yr medium-term target of the FOMC. This is good for policy makers, with a reactionary stance able to be maintained with little risk.