Bleak Data Confirms Lower Rates Ahead
The latest survey of business investment intentions from the Australian Bureau of Statistics made for very bleak reading. Not only is the non-mining sector not revising up their capital spending plans - as anticipated by the Reserve Bank of Australia - they have actually revised them down. Allowing for the differences between expected and actual investment outcomes over time, the latest survey suggests overall private business investment will fall by around 20% next financial year.
Based on current estimates, mining investment is expected to decline by almost 30% next financial year – a big downgrade from an expected decline of 12% in the previous survey. Quite clear, the slump in iron ore prices – and the more dodgy outlook or energy prices in general - has taken its toll on expansion plans. Investment in the non-mining sector, meanwhile, is not expected to decline by around 10% - compared with an expected fall of 7% in the previous survey.
The bottom line is that the mining investment downturn is deeper and quicker than previously expected, while the hoped for upturn in non-mining investment has so far failed to materialise. Given that office construction accounts for around 40% of non-mining investment and office vacancy rates in our major capital cities remains relatively high, it’s hard to expect much of an upturn in that area anytime soon. And thanks to the still uncomfortably high Australian dollar – and relatively strong growth in wage costs compared to major trading partners in recent years – another key source of non-mining investment, the manufacturing sector, remains in retreat.
To put all this in perspective, a 20% decline in a key cyclical sector of the economy that accounts for around 15% of national output is consistent with the type of declines normally seen in recession.
In the 1990-91 financial year, for example, business investment fell 16% while GDP overall fell by 0.4% - the last clear recessionary period Australia has experienced. And in the 1982-83 financial year – another recession period - business investment fell by 12.5% while GDP overall fell by 2.2%.
Based on those numbers it’s hard to believe business investment could slump by 20% in 2015-16 and Australian would not succumb to recession.
Looking at other parts of the economy, it’s hard to see what could pull the economy upward.
Home building has made a great contribution to growth in recent years, but it’s hard to see the already high level of housing construction ramp up a lot more. At best, home building may plateau over the coming year. Worse, as the Reserve Bank recently pointed out, the supply of available development land in the hot spots of Sydney and South East Queensland appears to be rapidly running out – suggesting supply side constraints might soon constrain the spate of high rise developments in both regions.
As for public spending, budget constraints at both the State and Federal level suggest we can’t expect too much. As it is, Federal Treasurer Joe Hockey was proud to boast recently that the budget deficit will shrink marginally next financial year from 2.6 to 2.1% of GDP. To economists, that means the budget will be a net restraint on economic growth next financial year.
While resource export volumes are growing, export income remains weak due to the slump in commodity prices. Manufacturing and service sector exports are lifting, but the upturn remains far from strong.
Of course, the great growth hope for next financial year is now consumer spending – which accounts for around 50-60% of GDP.
Both the Treasury and RBA are counting on a rise in consumer spending to an above-trend pace thanks to a decline in household saving, which in turn is caused by rising housing and share market related household wealth. But that’s seems a big ask considering than real wages are now hardly growing, unemployment remains relatively high, household debt is also high, and consumers still appear quite cautious about their job prospects and finances since the 2008 financial crisis.
The bottom line of all this is that the RBA’s recently released economic growth forecasts are likely to be revised down further in coming months, which in turn suggests interest rates will need to be cut further unless the Australian dollar slumps in a major way.
My call that the official cash rate will decline to 1.5% by year end and the $A will decline to around US68c remains firmly in place.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.