Bill Evans: Weak growth trashes RBA and Budget outlook

Via Bill Evans of Westpac:

The Australian economy grew by a disappointing 0.4% in the September quarter for annual growth of 1.7%.

Of most concern is that this represents the fifth consecutive quarter where private final demand, which declined by 0.3% in September, either contracted or was flat.

Within private final demand the most surprising undershoot was household consumption, which expanded by only 0.1%.

Over the last year household consumption has grown by only 1.2%, compared to a trend pace of around 2.8%.

This soft outcome for households is despite a 2.5% lift in household disposable income in the quarter, driven by a solid lift in labour income growth (1.1%); a 6.8% fall in tax paid and a 2.5% fall in interest paid (all these measures are nominal).

Consequently there was a substantial lift in the savings ratio from 2.7% in the June quarter to 4.8%. This is convincingevidence that uncertain households chose to “save” the tax and interest rate cuts, and then some.

The contraction in the dwelling construction cycle continued into the September quarter. New dwelling construction contracted by 2.8% to be down by 11.0% over the year.

With businesses facing flat demand it is not surprising that new equipment investment fell by 4.5% in the quarter (-2.2% for the year) with overall business investment down 2.0% for the quarter (-1.7% for the year).

Growth continued to be boosted by public demand (+1.7% for the quarter and 5.2% for the year).

The Federal Government and the Reserve Bank will be disappointed with this result. A lift in annual output growth from 1.6% to 1.7% is hardly a “gentle turning point” when private final demand contracted by 0.3% following a 0.1% contraction in the June quarter.

Despite a solid boost to incomes, the cautious consumer has chosen to lift its savings rate and hold spending effectively flat. The lift in savings is over and above the policy stimulus – suggesting heightened risk aversion.

RBA rate cuts have had some impact with house prices lifting nationally by 2.3% (including 3.5% in Sydney and Melbourne) in the September quarter. This turnaround has clearly failed to boost spending in the quarter although any wealth effect is likely to have substantial lags, probably in the order of 1 months.

That consumer caution, along with an uncertain global outlook, has constrained business investment while the contraction in the residential construction cycle continues to unfold.

It seems likely that the Reserve Bank will need to lower its optimistic growth forecast for 2020 of 2.8% given it is underpinned by a lift in consumer spending growth to 2.4% (compared to the current 1.2%) and a 6.2% lift in business investment.

Westpac has long held the view that the RBA’s 2020 growth forecasts were overly optimistic. Our forecast for growth in 2020 has been 2.4% following a 2.3% increase in 2019.

The main areas of difference with the RBA have been around the outlook for business investment growth (2.8% compared to 6.2% for the RBA) and dwelling construction (-6.0% compared to -2.6% for the RBA).

Our forecasts for consumer spending were largely aligned (2.3% compared to 2.4% for the RBA).

Following the lower than expected growth in the September quarter and the associated evidence that the household sector is gripped in a sustained period of caution and risk aversion (average quarterly growth in consumption of 0.28% since the September quarter 2018) we have lowered our forecast annualised growth pace for consumer spending in the first half of 2020 from 2.3% to 1.6%.

That lowers our forecast for growth in consumer spending for 2020 from 2.3% to 1.8%.

Along with some other more modest downward adjustments to business investment (2.8% to 2.2% and dwelling construction (-6% to -7.1%) we have lowered our GDP growth forecast for 2020 from 2.4% to 2.1%.

As discussed, that compares with the Reserve Bank’s forecast in November of 2.8%. Accordingly we expect that the RBA, while unlikely to follow Westpac’s forecast exactly, will revise down its 2020 growth forecast from 2.8% to 2.5%. A revision in growth from trend to below trend would represent an appropriate opportunity to deliver on the next rate cut from 0.75% to 0.5%.

That growth revision (from trend to below trend) will be released following its Board meeting on February 4 and, together with an associated boost in the forecast unemployment rate (currently flat lining at 5.2% to end 2020) will make the decision to further cut the overnight cash rate to 0.50%, at that February meeting, a reasonable response.

We expect that cut will be eventually followed by a further cut in June to 0.25%, a little after the Commonwealth Budget which will be released on May 12.

Westpac has argued strongly that the Commonwealth government should bring forward the personal income tax cuts which have been legislated to begin from July 2022. Such a policy initiative would boost the consumer spending profile through the second half of 2020 and in 2021.

A key issue here will be whether the Commonwealth government believes that the bring forward can be accommodated while still delivering on the election commitment of fiscal surpluses from 2019/20.

Current Budget forecasts point to surpluses of $7bn (2019/20); $11bn (2020/21); $17.8bn (2021/2022); and $9.2bn (2022/23).

The approach would be to bring forward the $14bn in tax cuts in two suggested stages of $7bn in 2020/2021 and 2021/22.

That would allow surpluses in 2020/21 and 2021/22 of $4bn and $3.8bn respectively – tight but nevertheless surpluses.

In that regard the Government’s Mid-Year Economic and Financial Outlook (MYEFO), which is scheduled to print before December 20, will be very important.

As with our expectation that the RBA will be revising down its growth forecasts in February the government may be forced to do the same in the MYEFO. Of most interest will be the impact on the fiscal outlook of a likely downward revision in the forecast for the growth rate in the Wage Price Index (currently 2.75% through 2019/2020 and 3.25% in 2020/2021). Note that the RBA is forecasting 2.3% in 2020 and 2021.

GDP growth is forecast at 2.75% ( 2019/20) and 2.75% (2020/21) compared with Westpac’s forecasts of 2.0% and 2.2% respectively.

On the other hand, the Government has forecast the iron price at USD 55 per tonne by end March 2020 – currently USD 89 per tonne and clearly a significant underestimate.

The revised fiscal outlook will be important for gauging whether the government assesses that there will be sufficient fiscal scope to accommodate the bring forward of the personal income tax cuts.

Even with a bring forward of the tax cuts, we assess that the economic environment (particularly around our forecast 5.6% unemployment rate through most of 2020) will be sufficiently threatening for the RBA to see the need for a second rate cut in June 2020 to the “effective lower bound” of 0.25%.

From that point, in an environment where we expect the US Federal Reserve to be cutting rates – putting downward pressure on global rates – the RBA will need to adopt a QE style policy to contain any unwelcome boost to the AUD as well as put further downward pressure on the risk free rate.

That policy is likely to take the form of a regular monthly purchase program of $2-3bn comprised of Commonwealth government bonds and probably, selected semi government securities. The program is likely to be open ended, contingent on the economic and inflation outlook.

Evidence from offshore, as set out in the Bank of International Settlements study (CGFS Papers No. 63) point to “overall, the effects have been estimated as positive for both output and inflation, but these assessments are subject to a high degree of uncertainty.”

Channels recognised in the studies refer to reductions in the risk free rate; impacts on bank lending (as reserves of the banks are increased); currency effects; and spill overs to other private sector rates.

Such a modest purchase program could be extended well into 2021 by which time we expect the economic outlook will have shown steady improvement.

David Llewellyn-Smith
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  1. I often get the feeling that these guys get too obsessed with numbers and don’t look at what is behind the numbers. After all, if you just looked at the numbers during the mining boom years or the property boom years you would have said things are going great. How many of these guys were saying things are going good but the whole thing is obviously unsustainable and we need to prepare for economic reform?

    • When your face is crammed with cake and your on a sugar/smell of new Jag/latest Krug/third beach house high ………. you tend not not worry where the riches (and sucker clients) are pouring in from………….

    • How many times have you ever heard someone in the economics establishment actually question the theories they swallowed in Uni as ‘gospel’. How many times do you hear them admit that eye-watering debt levels may be to blame for the fact that the last 0.25% rate cut didn’t deliver the growth that their ‘models’ told them it would. How long will it take for economists to finally clock that the economy has nothing to do with maths but is all about human activity and the incentives that individuals face in day-to-day life.

      Perhaps this will explain:
      “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
      ― Upton Sinclair,

      • Dominic. Thanks for the reference. I’ve used that saying myself, but never knew where it originated until now

        • Upton Sinclair is a gold mine for really pithy observations:

          “If we are the greatest nation the sun ever shone upon, it would seem to be mainly because we have been able to goad our wage-earners to this pitch of frenzy.”
          ― Upton Sinclair, The Jungle

          Sounds familiar?

        • And one more for the road:

          “So long as we have wage slavery,” answered Schliemann, “it matters not in the least how debasing and repulsive a task may be, it is easy to find people to perform it. But just as soon as labor is set free, then the price of such work will begin to rise. So one by one the old, dingy, and unsanitary factories will come down— it will be cheaper to build new; and so the steamships will be provided with stoking machinery , and so the dangerous trades will be made safe, or substitutes will be found for their products. In exactly the same way, as the citizens of our Industrial Republic become refined, year by year the cost of slaughterhouse products will increase; until eventually those who want to eat meat will have to do their own killing— and how long do you think the custom would survive then?— To go on to another item— one of the necessary accompaniments of capitalism in a democracy is political corruption; and one of the consequences of civic administration by ignorant and vicious politicians, is that preventable diseases kill off half our population. And even if science were allowed to try, it could do little, because the majority of human beings are not yet human beings at all, but simply machines for the creating of wealth for others. They are penned up in filthy houses and left to rot and stew in misery, and the conditions of their life make them ill faster than all the doctors in the world could heal them; and so, of course, they remain as centers of contagion , poisoning the lives of all of us, and making happiness impossible for even the most selfish. For this reason I would seriously maintain that all the medical and surgical discoveries that science can make in the future will be of less importance than the application of the knowledge we already possess, when the disinherited of the earth have established their right to a human existence.”
          ― Upton Sinclair, The Jungle

      • proofreadersMEMBER

        Perish the thought what rubbish they now teach as gospel in an economics degree – ZIRP 101 is to die for?

        • If you follow developments in economics closely you’ll note that every time the ‘models’ fail, they get tweaked post-facto to deliver the outcome that actually happened. Either that or some convenient excuse is trotted out.

    • Love this comment. Most of these finance guys have a list of economic indicators and are just box tickers. They see the economy as a black box where resources go in and these magical numbers come out. There is no need to analyse beyond that. Just blows my mind how these people have these high paying jobs when their analysis is so simplistic.
      There are also the types like ‘the excellent Damien Boey’ who does all these complex models but seems to get too caught up in the numbers. It’s not that complicated. Guys like that shouldn’t be in finance. They should be off doing R&D work.

  2. “This turnaround has clearly failed to boost spending in the quarter although any wealth effect is likely to have substantial lags, probably in the order of 1 months.” – this explains everything.
    So we need “equity mate” in order to procure anything. Wouldn’t that mean, due to ultra high home loans, we simply don’t have ability to save? And what comes next once households spend the 2 month equity they built? How far can the loans grow without wage growth?

    • Not just any old ‘equity mate’ – illusory profits. Unrealised profits. But don’t worry, prices only ever go UP so they’re as good as money in the bank, even if they’re strictly unrealised 😉

    • proofreadersMEMBER

      To the moon – just wait until Josh Rainbowberg orders the banks to lend whatever the credit?

      • I’ll be at the front of the line. Having got my stash of Pacific pesos at the introductory rate of 0% I’ll be headed down to my local bullion merchant. 😉

  3. The giant turd that is the Australian economy starts circling the drain just a little faster ……

  4. Is the solar cycle a leading or lagging indicator? The comments section of this blog has piqued my interest in Jan 2020. Bring on the future credibility rebuild of Lowe in full sun worshiper druid’s gown!