Summary: The Reserve Bank of Australia has pinned its policy forecasts to projected labour market strength, but the latest business conditions data show a hiring slowdown. Will Australia's central bank pivot to an easing stance to accomodate the slowdown?
Australian business conditions have continued to deteriorate in 2019 according to the NAB Business Survey for February, pointing to a continued slowdown of economic growth momentum ahead. Today’s business survey highlights that pressure within the business sector is building.
The slide in slowdown in economic growth, both globally and locally, is spilling over into the business sector with profitability taking a hit. This comes as the Q3 and Q4 2018 GDP readings now confirm that the domestic economy recorded the two weakest quarters of growth since the financial crisis as household spending continues to drag on growth. Last week’s weak Q4 GDP report, where GDP growth slowed to 2.3% year-on-year (well below the Reserve Bank of Australia’s 3% target), highlighted the loss in economic growth momentum in the back half of 2018.
As incoming data continues to point to little reprieve in a growth rebound, the RBA looks increasingly at odds with economic reality.
The RBA has pinned the future path of its monetary policy to strength in the labour market, which has so far remained a bright spot in the domestic economy. The RBA is banking on employment strengthening and wage growth coming through to offset the negative wealth effect and consequent hit to consumption due to falling property prices. In our view, the RBA is too optimistic and will need to cut the cash rate, but until there is evidence of labour market strength tapering off, the RBA will be less inclined to cut rates.
Today’s business survey highlights that the slide in the property market and slowdown in economic growth, both globally and locally, are spilling over into the business sector. This is of particular importance as the strength in the labour market will be crucial in determining the RBA’s next policy move. Leading indicators within NAB’s survey today highlight that business conditions are likely to remain weak; if growth continues to decline, businesses will cut hiring and unemployment will rise, and then we can expect a further easing bias to be adopted by the RBA.
Employment will not continue to hold up as confidence is eroded and growth continues to lose momentum. Currently, the labour market remains resilient, but unemployment is a lagging indicator, so the data only give us a backwards-facing view on the health of the labour market.
Within today’s survey, capacity utilisation continued to decline and is now below average. This is another leading indicator pointing to slowing in the labour market and a potential rise in unemployment ahead.
ANZ job advertisements are another leading indicator (unlike unemployment, which is lagging) that points to a potential drop in hiring ahead, indicating unemployment will rise. This is consistent with our view that economic growth is deteriorating and will continue to do so throughout the year.
Along with these leading indicators, the continued slump in building approvals –now down 28.6% y/y – highlights a marked decrease in residential construction to come, pointing to potential weakness in employment in residential construction. As the housing market slide continues, it is only a matter of time before jobs are affected, particularly in Sydney and Melbourne where the steepest declines have been felt. We expect the unemployment rate to creep higher as economic activity slows.
Given that strength in the labour market is crucial in determining the RBA’s next policy move, and that many leading indicators suggest labour market strength will soon drop off and unemployment will rise, we can expect a further easing bias to be adopted by the RBA. We don’t necessarily need to see unemployment move up in a big way, given that it has remained the RBA’s pillar of strength in the domestic economy. If this were to crumble, there is probably a relatively low threshold for moving to a cut. As previously noted, we believe eventuality will be inevitable, and the RBA will need to act by moving to cut the cash rate.
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