Australia losing steam

02 November 2011

The Australian economy lost momentum heading into the second half of 2011.  Business confidence fell as those firms which had been struggling with insipid demand and the strong A$ realised that no turnaround was likely in the short term.  As a result, employment intentions fell and some firms delayed hiring.  Unemployment has nudged higher as a result.  While the softening of the labour market is a recent development, it is an important one as it threatens to reinforce the weakness of consumer spending.  Similarly, residual fears about Europe’s debt problems are also taking their toll on Australian confidence.  

Resources still ok...

But while the domestically focussed part of the economy has veered off the strong growth path foreshadowed by policymakers, the mining investment story remains essentially unchanged.  While mining companies aren’t able to invest as much – or as quickly – as they desire, overall investment is still growing strongly.  What is now clear, however, is that this isn’t sufficiently strong to underpin the overall economy.  

Escalating financial market volatility and heightened fears about Europe’s debt situation has also taken its toll on some commodity prices, including a recent fall off in iron ore prices.  Sharply lower commodity prices could prompt some mining firms to temper their aggressive expansion plans, but as yet there is no sign of that occurring.  Indeed announcements of new expansions continue to flow.  

...but employment situation is challenging

Despite this, the weaker 3Q inflation data, with underlying inflation growing at just 0.3 per cent quarter on quarter, makes it clear that the Australian economy is currently growing at a sub-trend pace.  

This is also being seen in employment data, with the unemployment rate edging higher as the pace of employment growth fails to keep pace with the number of people entering the labour market.  And one reason to think that this process may persist is that economic weakness is increasingly concentrated in those sectors that employ a lot of people, namely construction, retail trade and manufacturing.

Moreover, even if these sectors simply defer hiring, any new entrants to the labour market will be more likely to join the ranks of the unemployed rather than obtain employment.  For example, while retail spending has been very weak over the last year, rising by just 2.1% over the year to August 2011, retail employment has increased by a reasonable 1.4per cent.  However, the NAB survey reveals that hiring intentions in the retail sector have deteriorated, and if this is reflected in retailers freezing staff numbers or actually retrenching some staff, then it will obviously weigh heavily on overall jobs growth.  

The construction sector is in a similar position.  While engineering construction is very strong, those projects are very capital intensive.  For example, the $43 billion Gorgon LNG development will only employ 6,000 people at its peak.  In contrast, the far more labour intensive housing and non-residential building sectors have experienced weaker building approvals over 2011 and this could be reflected in weaker employment in 2012.  But even if firms hoard workers, as long as they cease hiring, then this will still exert upward pressure on the unemployment rate.

Other relatively large employment sectors also face challenges.  For example, most State governments have announced voluntary redundancies programmes for State public servants.  And while these individual programmes are not particularly large, they do suggest that State governments are trying to limit employment growth.  Similarly, at a Federal level, the Commonwealth Government’s desire to return the budget to surplus as quickly as possible is posing as a constraint on employment growth.

Thus, even though mining investment is very strong, it appears increasingly unlikely that it will deliver enough “bang for the buck” to support the overall economy.  It is also worth reiterating that mining companies are finding increasingly difficult to achieve their aggressive investment plans.  For example, when quizzed in April 2011 about how much they planned to spend in 2011Q2, mining companies indicated that they would spend close to $20bn.  As it turned out, investment was actually less than $14bn in Q2.

The ‘wealth effect’ is an added element to the story

Taking a step back from the recent flow of data, policymakers (and investors) should also be wary of the possibility of an adverse feedback loop developing in the economy.  One reflection of consumer caution is the weakness of house prices over 2011, which have now fallen for 8 months and by 3.7per cent from their recent peak.  This is a sharper fall than occurred in 2008.  What has also been apparent over 2011 is that housing turnover has declined sharply.  This reflects potential vendors deciding not to put their houses on the market and accept lower prices.  Of course, as supply has declined, it moderated the pace of price decline.  

If, however, the unemployment rate starts rising more sharply, there is a risk that more people will be forced to sell their property into a falling market.  This would mean that the pace of price declines would accelerate.  And of course, falling house prices – alongside falling equity markets – also reduces household wealth and consumer confidence.  And this will make households less likely to spend, which will exert further pressure on retailers and retail employment.  

It is important to be clear that this is a risk; it hasn’t happened yet.  And lower interest rates will go a long way to ensuring that this risk doesn’t materialise, as they will make housing more affordable, enable some potential first-home buyers to enter the market and make it easier for existing mortgage holders to service their mortgage.  

Reserve Bank changes course

And fortunately, policymakers now appear to recognise that the Australian growth story is not going to plan.  And just as importantly they have signaled that they are prepared to lend a helping hand to support activity as necessary.  Lower interest rates will certainly provide a boost to confidence and will stabilise activity in 2012.  But it will take some time for the benefits of easier monetary policy to flow through the economy, which implies that conditions will remain challenging for many firms over the remainder of 2011 and early 2012.