Macro (Re)view (29/11) | Australian QE in prospect for 2020

The outlook for domestic monetary policy was the key focus this week following a speech by the RBA Governor Philip Lowe at the Australian Business Economists Dinner in Sydney. The speech was titled "Unconventional Monetary Policy: Some Lessons From Overseas" and, by way of background, drew upon the findings of a recent report released by the Committee on the Global Financial System, of which Governor Lowe is the Chair, at the Bank for International Settlements. The report examined the efficacy of central banks' use of unconventional policy tools in the post-GFC period. 

Governor Lowe discussed four unconventional policy tools; negative interest rates, extended liquidity operations, asset purchases or quantitative easing (QE), and forward guidance. The overarching observations were that liquidity operations were particularly effective in addressing dysfunction in markets and ensuring the real economy did not suffer from a constrained credit supply, though the effectiveness of the other tools was viewed as less compelling, in part due to negative side-effects that can be associated with those options. As such, the lesson was that as conventional monetary policy runs out of steam "a package of measures works best, with clear communication that enhances credibility". Tuesday night's speech was certainly consistent with the second part of this lesson. 

With the cash rate sitting at 0.75%, Governor Lowe outlined that the RBA is not yet at the point where it is considering implementing unconventional policy tools, however he noted; "Our current thinking is that QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that". The option of QE would involve the RBA buying government bonds in the secondary market, with the aim of lowering yields across the curve through a purchase and signaling effect, in turn supporting asset prices and keeping interest rates in the real economy low. The hurdle to going down the path of QE is high and is not seen by the governor as a  straightforward transition from cutting rates. As it stands, the RBA is forecasting gradual progress towards its objectives for full employment and inflation within the 2-3% target band, though if the outlook was to deteriorate and suggest those outcomes were unlikely, QE will come onto the Bank's radar. Back in August, Governor Lowe appeared before the House of Representatives' Standing Committee on Economics where the threshold for implementing QE was discussed. In the situation where other central banks around the world were cutting rates towards zero; domestic GDP growth was to remain stuck within the 1% range; the unemployment rate was rising; wages growth stays low; and inflation remains below target, Governor Lowe said "we'll need to look at all monetary options". 

In the first instance, however, the Board still has 50bps of rate cuts in reserve, which it is prepared to call on if the domestic labour market or developments from offshore were to deteriorate. On the former, the Deputy Governor of the RBA Guy Debelle discussed in a speech during the week the structural forces that have been at play in driving workforce participation to record-high levels. While this is a positive in and of itself, it has contributed to a prevalence of wages growth outcomes in the 2% range commensurate with the rise in supply of workers. As the Bank has found, that is not a pace consistent with inflation at target and thus further easing in the cash rate remains the most likely course of action. 

The data flow this week showed that the downturn in the nation's construction cycle extended to a fifth consecutive quarter after falling by 0.4% in Q3 (reviewed here). The weakness remains centred around residential construction, as new home building by the private sector contracted by a further 3.4% in the quarter to be down by 10.7% over the year. More positively, public infrastructure work appeared to be resuming its uptrend after coming through a soft patch over recent quarters, with activity up by 6.4% in Q3. 

Business investment was soft again in Q3 as private sector capital expenditure (capex) fell by 0.2%, with the annual decline steepening to -1.3% (reviewed here). The detail for the quarter was patchy with equipment spending contracting by 3.5% against a 2.7% rise from buildings and structures. Uncertainty offshore and weak domestic demand conditions have appeared to weigh on firms' investment plans for 2019/20 with estimate 4 softer than expected at $116.7bn, which implies only a modest 2.5% increase in capex spending over the year (see chart of the week, below). Three months earlier, firms were projecting capex to rise by around 10% over 2019/20. The downgrade has been driven by the non-mining sector, notably from services firms, with investment now anticipated to fall by 2.8% in the current financial year compared to a projected rise of around 6% three months ago. However, the outlook in the mining sector remains strong with investment forecast to rise by 15.7% in 2019/20 and bring to an end six consecutive years of decline associated with the wind-down from the boom in the early part of the decade. Next week's highlight is the National Accounts for Q3, with GDP growth expected to rise by 0.5% in the quarter and by 1.6% over the year (preview here).    

Chart of the week 

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Turning to developments offshore, US President Trump ratified legislation that was passed by the Senate last week that intensifies scrutiny of Hong Kong's autonomy from China. In effect, the legislation provides backing to anti-government protesters in Hong Kong and has led markets to question whether or not it could derail progress on reaching the phase one trade deal between the US and China. Focusing on the US, Federal Reserve Chair Jerome Powell in a speech this week reiterated the message that, after delivering rate cuts at its previous three meetings, the monetary policy stance was now well-calibrated to support a continuation of strong labour market conditions and a sustainable return of inflation to the 2% target. 

Weaker global growth and trade uncertainty has slowed the US economy over the past year, and while these remain ongoing risks, growth is holding up and was revised higher this week to a 2.1% annualised pace in Q3 from the initial estimate of 1.9%. The growth engine in the US economy has been consumer spending and the early indications are that it remained solid at the start of Q4 rising in line with estimates by 0.3% in October. However, inflation remains muted with the Fed's preferred measure, the core PCE index, easing from 1.7% to 1.6% over the year. Meanwhile, durable goods orders were more constructive than anticipated rising by 0.6% in October against an expected fall of 0.9%, while orders excluding transportation also lifted by 0.6% on the month (expected 0.1%), but both remain lower over the year at -0.7% and -0.4% respectively, which underscore the weakening impact that economic and trade uncertainty has had on business investment.

In Europe, the EU Parliament approved a new Commission to be led by Germany's Ursula von der Leyen from December 1. The data flow was solid, with the unemployment rate in the 19-nation euro area easing from 7.6% to 7.5% in October to be at its equal-lowest level since July 2008. Headline inflation in the bloc lifted from 0.7% to 1.0% in annual terms to November and was above the consensus forecast for 0.9%, while core inflation also firmed from 1.1% to 1.3% over the year. Lastly, in the UK, PM Boris Johnson appears on track to claim victory in the General Election to be held on December 12, with the closely followed YouGov Poll pointing to a 68-seat majority for the Conservatives.      

    

Preview: Australian Q3 GDP

The ABS is scheduled to release the September quarter National Accounts today (4/12) at 11:30am AEDT. Momentum in the Australian economy has decelerated sharply over the past year; from its most recent peak in mid-2018 GDP growth has slowed from a 3.1% annual pace to 1.4% in mid-2019. The key dynamics have been a weakening global economy, with trade and geopolitical tensions accentuating the impact of more entrenched structural headwinds, while domestic private sector demand has been weighed by slowing household consumption growth, a downturn in the residential construction cycle and weak business investment. For today's release, GDP growth is expected to have risen by 0.5% in Q3 and 1.6% through the year according to estimates compiled by Bloomberg.   

As it stands | National Accounts — GDP

GDP growth in the June quarter was 0.5%, matching both the consensus forecast and the outcome from Q1. Through the year, growth eased from 1.7% to a new post-GFC low of 1.4% and is below the rate of population growth (1.6%). Australia's trend or potential rate of growth is estimated to be around 2.75%. The recent momentum has at least improved somewhat; output growth was tracking at around a 1% annualised pace over the second half of 2018 but firmed to around a 2% annualised pace over the first half of this year. The RBA assessed this development as a sign the domestic economy may have reached a "gentle turning point".  

Activity in the global economy slowed further over the first half of 2019 as trade tensions, most notably between the US and China, and geopolitical uncertainties in the UK and in Europe intensified. In response, global trade flows weakened sharply and investment plans from firms were scaled back as sentiment deteriorated. These impacts were most pronounced within the global manufacturing sector, which slid into its deepest contraction in around 7 years in the first half. Meanwhile, activity in the more domestically-focused services sector also slowed but remained in a modest expansionary phase. 

These headwinds from offshore continued to set a challenging backdrop for the Australian economy over the first half of 2019. Growth in household consumption — the largest component of the domestic economy — slowed to its weakest annual pace in 6 years at 1.4% as low wages growth, a focus on paying down debt and subdued confidence weighed on spending, particularly in discretionary areas. Early indications were that stimulus from RBA rate cuts and tax relief to low-and middle-income earners was yet to gain traction with consumer spending, though conditions in the established major property markets in Sydney and Melbourne improved notably once the hurdle of May's federal election was cleared. In contrast, the deceleration in the residential construction cycle gathered pace with activity contracting by more than 9% over the year and was broadly based across the states, while dwelling approvals continued to weaken over the first half. 

Weakness in business investment persisted into 2019 falling by 1.6% over the year to Q2 weighed by the wind-down from completing projects in the LNG sector. Non-mining business investment lifted modestly over the past year supported by demand for machinery and equipment in the services sector, though at the same time non-residential construction activity softened. Against weakness in global trade, Australia has been relatively insulated due to strength in resource and services exports and by a depreciation of the domestic currency. In line with weak private sector demand, import volumes contracted by around 3% over the past year. Elevated commodity prices continued to generate a tailwind for national income growth and drove Australia to its first current account surplus since the mid-1970s in Q2, providing fiscal authorities with scope for infrastructure investment to support robust population growth in the capital cities and spending on public health initiatives. 

Key dynamics in Q3 | National Accounts — GDP

Household consumption — Retail sales volumes contracted by 0.1% in Q3 and fell by 0.2% over the past year to be at its weakest pace since 1991. Recent stimulus from RBA rate cuts and tax relief to low-and middle-income earners had yet to gain traction in supporting discretionary spending, which is a likely response to a weakening in consumer sentiment over the quarter prompted by concerns over the near-term economic outlook. Slow wages growth also persisted as a headwind for households. In spite of robust employment growth over Q3, the unemployment rate was little changed at 5.2% and spare capacity more broadly remained elevated as participation lifted to a record-high level. Spending on essential goods and services is likely to again drive household consumption growth in the quarter.  

Dwelling investment — The downturn in the residential construction cycle continued at pace in Q3 as new home building by the private sector contracted by 3.4% to be down by 10.7% over the year. Renovation work was broadly flat in Q3 but fell by 7.9% on a year earlier. In total, private residential construction activity contracted by 3.0% in Q3 and by 10.4% through the year, making this the sharpest downturn the sector has encountered in 18 years.  

Business investment  — Private sector capital expenditure declined by 0.2% in Q3 to be down by 1.3% over the year. Business investment is facing headwinds from uncertainty offshore and weak domestic demand conditions. This is having a notable impact on investment from the non-mining sector, though an improving mining sector is providing some offset.  

Public demand — Strong growth in public demand continued in Q3 rising by 1.5%. Public spending was up by 0.9% in the quarter and is supported by health and aged care initiatives. Meanwhile, there was renewed strength in underlying investment after a recent period of softness rising by 3.8% in Q3.  

Inventories  — For the second straight quarter inventories contracted, falling by 0.4% in Q3 led by the retail and manufacturing sectors. However, this was well below the 1.0% contraction recorded in the June quarter and thus inventories are expected to contribute modestly to GDP growth in Q3 by around 0.2ppt.      

Net exports — After a 0.6ppt contribution in Q2, net exports added a relatively modest 0.2ppt to activity in Q3. Export volumes lifted by 0.7% in the quarter, while imports showed continued weakness (-0.2%) in response to a lower Australian dollar and soft domestic demand conditions.  

Australian CapEx -0.2% in Q3; 2019/20 investment plans $116.7bn

Australian private sector capital expenditure (capex) declined for the third consecutive quarter in Q3, highlighted by weakness in equipment spending. Investment plans for 2019/20 were softer than anticipated and is centred on a downgrade in the non-mining sector.

CapEx — Q3 | By the numbers

• Total private sector capex spending fell by 0.2% (-$68m) in Q3 to $29.41bn against the median forecast for a stable outcome (0.0%). Capex declined by a downwardly revised 0.6% in Q2 from -0.5%. In annual terms, the pace of decline in capex lifted to -1.3% from -1.0%.

• Equipment, plant and machinery investment fell by 3.5% in the quarter (prior rev: +2.0%q/q), or by $488m to $13.56bn. This swung the annual pace from an acceleration of 5.9% to a contraction of 2.4%.

• Buildings and structures investment increased by 2.7%q/q (prior rev: -3.0%), or by $420m to $15.85bn, with the annual decline falling to just -0.3% from -6.4%.

• The 4th estimate of investment plans for the 2019/20 financial year was $116.7bn, which was softer than the $120.0bn figure anticipated by markets. Investment plans were upgraded by 3.4% compared with the previous estimate nominated by firms 3 months earlier and implies only a modest 2.5% year-to-year rise in capex spending.

CapEx — Q3 | The details 

Total capex spending by private sector firms contracted for the 3rd straight quarter with a modest fall of 0.2% in Q3 to be down by 1.3% over the past year. The weakness has centred on the non-mining sector of the domestic economy, in which capex spending fell by a further 1.8% in Q3 (-$388m) to drive the annual pace into a contraction of 2.3% — its weakest since Q4 2015. 

Breaking this down further, the slowdown in non-mining business investment has been driven by the services sector. Capex by services firms contracted by 2.7% in Q3 (-$518m) to $18.44bn and follows declines of 2.7% in Q2 and 1.4% in Q1. Over the year, services sector capex fell by 3.0% to be contracting at its fastest pace in nearly 4 years. Here, the weakness has been focused on equipment spending, though this has been moderated by rising investment in buildings and structures. The manufacturing sector saw capex rise by 5.5% in Q3 ($130m) to $2.50bn to be up by 3.0% over the past year, supported by investment in facilities and plant and equipment, though this is within the context of a wider downtrend since 2017. 

Mining sector capex lifted by 3.9% in Q3 ($321m) — its strongest quarterly rise in more than 7 years — to $8.47bn, with annual growth turning positive for the first time since the March quarter of 2013 at 1.2%. With projects now complete, mining firms will turn their focus to investment that will sustain and or expand production. 

The state detail showed declines in capex spending in Q3 occurred in New South Wales -0.3% (+2.0%Y/Y), Victoria -1.0% (+4.3%Y/Y), South Australia -7.0% (-1.3%Y/Y), Tasmania -23.1% (-31.8%Y/Y), Northern Territory -13.5%q/q (-48.2%Y/Y) and the ACT -12.2% (+4.6%Y/Y). The mining states of Queensland and Western Australia saw capex rise by 2.3% (-1.7%Y/Y) and 1.6% (-2.1%Y/Y) respectively in Q3.

The 4th estimate of investment plans for the 2019/20 financial year was nominated by firms at $116.69bn; a figure which includes 3 months of actual spending details and a forecast for the remaining 9 months. As such, firms upgraded their anticipated level of capex spending in the current financial year by 3.4% on the total they put forward 3 months earlier, while also implying a 2.5% increase compared with 2018/19. However, in Q2's capex report, firms had upgraded their expected level of capex spending in 2019/20 by 14.4% on estimate 2 and this implied a year-to-year increase of 10.2%. Thus, over the past quarter, firms have sharply scaled back their investment plans for 2019/20. In the RBA's recent quarterly Statement on Monetary Policy, business investment was forecast to rise by 6.9% in 2019/20.  

Leading the downgrade has been the non-mining sector, in which aggregate capex spending is now projected to fall by 2.8% in 2019/20 to $78.31bn. In Q2's report, non-mining investment was anticipated to rise by around 6% over the year. The weakness is driven by the services sector, with investment projected to fall by 3.3% over the year to $68.57bn, however manufacturing capex is anticipated to rise by 1.0% to $9.74bn. In the mining sector, the outlook is strong with capex projected to rise by 15.7% over the current financial year, which would be its first year-to-year increase since 2012/13.

CapEx — Q3 | Insights   

Ahead of next week's Q3 GDP growth figures, today's report pointed to another quarter of softness from business investment. In terms of investment plans, the outlook for the mining sector remains robust, though that is to a large extent moderated by a downgrade in the services sector. This is likely a reflection of below-trend conditions and confidence of firms highlighted in NAB's Business Survey. Business investment is facing strong headwinds across the globe from trade and geopolitical uncertainty and within that backdrop domestic firms are cautious.  

Preview: CapEx Q3

Australia's capital expenditure survey (capex) for the September quarter is due to be released by the ABS at 11:30am AEDT today. The capex survey provides a partial estimate of business investment over the quarter, as well as firms' investment intentions for the next financial year. Following declines in the previous two quarters, capex is forecast to have stabilised in Q3 reflecting the completion of major projects in the mining sector and a patchy profile from non-mining investment of late. The outlook for investment intentions is on the improve but faces headwinds from weak domestic demand conditions as well as economic and political uncertainty offshore.  

As it stands | Capital Expenditure

In the June quarter, capex spending declined unexpectedly by 0.5% to $29.2bn to be down by 1.0% on a year earlier. The weakness in Q3 was centered on construction, with buildings and structures contracting by 3.3% to $15.1bn (-6.6%Y/Y), while equipment, plant and machinery lifted by 2.5% to $14.2bn (+5.7%Y/Y).   

Mining sector investment posted its strongest quarterly result in 5 years in Q2 rising by 1.7% to $8.0bn as the wind-down from completing LNG projects was consigned to the past. The annual pace of decline slowed from -12.2% to -6.8%; well down from the trough reached 3 years earlier at -37.1%. Non-mining investment contracted by 1.3% in the quarter to $21.2bn, with the annual pace pulling back from 2.8% to 1.4%. After sizeable declines in the previous two quarters, manufacturing capex lifted by 8.5% in Q3 to $2.4bn (-0.4%Y/Y), though this was offset by a 2.4% fall in services capex to $18.8bn (+1.6%Y/Y). 

The 3rd estimate of capex plans for 2019/20 was upgraded by 14.9% on estimate 2 to a total of $113.4bn. This figure was 10.7% above the 3rd estimate put forward for the 2018/19 financial year. Investment intentions in the mining sector for 2019/20 lifted by 20.7% on a year earlier to $38.1bn to point to its first year-to-year rise since 2012/13. Non-mining investment was projected to rise by 6.2% over 2019/20 to $75.3bn, with intentions in the services sector up by 5.8% to $66.0bn and manufacturing lifting by 8.6% to $9.3bn. 

For a full review of Q2's report see here

Market expectations | Capital Expenditure

In today's report, the median expectation according to Bloomberg is for capex to be flat (0.0%) over Q3, between a range of forecasts from -1.4% to +1.0%. In terms of investment intentions, Q3's report includes the 4th estimate of expected capex for the 2019/20 financial year, which is based on 3 months of actual spending and a forecast for the remaining 9 months. The median expectation for estimate 4 is $120.0bn, with individual forecasts ranging between $113.5bn and $123.0bn.

What to watch | Capital Expenditure

The all-important intentions component is where markets will focus their attention. Firms reported their '4th estimates' of capex plans in 2019/20 during October and November. Over the period, global uncertainty eased slightly as the US and China agreed to the outline of a partial trade deal, the UK reach a new Brexit deal with the EU, while central banks in the US, Europe, Japan and locally in Australia reiterated their respective monetary policy stances would remain accommodative. However, caution still attends the outlook for an improving global economy in 2020, while from a domestic standpoint the NAB's Business Survey continued to show that conditions and confidence were stuck below their long-run averages. 

The median forecast for estimate 4 of $120.0bn for 2019/20 implies a lift of 5.8% on estimate 3 and is 5.4% above the 4th estimate put forward for 2018/19. The upgrade of 5.4% would only be in line with the series average for year-to-year increases for the 4th estimate, though if it materialises it would be the strongest outcome since 2011/12, which highlights the intense headwinds business investment has faced over recent years as the mining sector has unwound from the boom in the early part of the decade. The RBA closely monitors the intentions component in this survey and in its recent Statement on Monetary Policy it forecast business investment to rise by 6.9% over the year to mid-2020, supported by both mining and non-mining investment. 

Australian Construction Activity -0.4% in Q3

Australian construction activity contracted for a 5th consecutive quarter in Q3, though the 0.4% decline was more modest than anticipated and continued some positive details, most notably for non-residential work. The rollover in the residential construction cycle continued at pace, while a resumption of the uptrend in public works helped to mitigate weakness in private infrastructure activity.   

Construction Work Done — Q3 | By the numbers

• Total construction activity across the private and public sectors fell by 0.4% in the September quarter to $50.85bn, with markets anticipating a larger fall of 1.0%. Work done in Q2 was revised to show a smaller contraction of 2.8% compared to the 3.8% decline initially reported by the Bureau. Over the year, the pace of contraction slowed from -9.8% to -7.0%.   

• The headline results in Q3 were;

• Residential work -3.1%q/q to $18.27bn (-10.6%Y/Y)
• Non-residential work +4.0%q/q to $11.44bn (+5.3%Y/Y)
• Engineering work -0.2%q/q to $21.15bn (-9.6%Y/Y)  

Construction Work Done — Q3 | The details 

The downturn in Australia's construction cycle extended to a 5th straight quarter, with total activity falling by 0.4% in Q3 to be down by 7.0% through the year. The weakness centres on residential construction, with the non-residential sector bouncing back from a soft patch, while the trough for engineering work looks to be in. 

Activity in the private sector fell by 2.1% in Q3 to $38.65bn as the annual decline eased from -8.6% to -7.6%. This reflects sharp declines from both residential and engineering work, though non-residential activity is trending higher after a period of weakness in the second half of 2018.

 

The rollover in the private residential construction cycle continued at pace in Q3 as activity fell by 3.0% to accelerate the decline in annual terms from -8.1% to -10.4%. On that basis, the sector mired in its deepest downturn in 18 years. New home building contracted by 3.4% in Q3 to mark a 5th consecutive negative quarterly outturn, while the decline in activity over the year steepened from -8.5% to -10.7%. Alteration work was broadly flat in Q3 (-0.2%) but the contraction in annual terms deteriorated from -4.9% to -7.9%. Dwelling approvals fell by more than 7% in Q3 and were down by 21% year-on-year, indicating that further weakness in the sector is likely to be ahead.  

  

The non-residential sector is a bright spot for construction work with activity lifting by 4.1% in the quarter to be up by 6.4% over the year. This segment is being supported by a recent uptrend in approvals for projects such as offices and other commercial buildings. 

Private engineering (or infrastructure) work fell by 4.6% over the quarter and was down by 11.4% over the year. However, the outlook is supported by rising investment intentions in the mining sector and tomorrow's Capital Expenditure survey will provide more insight into this.

Turning to the public sector, activity lifted by 5.4% in Q3 to bring to an end a run of four previous quarterly contractions. This slowed the decline in annual terms from -13.4% to -5.1%. The resumption of the uptrend in public works was driven by a 6.4% lift in infrastructure work (-7.0%Y/Y) and a more modest 2.6% rise from building activity (+0.4%Y/Y). The recent slowdown in public infrastructure work likely reflected the completion of earlier projects, but with an elevated pipeline of work to come activity is likely to strengthen from here.   

    

The state-based outcomes are displayed as a heatmap, below. This highlights that the weakness in residential construction is evident across all states outside of Victoria, though at the same time the lift in non-residential work has been spread across most states some there has been some offset occuring. Engineering work has been soft across the mainland states over the past year, though activity in New South Wales and Victoria looks to have rebounded in this most recent quarter.  

Construction Work Done — Q3 | Insights

Overall, the outcome from today's report was better than anticipated, but construction will drag modestly from GDP growth in Q3. Activity continued to contract in residential construction and will persist well into 2020 given the ongoing weakness in dwelling approvals. The rollover in the residential sector is being moderated by an improving non-residential cycle and a renewed uptrend in public infrastructure work. 

Preview: Construction Work Done Q3

At 11:30am AEDT today, the ABS is due to publish its latest update of Australian construction activity for the September quarter and this will help inform the outlook ahead of next week's GDP growth figures for Q3. Over the past year, the nation's construction cycle fell into a sharp downturn driven by a rollover of activity in the residential sector, the wind-down in the mining sector associated with the completion of large-scale LNG projects, and a slowdown in public works. 

As it stands | Construction Work Done

Construction activity fell for the 4th straight quarter in Q2 with a sharper-than-expected decline of 3.8%. Over the year, activity contracted by 11.1% subtracting around 1.1ppts from national GDP growth. 

Private sector residential construction work fell by 5.3% in Q2 to be down by 9.9% through the year, which is its weakest annual pace in 18 years, with construction for houses -8.9%Y/Y and units -11.2%Y/Y. Non-residential (commercial) work in the private sector contracted by a sharp 7.8% on the quarter and by -3.8% year-on-year following an earlier upswing between 2017 and mid-2018. Private engineering work pulled back by a further 2.5% in Q2 for an annual decline of 15.7%, though the trough should be in with the mining sector set to lift investment for the first time in 6 years in 2019/20.  

In the public sector, total activity slowed by 0.8% in Q2 and fell by 13.0% over the year. Infrastructure work lifted by 0.9% in the quarter but was down by around 16.0% in year-on-year terms, which is likely to prove a temporary period of weakness given the elevated pipeline of projects to be completed. Public building weakened by 5.1% in Q2, swinging the annual pace from +4.6% to -3.7%. 

For a full review of Q2's report see here    

Market expectations | Construction Work Done 

In today's release, the median forecast according to Bloomberg's survey of economists is for construction activity to decline by 1.0% in Q3, with the range of individual estimates spread between -3.5% and +1.0%.

What to watch | Construction Work Done 

The outcome for private residential construction work is key and will provide an indication of the extent to which it will drag on GDP growth in Q3. In the previous quarter, residential construction subtracted 0.2ppt from overall activity and was a drag of -0.5ppt across the past year. The weakness is set to persist well into 2020 with dwelling approvals falling by 7.4% in Q3 to be tracking around 21% down on the level from a year earlier.  

Macro (Re)view (22/11) | Waiting and watching

Developments on the US-China trade front continued to the main focus of global markets this week as prospects for the finalisation of the phase one agreement before year's end appeared to be fading. Six weeks have now past since top-level delegates from the world's two largest economies met in Washington and agreed to the outline of a partial deal in what were the most tangible signs of progress in the 18-month long trade and technology dispute. Concerns over progress were raised this week after the US Senate passed legislation that in effect intensifies scrutiny around the extent of Hong Kong's autonomy from China, which has been the source of escalating anti-government protests in Hong Kong over recent months. The legislation that is expected to be ratified by US President Trump will require Hong Kong authorities to demonstrate it is maintaining a sufficient level of autonomy from Chinese rule to retain its special status as a separate jurisdiction under US law, as well as introducing the possibility of human rights sanctions on officials. While the move drew condemnation from China, it is unclear how it may impact trade negotiations with the US. Later on in the week, Chinese Vice Premier Liu said he was "cautiously optimistic" that the phase one agreement could be finalised, while an article from the South China Morning Post indicated that both sides would likely support postponing the introduction of new tariffs set to start on December 15 if a deal is unable to be reached before then. Overall, the uncertainty saw equity markets softer through the week, driving a flattening of the yield curve with the spread between US 2-year and 10-year treasury yields coming in for 9 straight sessions (see chart of the week, below).

Chart of the week 

In the US, the minutes from the Federal Reserve's (Fed) meeting at the end of October were released. At that meeting, the Fed's policy-setting Committee cut its interest rate target range by 25 basis points for the third consecutive occasion, citing risks to the economic outlook from global developments and muted inflation. Following this period of easing, the minutes reiterated the message that the Committee has shifted to wait-and-see mode from its earlier proactive policy stance, though it remains mindful it will have more work to do if downside risks were to materialise. The Committee expects that a strong labour market will continue to support the household sector and underpin the domestic economy from weakness in business investment and exports due to trade tensions and slower growth offshore, though as the events of this week demonstrate, this is a rather precarious balance and explains why the risks are assessed as remaining "tilted to the downside". The latest indications are that activity in the US economy is tracking at a below-trend pace, based on IHS Markit's 'flash' composite Purchasing Managers' Index (PMI) reading of 51.9 in November. Conditions could be set to improve in 2020 with activity in the manufacturing sector rising to a 7-month high at 52.2 and services firming to a 4-month high at 51.6. The consumer is key to growth prospects over the year ahead and while sentiment according to the University of Michigan's index improved by 1.4% over November to a reading of 96.8, a 1.4% decline in the assessment of current economic conditions amid trade and political uncertainty warrants caution. 

In Europe, IHS Markit's flash PMIs for November were in line with the previous two months by indicating that activity in the bloc has essentially stalled as the composite index softened slightly to a 50.3 reading. Weakness persists in manufacturing where the sector remains mired in its deepest downturn in 6 years, though November's reading lifted to a 3-month high of 46.6 in a sign that activity is beginning to stabilise. While the services sector has remained resilient to this weakness throughout 2019, recent indications are that spillover impacts are in train as activity softened to its lowest level since the start of the year at a reading of 51.5. Germany narrowly avoided falling into a technical recession in Q3, though the largest economy in the bloc remains under the strain of trade tensions and external weakness with its composite PMI remaining in contraction at 49.2 in November. 

Also this week, the Account of the European Central Bank's policy meeting in late October was published. At its September meeting, the Governing Council delivered a comprehensive package of stimulus measures to revive an ailing inflation outlook prompted by an ongoing slowdown in the euro area economy. Thus, October's meeting was very much focused around taking a "wait and see" stance that will allow the Governing Council time to assess how the economy responds to this new stimulus. In the lead up to September's meeting, several members of the Governing Council had been in public opposition to various elements of the stimulus package, most notably the reintroduction of quantitative easing. At what was the former ECB President Mario Draghi's final meeting, the Account outlined that "a strong call was made for unity of the Governing Council", noting that while robust discussions were appropriate and necessary, "it was regarded as important to form a consensus" as it would enhance its commitment to its inflation-targeting regime. This is the task now in front of the new President Christine Lagarde, who in her first major speech in the role called on fiscal authorities to work in tandem with the ECB's accommodative monetary policy stance to drive the euro area's long-term growth potential.

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The domestic perspective was informed this week by the minutes from the Reserve Bank of Australia's Board meeting held earlier this month. As was widely expected, the Board elected to hold the cash rate at 0.75% at that meeting on the basis that it wanted to "wait and assess" the impact of the three rate cuts it had already delivered in 2019 in June, July and October. Overall, the Board's assessment is that this easing is bolstering employment and income growth and is thus assisting with gradually returning inflation to target, while it has also noted an improvement in conditions in the established housing market and the "positive spillovers" this will generate for the broader economy. Less certain is what the extent of those spillovers is likely to be and how earlier rate cuts and tax relief will work their way through to household spending. Adding weight to the decision to remain on hold, the Board recognised that with interest rates at a record low level there was a negative confidence impact on savers, while it also discussed the thesis that further rate cuts "could have a different effect on confidence than in the past, when rates were at higher levels". Notwithstanding, the Board remains prepared to ease further and is closely monitoring developments from offshore as well as the state of the domestic labour market. In looking ahead, the Board anticipates that output growth will lift to trend (2.75%) next year, before firming to around a 3.0% pace in 2021, based on stimulus from low interest rates, tax cuts, rising house prices, a turnaround in mining investment and ongoing infrastructure spending. Regarding infrastructure, this week PM Morrison announced that $3.8bn of projects will be brought forward over the next 4 years, with the impact to be a $1.8bn boost in spending between now and the end of the next financial year. 

Macro (Re)view (15/11) | Downside risks remain prominent

As the Reserve Bank of Australia (RBA) has highlighted throughout much of 2019, the domestic economy is operating with considerable spare capacity and while this week's developments offered few new insights on this theme they underscored the challenge facing both monetary and fiscal authorities looking towards the new year. For the RBA, the state of the labour market is central to its thinking at the moment so this week was of key interest to markets. Counter to expectations for a 16.0k increase, employment fell by 19.0k in October to make this its weakest monthly outturn in more than 3 years (full review here). Though monthly outcomes are volatile, the key question is whether the slowdown in employment growth from 2.5% to 2.0% in annual terms becomes more entrenched in the months and follows the path implied by the forward-looking indicators.

That situation would make it considerably more difficult to lower the spare capacity that exists in the labour market given that the participation rate remains close to its highest level on record, notwithstanding a decline from 66.1% to 66.0% in this latest report. As it stands, Australia's unemployment rate returned to 5.3% after easing from this level to 5.2% in September, while underutilisation (13.5% to 13.8%) and underemployment (8.3% to 8.5%) also unwound their improvements from the previous month. Consistent with a labour market that it some way off testing its capacity constraints, wage pressures remain subdued. In Q3, the Wage Price Index matched market expectations at 0.5% in the quarter and 2.2% through the year; the latter easing from a 2.3% annual pace in Q2 (full review here). Public sector wages growth continues to outperform, though it slowed from 2.6% to 2.5%, as private sector wages growth held steady at around 2.3% (see chart of the week, below). Overall, it will remain clear to the RBA that labour market conditions need to be considerably tighter to generate a pace of wages growth that is consistent with inflation between its 2-3% target band. Thus, further easing appears likely in early 2020 and market pricing for this has firmed accordingly. 

Chart of the week

Fiscal policy could also have a more impactful role to play, with this week's Westpac Melbourne Institute Index of Consumer Sentiment report highlighting an ongoing reticence to spend. In November, consumer sentiment lifted by 4.5% to mostly reverse the previous month's fall of 5.5%, though it remains at an outright pessimistic level of 97.0. Westpac's Chief Economist Bill Evans reports that views on family finances improved compared to a year ago (+5.2%) and for the next 12 months (+5.7%) in November, though both sub-indexes are at below long-run average levels and were coming off sharp falls in the previous month, so the magnitude of the gains since September can be considered disappointing as they have occurred alongside stimulus from RBA rate cuts, federal government tax relief and improving housing market conditions. Highlighting the lacklustre appetite for discretionary spending at the moment, a little more than half of respondents said they would spend about the same this Christmas as they did last year, while an additional 1 in 3 respondents planned on cutting back. Also of note, views around the economic outlook improved in November; next 12 months +4.0% and next 5 years +5.2%, but both sub-indexes have been strong headwinds for consumers over the past year falling by 13.1% and 10.1% respectively. 

For firms, NAB's Business Survey indicated a slightly improved, though still soft, tone in October. Business confidence firmed from 0 to +2, while conditions lifted from +2 to +3; however, both are still comfortably below their long-run averages of +6. The improvement in overall conditions came from the trading sub-index rising from +4 to +7 and from profitability lifting from -2 to 0. Relevant to our earlier discussion on the labour market, this was not enough to generate stronger employment expectations, which after holding at +4 indicated that jobs growth was likely to average around 18.0k per month over the next 6 months, based on analysis from NAB Economics. Meanwhile, the Survey's forward-looking indicators showed further signs of stabilisation, with forward orders up from -2 to +3 and capacity utilisation broadly flat at 81.7%, though they still remain tilted towards a continuation of below-average conditions. 

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Turning to the offshore perspective, trade developments continued to be the main focus for markets, which on the whole were fairly subdued over the course of the week. Risk sentiment appeared to cool slightly as the data flow disappointed somewhat, tensions in Hong Kong escalated, and a modest bid came into bond markets to halt their sharp sell-off from the past couple of weeks. In the US, President Trump at an address to The Economic Club of New York said that the phase one trade deal with China was "close" to being finalised but offered few new insights into the negotiations. Trump also maintained his criticism of the Federal Reserve (Fed) for not being aggressive enough with its recent easing in monetary policy, arguing that it has placed the US at a competitive disadvantage with other countries. During his testimony to the Congress this week, Fed Chair Jerome Powell outlined that weakness in global growth, trade uncertainty and soft inflation had prompted the Committee to cut its benchmark interest rate 3 times this year and now assessed the current stance as "likely to remain appropriate", though "noteworthy risks" remain to its baseline outlook for moderate GDP growth, strong labour market conditions and inflation near to the 2% target. Key data this week showed a modest 0.3% lift in retail sales in October, while core sales (adjusted for gasoline and vehicle purchases) increased by 0.2%, as both categories reversed declines in the previous month. Meanwhile, headline inflation firmed from 1.7% to 1.8% year-on-year in October, though core inflation softened against expectations from 2.4% to 2.3%.   

Over in Europe, the second estimate of GDP growth in Q3 for the 19-nation euro area was unchanged at 0.2%, though the annual pace was revised up from 1.1% to 1.2%. Germany, the largest economy in the bloc, avoided sliding into a technical recession as had been expected by markets with output rising by 0.1% in Q3 following a downwardly revised contraction of 0.2% in the previous quarter. In annual terms, growth lifted from 0.3% to 0.5% but remains soft and has been heavily impacted by weakness in foreign demand for exports, while production in its key automotive sector has also faced headwinds in adjusting to new emissions regulations. Germany's Finance Minister Scholz said the result was not indicative of an economy in crisis and, much to the disappointment of markets, pushed back against the notion that fiscal stimulus was required. In the UK, despite a 58.0k fall in employment over the 3 months to September, the unemployment rate eased from 3.9% to 3.8% to its lowest level since 1974. Overall, the labour market appears to remain tight but conditions could be softening as the pace of wages growth slowed from 3.8% to 3.6% over the past 3 months. Inflation was also contained in October with the headline reading easing from 1.7% to 1.5%Y/Y, while it was unchanged at 1.7%Y/Y on a core basis.  

In Asia, the latest activity indicators out of China continued to point to headwinds for the world's second-largest economy as retail sales (7.2%Y/Y), industrial production (4.7%Y/Y) and fixed asset investment (FAI) (5.2%ytd) all fell short of expectations in October. Weakness in investment remains a key concern for authorities with this latest FAI result the softest since 1998. In Japan, GDP growth almost stalled in Q3 rising by just 0.1%, with the annualised pace pulling back sharply from 1.8% to 0.2%. The result reflected a slowing in consumption and weakness in exports, though business investment provided some offset. Closer to home, the Reserve Bank of New Zealand surprised markets this week by keeping its benchmark interest rate on hold at 1.0% on the basis that economic conditions had not yet deteriorated to the extent that called for an additional 25 basis point cut to be delivered; an outcome that had largely been discounted within market pricing in the lead up to the meeting. However, the Bank remains alert to the downside risks domestically and offshore and is prepared to provide additional support "if economic developments warranted it".