Australian Current Account +$10.0bn in Q3; net exports -2.0ppts

The remaining indicators ahead of tomorrow's September quarter national accounts were released by the ABS this morning. Net exports will subtract 2.0ppts from GDP growth in the quarter, while public demand adds in the order of 0.3ppt. Overall, the Australian economy is likely to have rebounded by around 3.0% in the quarter after contracting by 7.0% in Q2.  

Balance of Payments - Government Finance  — Q3 | By the numbers

• Australia posted its 6th straight quarterly surplus on its current account coming in at $10.024bn in Q3, which was stronger than the consensus estimate of $7.1bn, while Q2's surplus was revised lower to $16.345bn from $17.738bn.  

• The surplus on the trade balance narrowed sharply to $13.625bn from $22.340bn as exports pulled back (-6.0%) and imports lifted (2.7%) on the reopening of the economy. 
• The income deficit continues to narrow, improving to $3.331bn from $5.591bn.
• Net exports are expected to subtract 2.0ppts from GDP growth in Q3 — more severe than anticipated (-1.7ppts). 

• The separately released ABS Government Finance data reported that public demand was expected to add 0.3ppt to Q3 GDP growth, led by consumption spending. 

Balance of Payments - Government Finance — Q3 | The details 

Australia continues to be a net exporter of capital to the rest of the world as its current account stayed in surplus for a 6th consecutive quarter. This is very unusual in a historical context and reflects the ramp-up in resources production together with favourable price movements for commodities, coming after the unwind of the mining investment upswing that occurred through the early to mid-2010s. The impact of the pandemic has more recently induced significant volatility into the equation. 

Highlighting this, the trade balance narrowed by 39% in Q3 to $13.6bn after rising by 24.3% in Q2. In Q2, the pandemic restrictions had an outsized impact on imports (-14.3%) relative to exports (-8.3%). This dynamic flipped in Q3 as the reopening of the economy saw domestic demand coming back, reflected by imports lifting (2.7%), while exports declined (-6.0%) on weakness in the global economy. Adjusting for price movements over the quarter, import volumes rebounded by 6.5% in Q3 (-13.9%Y/Y) as export volumes weakened by 3.2% (-14.9%Y/Y). The ABS advises that the overall impact is that net exports will subtract 2.0ppts from GDP growth in Q3.

The pandemic has very much been a services-related story and today's data highlighted this theme again. Export of services fell another 8.8%q/q (-40.7%Y/Y), with goods also down but modestly in comparison -2.1%q/q (-7.8%Y/Y). 

On the import side, goods rebounded by 6.8%q/q (0% Y/Y) on reopening dynamics. Services were up in Q3 (4.4%) but remain heavily lower through the year (-57.1%), with the major influence being the restrictions on offshore travel. 

The narrowing in the income deficit from $5.6bn to $3.3bn came as income to domestic investors lifted sharply (14%) due to the strength of the performance of global equity markets, while income to foreign investors was softer over the quarter (-1%). 

In the latest Government Finance data for the September quarter, the ABS reported that government consumption spending lifted by 1.4% to $103.79bn, while underlying investment (net of private-public transfers) was up by 2.7%q/q to $25.0bn. Public demand is likely to add around 0.3ppt to GDP growth in Q3 according to the ABS.   

Balance of Payments - Government Finance — Q3 | Insights 

Net exports will be a larger drag on economic activity than most had factored in, though this will be moderated slightly by increased public spending following the pandemic. But the main story in tomorrow's national accounts is the rebound in household consumption on the reopening of the economy from its Covid-19 shutdown.    

Preview: RBA December meeting

The Reserve Bank of Australia's final scheduled Board meeting for 2020 takes place today, with the decision statement from Governor Philip Lowe due at 2:30pm (AEDT). Expectations for this meeting are low with no changes in policy to be the call after the Board announced significant easing measures in November as rates were lowered by 15 basis points to 0.1% across the targets for the cash rate and 3-year Australian Government bond yield and on new drawings under the Term Funding Facility, and a $100bn quantitive easing (QE) program was announced focused on maturities within the 5 to 10-year range through to mid-2021. Furthermore, the rate banks earn on deposits held at the RBA was lowered from 0.1% to 0%. Given this, tomorrow's parliamentary testimony where Governor Lowe appears before the House of Representatives Standing Committee on Economics (12.00pm AEDT) potentially shapes as being of more interest to the markets.    

That said, Governor Lowe's commentary on economic developments in today's statement will be key. A theme of improving momentum in the recovery has emerged since the November meeting with the economy opening up more widely and clear signs that earlier stimulus measures are gaining traction. While there has been encouraging news in the data of late and optimism around potential vaccines for 2021, the tone Governor Lowe takes this week is likely to be one of caution. With uncertainty over the economic outlook remaining elevated and the recovery still a long way from being complete, there can be no room for complacency. As such, Governor Lowe will reiterate the earlier guidance that the Board is "prepared to do more if necessary" providing an assured message turning into 2021 that its policy stance is alert and flexible to changes in economic conditions.

On the QE program, the RBA has kept purchases in line with its pre-advised run rate of $5bn per week with $19bn in purchases completed so far ($16bn in AGS, $3bn in semis). In addition, $5bn of purchases have been completed in support of the new 0.1% yield target on 3-year AGS. Meanwhile, drawings under the Term Funding Facility have been stagnant since the end of September at around $83.5bn according to the latest data.

Australian Business Indicators Q3: Inventories -0.5%

The resumption of trade after the reopening of the domestic economy from its Covid-19 shutdown was the key theme from today's ABS Business Indicators data for the September quarter. Inventories will contribute positively to GDP growth in the quarter; the wages bill rebounded as firms called staff back to work, and company profits advanced as sales increased after the shutdown-disrupted Q2.           

Business Indicators — Q3 | By the numbers 

• Inventories declined by 0.5%q/q in Q3 to $163.9bn, which was slightly better than forecast (-0.7%), as the annual pace was little changed at -4.6% from -4.5%. 
• Company gross operating profits lifted by 3.2% to $117.4bn in Q3 on the reopening, coming after government subsidies drove a 15.8% surge in Q2. The combined effects have elevated the pace over the year to 18.6% from 13.1%. 
• Wages and salaries rebounded by 2.4% in the quarter to $145.5bn after Q2's record contraction of 3.3%. The annual pace improved to 0.4% from -1.0%. 

Business Indicators — Q3 | The details

The shutdown had profound effects on demand and trading conditions. Ahead of the shutdown was the period of stockpiling as households made preparatory purchases. The combined result was a very sharp contraction in inventories over the first half of the year (-4.2%). Inventories were lower again over Q3 (-0.5%), but at a greatly reduced pace (Q1 -1.4% and Q2 -2.9%), and so for GDP purposes this will constitute a sizeable positive contribution to output in the quarter. The two industries that contributed most were manufacturing (1.6%) and accommodation and food services (15.3%), but inventories continued to fall for wholesalers (-2.2%) and miners (-1.8%).

Growth in gross company profits was supported by the reopening of the economy rising by 3.2% overall in Q3 to be 18.6% higher through the year. In the June quarter, government subsidies supported firms by the transfer of incomes from the public to the private sector, and this continued into Q3. Remarkably, despite this being the first major economic downturn the nation has endured since the early 1990s, company profits are 19.6% higher than they were at the end of 2019. The outcomes have been very uneven; non-mining sector gross profits up by a further 9.9% after soaring by 29.9% in Q2, while mining gross profits were down 9.4% in Q3 and contracted by 3.9% in Q2. Benefitting most from the income transfers have been services-related industries that were heavily impacted by the containment measures, as seen by the extraordinary growth rates for gross operating profits shown in the summary table above in industries such as other services, administration, arts and recreation and accommodation and food. To be more consistent with how company profits are reported in the national accounts, an adjustment is made for changes in the valuation of inventories. Making this adjustment, gross company profits were 2.2% higher in Q3.  

The story of the reopening is well conveyed through the chart below with the outturns for sales income across the economy rebounding in Q3 (green bars) compared to the collapse that occurred in Q2 (grey bars). The most extreme moves came in two of the hardest-hit industries by the restrictions in accommodation and food services and arts and recreation services.    

The wages bill plunged by 3.3% in the June quarter (-1.0%Y/Y) as the shutdown led to upheaval in the labour market. With firms calling staff back to work and rehiring on the reopening, wage incomes rebounded by 2.4% in Q3 (0.4%Y/Y). At $145.5bn the level of wages is around 0.7% below its pre-pandemic baseline, but this is improved from a trough of -3.1% in Q2.    

Business Indicators — Q3 | Insights

Today's report highlighted the improving trading conditions for firms brought on by the reopening of the Australian economy from its shutdown to contain the Covid-19 spread. Inventories will add to GDP growth in Q3, while the lifts recorded across company profits, sales and wages reflect the progress being made in the recovery. 

Macro (Re)view (27/11) | Pandemic continues to test

Updates out in Australia this week were on construction activity and private sector capital expenditure for the September quarter, providing some insights ahead of next Wednesday's national accounts. The Q3 national accounts are expected to show that the Australian economy rebounded from its Covid-19 shutdown as the easing of restrictions led to a greatly increased range of opportunities for households to spend, supported also by an unprecedented tide of fiscal and monetary stimulus measures, though the later reversal of Victoria's reopening weighed heavily. For a detailed preview of next week's national accounts see here. 

Australian construction activity declined by more than expected in Q3 contracting by 2.6% against -2.0% forecast (review here). The impact of Victoria's shutdown accentuated the decline as restrictions limited worker capacity on sites as non-residential construction work in the state plunged by 14.7%q/q to be down by 3.4%q/q nationally. Weakness in private sector residential construction cycle persisted (-1.2%), albeit around a divergent outlook for houses and units. Work done in the detached housing segment was up in the quarter (1.1%) — so too alterations (4.6%) — on the support of a range of government stimulus measures, while very low interest rates have also spurred demand recently, particularly from first home buyers. But higher-density housing was down sharply (-6.2%) and is facing headwinds from low population growth dynamics due to the closure of the international borders, while the investor segment that has typically favoured this stock is confronting a market where vacancy rates are now much more elevated than before the pandemic (see chart of the week, below). Helping to offset some of the weakness in private sector construction activity was a 3.2% lift in public works. Going forward, more support will come from this area as the states and territories bring forward infrastructure projects to support the economic recovery. 

Chart of the week

Capital expenditure by private sector firms remained weak in Q3 (-3.0%) as spending has been cut back or shelved to preserve liquidity, while elevated uncertainty around the economic outlook has understandably brought about increased caution (review here). The reinstated shutdown in Victoria had an outsized impact (-7.7%) on the national outcome, but it should improve in Q4. Buildings and structures capex was down by 3.7% over the quarter while equipment spending contracted by 2.2%. Firms' forward-looking investment plans in the current financial year were upgraded to around $105bn; some 6% higher than the level estimated 3 months ago, but have fallen heavily (-10.3%) when compared with intentions at the same stage for the outlook in 2019/20. Most notably, investment plans in aggregate by firms in services-related industries have rolled over since the pandemic emerged and point to a year to year fall in capex of 13.2%. 

Also of note this week, a speech by the Deputy Governor of the Reserve Bank of Australia Guy Debelle provided an overview of the sweeping changes that have occurred in the Board's monetary policy stance in response to the pandemic crisis. The key point was that the transmission of the package of measures now in place to the real economy was occurring through lower borrowing costs for both households and businesses, but given the difficult outlook for the labour market the Board's expectation was that the cash rate would not be increased "for at least 3 years". The advanced PMI readings for November provided an encouraging analysis of the momentum of economic activity, with the composite index increasing in pace to a 4-month high at 54.7 with Victoria opening up more widely. Activity in the services sector was rising at its fastest pace in 4 months (54.9), while manufacturing was at a 35-month high (56.1).

— — —  

Turning the focus offshore to the US where the news that president-elect Joe Biden would nominate the former Federal Reserve Chair Janet Yellen to the role of Treasury Secretay was well received by the markets on the basis of familiarity and on the expectation that this could lead to the fiscal and monetary authorities working more hand in hand to support the recovery. While the Fed and Treasury have on the whole worked cohesively since the onset of the pandemic, some discord emerged last week after Treasury Secretary Steven Mnuchin called for an end to some of the Fed's emergency lending facilities. In media appearances before this news, former Chair Yellen had been a strong advocate for fiscal policy to play a more active role in the way out of this pandemic crisis. On matters closer at hand, the minutes from the Fed's policy-setting Committee's meeting in early November were published. While GDP growth according to this week's second estimate was reported to have rebounded by 7.4% in Q3 coming after a 9.0% contraction in Q2, the Committee judged that the pace of activity had since moderated and expressed concerns that the short-term risks to growth prospects, employment and inflation due to the pandemic "posed considerable risks to the economy's medium-term outlook". As a result, the Committee is open to doing more, with "many participants" being in favour of providing more guidance to the markets on its asset purchases, essentially establishing a more defined link between the pace and maturities of purchases to changes in economic conditions, but there was also some hesitancy put forward to this approach given the uncertainties of the situation and how best to respond to it. In the data this week, the drift down in personal income growth continued slowing to 5.5%Y/Y in October from 6.5% reflecting the withdrawal of fiscal support measures, while the rebound in personal spending since the reopening was starting to stall (-0.6%Y/Y). Also of concern was a second straight miss on initial jobless claims at 787k (vs 730k expected) following on from the downside surprise reported last week. 

The situation in Europe was best highlighted by the flash PMI readings for November that conveyed an economy contracting at a sharp pace following the reinstatement of shutdowns across the continent to contain a resurgence in the virus. Economy-wide activity according to the composite index fell well into contractionary territory at a reading of 45.1 (vs 45.6 expected) from 50.0 in the month prior, making this its weakest outturn since the initial round of shutdowns earlier in the year, albeit this was nowhere close to the low of 13.6 in April. The services sector slowed further in the month falling to 41.3 from 46.9 with activity being heavily affected by tightened restrictions. While the continent's key manufacturing sector has again proved to be more resilient to the impacts of the pandemic, the level of activity slowed in the month (55.5 from 58.4) in a sign that the deterioration in overall economic conditions was weighing on industrial demand. The account of the meeting by the European Central Bank's Governing Council in late October released this week spoke of their concerns that this latest slowdown could have beyond the duration of the shutdown, noting that it would have to "consider the possibility that the pandemic might have longer-lasting effects both on the demand side and on the supply side, reducing potential growth". At this meeting and then over the period that has ensued, the Governing Council has maintained that it will "recalibrate its instruments" to updated economic forecasts when it meets again in December, with the account highlighting the effectiveness of both its PEPP and TLTRO programs. In the UK, Chancellor Rishi Sunak unveiled the 2020 Spending Review that showed emergency support measures since the onset of the pandemic have totaled £280bn, with much of this focus on income subsidies to prevent a surge in unemployment, putting the budget deficit on track to rise to a post-war high of 19% of GDP in 2020/21. According to OBR forecasts, the UK economy is anticipated to contract by 11.3% in 2020, driving the unemployment rate up to a peak of 7.5% by mid next year from 4.8% currently.

Preview: Australian Q3 GDP

Australia's national accounts for the September quarter are due to be published by the ABS this morning at 11:30am (AEDT). Expectations are for a rebound in real GDP of 2.5%q/q. The national shutdown following the onset of the Covid-19 pandemic led to the sharpest quarterly contraction in economic activity in the post-war period as GDP declined by 7.0% in the June quarter (see here), leaving its level 7.2% lower than at the end of 2019. Towards the end of the quarter, restrictions began to be gradually eased in most states enabling the recovery to commence. However, the recovery that has been taking place is far from complete and has been uneven across the economy due to the lasting effects of the pandemic through ongoing restrictions on activity and elevated spare capacity in the labour market, while in Victoria an acceleration in virus cases between late June and July led to the authorities there mandating a statewide shutdown by early August, with stringent containment measures in Melbourne remaining largely in place until late October.

Reflecting the impact of the reversal of Victoria's reopening, mobility indicators in Melbourne rolled over and remained considerably lower than in the other capitals throughout the September quarter. Mobility in Sydney appeared to be initially affected by the developments in Melbourne before recovering over August and September, while the other capitals were generally resilient and remained broadly steady as the recoveries in those cities progressed. 

The initial reopening phase led to a partial recovery in the Australian economy that was supported by significant monetary and fiscal stimulus measures, helping to attenuate the shock that occurred in the labour market as the pandemic emerged. Around half of the earlier 872k job losses had been restored by the end of the quarter and while hours worked had improved sharply since the reopening the level was still around 5% below its pre-pandemic baseline. The easing of restrictions together with strengthened household balance sheets enabled household consumption spending to rebound in Q3, clearing some of the pent-up demand that accumulated during the shutdown. Policy stimulus also contributed to a sharp rebound in the detached housing market by owner-occupiers, with the first home buyer segment buoyed up by additional government incentives in some states, and while this was assisting the near-term outlook for residential construction, the headwinds from weak population growth dynamics will be intense for higher-density housing. Elevated uncertainty continues to restrain business investment and the outlook is unlikely to improve significantly until the effects of the pandemic dissipate more materially.

As it stands | National Accounts — GDP

The national shutdown and introduction of a wide range of other containment measures including activity and mobility restrictions led to a historic contraction in Australian GDP of 7.0% in the June quarter, swinging the pace through the year deeply negative to -6.3% from 1.6%. Larger declines in GDP were recorded in economies offshore where virus outbreaks were much more severe than in Australia, requiring tighter sets of restrictions and shutdowns of longer durations. In the June quarter, GDP across OECD economies contracted by 10.6%, with the euro area (-11.8%) and UK (-19.8%) especially hard hit, while US GDP declined by 9.0%. China's economy started to reopen in the June quarter and this generated an 11.7% rebound in output coming after a 10.0% fall in Q1.

Around 96% of the contraction in the Australian economy in Q2 was accounted for by a 12.1% fall in household consumption as the restrictions severely limited spending opportunities. Services consumption, most notably in discretionary areas such as overseas travel, recreation and culture and hotels, cafes and restaurants, collapsed during the quarter (-17.6%) while goods consumption also declined but much more modestly by comparison (-2.8%). The Federal Government's fiscal support measures were a key offset to the impacts of the dislocation in the labour market and the restrictions, with the ABS estimating that they bolstered household income by $48bn in the quarter. Given the limitations on spending opportunities, the household saving ratio surged from 3.6% to a 46-year high of 19.8%. 

 

Weakness in the residential construction cycle accelerated in Q2 (-6.8%), while conditions in the housing market also deteriorated due to the disruptions associated with the shutdown and in response to elevated uncertainty over the economic outlook in general and population growth dynamics following the closure of the international borders. Business investment was cut back or shelved during the quarter (-3.8%) as firms focused on preserving liquidity during this phase of the crisis and scaled back forward-looking spending plans in response to very limited visibility over the future demand profile. A sizeable contribution from net exports (+1.0ppt) helped moderate the overall contraction in GDP in Q2, but on very weak details as imports (-12.9%), particularly in services-related industries such as offshore tourism, were hit much harder by the restrictions than exports (-6.7%). 

Key dynamics in Q3 | National Accounts — GDP 

Household consumption — Retail consumption rebounded sharply over the quarter as the reopening provided more opportunities to spend and this was enhanced by household balance sheets that had been bolstered by the earlier fiscal support measures. However, the pace of the rebound was moderated by the return to shutdown in Victoria. Amid the presence of ongoing restrictions and precautionary behaviour, there have been large shifts in previously normal consumption patterns with spending in services-related areas remaining weak, though this has to some extent been substituted with increased goods-related consumption such as new vehicles and more in-home spending, while the share of purchases being made online continues to be significantly elevated on pre-pandemic levels.   

Dwelling investment — Residential construction activity was supported by a modest rise in detached housing (1.1%), while alteration work advanced strongly (4.6%) in response to the traction from the Federal Government's HomeBuilder scheme. Attenuating this was a 6.2% contraction in private sector unit construction amid a difficult outlook due to low population growth and soft investor sentiment. 

Business investment — Firms understandably remain reluctant to invest due to elevated uncertainty over the economic outlook and a focus on preserving capital during the pandemic crisis. Private sector capital expenditure contracted by 3.0% in Q2 and was accentuated by weakness in Victoria due to the shutdown. 

Public demand — Public consumption spending increased further over the quarter (1.4%) after a sharper pandemic-induced lift (3.0%) in Q2. Underlying investment also advanced (2.7%), with infrastructure investment by the states and territories likely to ramp up as key projects are brought forward.       

Inventories — A modest decline in Q3 followed the sharp run down that occurred over the first half of the year as the shutdown led to weak demand conditions and disruptions to trade. Inventories will contribute positively to GDP growth in Q3.     

Net exports —  Import volumes rebounded on the reopening of the economy with strong gains across consumption and capital goods, while exports declined reflecting weak demand conditions offshore. Net exports will subtract 2.0ppts from GDP growth in Q3. 

Australian Q3 CapEx -3.0%; 2020/21 investment plans $105bn

Australian private sector capital expenditure weakened by more than expected falling by 3.0% in the September quarter as the pandemic continue to weigh on business investment and notably so in Victoria due to the reversal of the state's reopening. Firms' investment intentions for 2020/21 were upgraded from 3 months ago, but elevated uncertainty continues to set a challenging background.    

CapEx — Q3 | By the numbers

• Private sector capex contracted by 3.0% in the September quarter to $25.85bn, coming in weaker than the median estimate for a 1.5% decline, while Q2's initially reported fall of -5.9% was revised to -6.4%. In annual terms, the decline in capex extended to -13.8% from -11.7%. 

• Equipment, plant and machinery capex contracted by 2.2% to $12.1bn to be 12.3% lower through the year (from -13.9%).

• Buildings and structures capex fell by 3.7%q/q to $13.8bn as the contraction in annual terms widened to -15.0% from -9.6%.

• For forward-looking investment plans, firms' 4th estimate for spending over 2020/21 came in at $104.98. This was 6.3% higher than the 3rd estimate put forward 3 months ago, but it points to capex falling by 10.3% when compared with the same estimate for 2019/20. 

CapEx — Q3 | The details

Capital expenditure by Australian private sector firms had been weakening before the Covid-19 pandemic emerged and this has since been accelerated as firms have focused on preserving capital to make it through the initial phase of the crisis by cutting back or delaying all but essential investment spending. Furthermore, the onset of the pandemic has meant that the economic outlook has become much more uncertain than usual, and as a consequence firms are understandably reluctant to invest with such limited visibility over the future.  

 

At the sector level, the effects of the pandemic have been much more pronounced on capex by firms in services industries than by those in manufacturing and mining as the impact of the restrictions has hit them more directly. Total capex was down by 3.0% in Q3 falling to its lowest level since 2007 at $25.85bn. The reversal of Victoria's reopening had a marked impact (-7.7%q/q) accounting for roughly half of the decline in capex nationally for Q3. Capex by the non-mining sector weakened by 3.0% to a 13½-year low of $17.49bn, which incorporated a 3.3% contraction from the services industries to $15.27bn (-18.9%Y/Y) and a 1.0% slide in manufacturing investment to $2.22bn (-12.9%Y/Y). After a positive start to 2020, mining sector capex has declined over the past two quarters, though the level is down fairly modestly compared to a year earlier (-2.8%). 

For forward-looking investment plans, Australian firms estimated total capex for the 2020/21 financial year to be around $105bn. This was the 4th estimate firms have put forward for the current financial year and this latest figure was 6.3% higher than the previous figure from 3 months ago ($98.7bn). There are a couple of factors at play here. A separate business survey conducted by the ABS last week found that the proportion of firms citing economic uncertainty as influencing capex decisions had decreased markedly from 59% in August to 29% by October, while policy support, including the provision in the recent Federal Budget that has expanded and lengthened access for firms to instant asset write-offs, has gained some traction, though modestly so at this stage.

Source: ABS 

Looking further into capex plans, non-mining capex intentions for 2020/21 have lifted by 14.1% from 3 months ago to around $69bn, which is driven by a 14.1% elevation in services capex plans to $59.8bn, while manufacturing investment plans were advanced by 13.9% to $9.4bn. Meanwhile, mining capex plans were dealt a downgrade of 5.8% on the previous estimate to $36bn. But as the chart below shows, investment plans across the economy are noticeably lower than they were a year earlier reflecting the effects of the pandemic; total capex -10.3%, non-mining -12.2% (services -13.2% and manuafacturing -4.9%) and mining -6.4%. These projected declines for 2020/21 compared with 2019/20 have scope to minimise if the recent strength in the recovery of the domestic economy is sustained, policy support gains more traction and if the pandemic remains under control.  

CapEx — Q3 | Insights

Today's report continued to reflect the ongoing effects of the pandemic on business investment with spending being cut back to preserve liquidity and uncertainty around the economic outlook weighing on forward-looking intentions. Victoria's return to shutdown accentuated the weakness in capex in the quarter. The positives can be taken from the upgrades in the latest estimates for capex plans in 2020/21, though the outlook is still challenging.  

Preview: CapEx Q3

The ABS is due to publish its September quarter update on Australian private sector capital expenditure today at 11:30am (AEDT). The emergence of the Covid-19 pandemic and related uncertainty saw firms respond by cutting back investment spending and forward-looking plans as the focus turned to maintaining liquidity during the initial phase of the crisis. Uncertainty around the economic outlook is elevated, but the recent Federal Budget contained measures to drive investment spending in the near term.  

As it stands | Capital Expenditure

The decline in Capex in Q2 was accelerated at -5.9% as firms reduced investment spending to preserve liquidity as the shutdown measures were introduced. This followed a period in which capex had fallen in each of the previous 5 quarters, lowering the level to its weakest since Q3 2007 at $26.1bn (-11.5%yr). Spending on equipment, plant and machinery contracted by 7.6% to $12.1bn (-13.8%yr) and buildings and structures investment weakened by 4.4% to $14.0bn (-9.4%yr).  

Across the sectors, non-mining investment fell by 8.0% in Q2 — its 6th straight quarterly decline — to $17.7bn (-17.3%yr). Within this, services industries contracted by 8.4% to $15.5bn and manufacturing weakned by 4.5% to $2.2bn (-7.0%yr). After lifting by 4.4% in the March quarter, mining capex eased by 1.2% in Q2 to $8.4bn (3.9%yr), but the sector posted its first year to year rise in investment spending in 7 years. 

Firms' 3rd estimate of total capex plans for 2020/21 was nominated at $98.6bn, which on a like for like basis with 2019/20 pointed to a fall in investment spending of 12.6% over the year. The impact, though, was uneven with the non-mining sector taking the full brunt (-19.4% year to year) as investment in the mining sector was projected to hold steady (0.6% year to year). A full review of Q2's report is available here.    

Market expectations | Capital Expenditure

For today's report, the median estimate is for capex to have contracted by a further 1.5% in the September quarter, with the range of estimates between -6.0% to 1.7%. On the invetment intentions component, no median estimate is put forward but there may be some revision to the upside for the 4th estimate of plans for 2020/21 with significant progress being made in containing the pandemic, a less pessimistic economic outlook than earlier feared and given the incentives in the recent Federal Budget around the expansion to instant asset write-offs. 

What to watch | Capital Expenditure

The capex intentions component is where most of the interest in today's report will be focused on. In last week's ABS Business Impacts of Covid-19 Survey, there were some signs that the incentives in the Federal Budget were having a positive influence on firms' near-term capex plans, though concerns around economic outlook and uncertainty over the demand profile for their goods and services were higher-order considerations.  

Source: ABS 

Australian construction activity -2.6% in Q3

Australian construction activity weakened by more than expected in the September quarter, mainly reflecting the impact of the shutdown in Victoria on non-residential construction work. Against weakness in private sector construction work, governments are starting to lift spending on public works providing stimulus to the economic recovery.  

Construction Work Done — Q3 | By the numbers

• Total construction work done (private and public sectors) declined by 2.6% in the September quarter to $51.179bn against the median estimate for a 2.0% contraction (Q2 was revised to +0.5% from -0.7%). The decline in annual terms steepened to -4.2% from -0.3% (revised from -2.2%). 
• The headline results were;  
• Engineering work -3.3%q/q to $22.21bn (4.0%Y/Y)
• Building work -2.0%q/q to $28.97bn (-7.2%Y/Y)
• Residential work -1.0% to $17.22bn (-8.9%Y/Y)
• Non-residential work -3.4%q/q to $11.75bn (-4.5%Y/Y)  

Construction Work Done — Q3 | The details 

Overall Australian construction activity was 2.6% lower in the September quarter weighed by weakness in work done by the private sector and by the impacts of the shutdown in Victoria. Whereas during the national shutdown in Q2 the construction sector in aggregate was less affected by the social distancing and mobility restrictions than many other industries, construction work in Victoria, notably in the non-residential segment, was directly impacted when the state went back into lockdown and this was reflected in the weaker-than-expected national result reported today for Q3. The impact of elevated uncertainty over the economic outlook was reflected by the decline in private sector activity as projects were shelved or delayed. Helping to moderate this was a pick-up in activity from the public sector as governments brought forward projects to provide stimulus to the recovery with the promise of much more to come. 

In the private sector, total construction activity contracted by 4.4% in the quarter (-6.9%Y/Y) as the level at $38.12bn slid to its lowest since Q4 2010. Within this, non-residential (commercial) work weakened sharply (-6.4%q/q) mainly reflecting the impact of the shutdown in Victoria (-21.4%), as per the chart below.  

Activity in private sector residential work declined by 1.2% in the quarter (-9.3%Y/Y), with only a modest fall coming through in Victoria (-0.5%q/q) that centered on unit construction (-2.0%q/q). New home building in Australia pulled back by a further 2.0% in Q3 — its 9th consecutive quarterly decline — to be 11.1% lower through the year. But alteration work (albeit coming off a 5% fall in Q2) rebounded by 4.6% as the Federal Government's HomeBuilder scheme that provides eligible recipients with grants of $25k to put towards substantial renovations quickly gained traction in the market.

There is currently a very uneven outlook for residential construction. The detached segment is being buoyed by stimulus measures from ultra-low rates as well as government incentives targeted mainly at first home buyers. However, the higher-density segment is coming up against headwinds from weak population growth dynamics due to the international border closures making developers reluctant to commit to new projects, while elevated vacancy rates in the capital city markets are weighing on investor sentiment. As these effects play out, the two lines in the chart below are likely to diverge further. 

Public sector construction activity lifted by 3.2% in Q3 to $13.06bn to be 4.9% higher over the year. Building work led with a 4.6% rise (8.5%Y/Y), while a smaller increase of 2.7% came through in engineering work (3.5%Y/Y). The overall dynamic being that governments are looking to provide an offset to the weakness in the private sector by raising spending in public works providing stimulus to the economic recovery. The recent Federal Budget contained incentives for the states and territories to accelerate the rollout of infrastructure projects so the uptrend can be expected to steepen over the coming years.    

Construction Work Done — Q3 | Insights

Today's report was a little weaker than expected — in part due to an upward revision to the June quarter data — as construction activity was weighed by the shutdown in Victoria. The disruptions were mainly associated with non-residential construction work due to limitations on the number of workers permitted on site and restrictions on mobility between sites. Residential activity was a little weaker in Q3 as a decline in new home building was moderated by a lift in alteration work due to the support of the HomeBuilder scheme, while there is a divergent outlook in place between the detached and higher-density segments over the near term. Meanwhile, the public sector is beginning to ramp up infrastructure spending to provide support to the economic recovery.    

Preview: Construction Work Done Q3

Today at 11:30am (AEDT), the ABS is scheduled to publish its report on Australian construction activity for the September quarter. The nation's construction cycle was in a downturn before the onset of the pandemic, but the sector was relatively less affected by the restrictions that followed than many other services-related industries. However, in Q3 Victoria's state-wide shutdown severely restricted activity on sites so this is likely to accentuate the earlier cyclical weakness.   

As it stands | Construction Work Done

Australian construction activity was held to a modest decline of 0.7% in the June quarter to be 2.2% lower over the year. The underlying details reported a 3.8% lift in engineering work in the quarter that moderated a 3.9% fall in building work (see here). 

On the latter, the downturn in private sector residential construction deepened (-5.6% in Q2) while the non-residential segment also came under pressure (-1.5%), with earlier weakness in approvals suggesting this trend will continue. Private engineering work surprised with an 8.6% rise in Q2, but this was coming off a low base associated with the wind down of completing projects in the resources sector. Public sector construction activity declined by 3.2% in the June quarter on falls in both engineering (-3.3%) and building work (-3.1%). 

Market expectations | Construction Work Done 

Construction activity is forecast to fall by 1.9% on the median estimate according to data compiled by Bloomberg. The range of estimates sits between -4.0% to 0.6%.   

 

What to watch | Construction Work Done

Stimulatory policy from governments at the federal and state levels has supported the near-term outlook for detached residential work as seen in recent approvals data, though higher-density projects are being delayed or shelved due to the uncertainty around population growth dynamics due to the border closures. The pipeline of non-residential projects remains challenged by uncertainty and by the reticent of firms to commit to new investment plans. On the infrastructure side, the recent Federal Budget contained measures to encourage the states to roll-out projects on an accelerated basis. 

Macro (Re)view (20/11) | Australian recovery builds momentum

Australia's labour market was the focus of attention this week for both the markets and the nation's policymakers. The key theme that emerged was that the recovery in the labour market regained momentum after showing signs of stalling recently, and although a long and uncertain path still lies ahead it is clear that there is a willingness from policymakers to keep accommodative settings in place for the duration of that journey. After softening in September weighed by the impact of the shutdown in Victoria, the labour market defied market expectations for further weakness by rebounding aggressively in October (see here). Employment (on net) surged higher by 178.8k in the month against a median estimate that was positioned for a decline of 27.5k after a 42.5k fall in September. Driving this result was an 81.6k contribution to employment in Victoria as preparations for the reopening were made in advance of the easing of restrictions, though the gains in employment were spread across the nation. The composition of October's employment outcome could be conveying a key development as the full-time segment (+97.0k) outperformed part-time (+81.8k) for the first time in the reopening phase. So far, the recovery has been driven by part-time employment being restored as restrictions were eased, but a broadening out of the momentum to the full-time segment would be significant, pointing to the durability underlying economic activity. 

Another encouraging sign was the lift in hours worked rising by 1.2% for the month nationally, with a 5.6% boost coming through in Victoria. From its pre-pandemic baseline, hours worked have recovered from a trough of -10.4% to -3.8%, while the impact on employment has been less severe (-6.7% to -1.7%) helped by the support of the Federal Government's wage subsidy policy (see chart of the week). Victoria also accounted for a large share of the surge in the national participation rate that advanced by 1ppt in October to 65.8%. The strength in employment was able to limit the rise in the headline unemployment rate to 7.0% from 6.9%. Meanwhile, the boost in hours worked helped drive both underemployment (-1ppt to 10.4%) and underutilisation (-0.9ppt to 17.4%) lower. However, spare capacity remains highly elevated and this will continue to place downward pressure on wages growth and inflation. Spare capacity in addition to the rising prevalence of wage freezes and delays of earlier agreed increases in enterprise agreements contributed to slowing the Wage Price Index to new record lows at 0.1% in Q3 and 1.4% over the year (see here).  

Chart of the week 

This week's communications from the RBA again unscored the central bank's commitment to the labour market recovery. The November Board meeting minutes outlined that despite the progress made during the initial phase of the reopening, the recovery was forecast to be "protracted and uneven" and pointed to a "large shortfall in activity and employment from levels that would be consistent with full employment". Hence, this was the basis of the Board's decision to ease its policy stance at that meeting including lowering its rates structure by 15 basis points to 0.1% across the cash rate, 3-year bond target and Term Funding Facility, and by announcing a $100bn quantitive easing program, while it also pledged to "do more if necessary". Further, and as Governor Philip Lowe elaborated on during a speech this week, the nature of the Board's forward guidance has shifted to a focus on actual rather than anticipated outcomes of inflation; in effect signalling that accommodative monetary policy will be maintained until such a time that the labour market has tightened materially and wages growth is much higher than it is currently. In other developments this week, October's preliminary estimate of retail sales (based on around 80% of total turnover) lifted by 1.6% in the month as the early stages of the reopening saw turnover in Victoria rebound by 5.2%. This came after declines nationally in the prior two months (-4.0% in August and -1.1% in September), but momentum could be building again into the Christmas period taking October's outturn into account with the trends in high-frequency credit card data over November as Victoria opens up more widely and the recent surge in consumer confidence readings. The ABS also released its latest household and business Covid-19 impacts surveys. There were signs that some types of household activity had risen over October from the month prior (see here), while businesses' capex plans were gaining some traction in response to the recent incentives announced in the Federal Government's 2020/21 Budget.

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Turning to the offshore perspective, the tension between the hopes that potential vaccines bring and the near-term risks of the pandemic continued to be the main theme across markets this week. Further positive news on the effectiveness of both the Pfizer and Moderna vaccines in development provided the optimism, but the negatives came from the increasing rate of virus cases in the US leading to the re-introduction of restrictions across several sates, including in New York where public schools have been ordered to close. Highlighting the risks posed to the economy in the near term, retail sales for the month of October slowed to a 0.3% rise — its weakest outturn of the reopening phase — missing the consensus forecast for a 0.5% increase, while control group sales (more closely aligned with consumer spending for GDP purposes) disappointed by a larger margin coming in at 0.1% against 0.5% expected. In addition to virus-related concerns, the result could also be reflecting the impact of earlier fiscal support measures fading and seemingly slim prospects for a new package to be agreed by the Congress in the near term. Also disappointing was the figure on initial jobless claims that lifted week on week for the first time in 5 weeks rising to 742k from 711k, with the consensus being for a small decline to 700k. Much better news continues to come from the housing market which has been a source of strength so far in the economic recovery in the US. Housing starts have now returned to around their pre-pandemic level after rising by another 4.9% in October to the up by 64% on the trough during the shutdown, while existing home sales advanced for a 5th straight month with a 4.3% gain in October. On the policy front, it was a consistent message from Federal Reserve officials this week including Evans, Mester, Kaplan and Bostic around rising risks and uncertainty for the economic outlook posed by the latest surge in the virus, emphasising the importance of fiscal and monetary support. The request late in the week from the US Treasury Secretary Steven Mnuchin for unused funding appropriated under the CARES Act to the Fed for some of its emergency lending programs to be returned and repurposed by Congress clearly came as a surprise, with the central bank issuing a response that said these facilities still had an "important role as a backstop for our still-strained and vulnerable economy". 

In Europe, the vulnerability of the economy to the resurgence in the virus and return to shutdowns in the continent continued to be the main message from ECB President Christine Lagarde this week. Speaking virtually to the European Parliament, President Lagarde outlined that the encouragement provided by the news on the progress of vaccines was not enough to offset the downside risks the economy is currently confronted with as activity in the services sector is pulling back, uncertainty weighs on consumer spending and business investment responds negatively to soft demand conditions. Given this, President Lagarde said that it was the role of the ECB to "preserve favourable financing conditions" and that its PEPP and TLTRO programs had shown their effectiveness in this regard throughout the pandemic, both of which are expected to be adjusted by the Governing Council at the December meeting to provide further easing in the monetary policy stance. Fiscal support is also key and President Lagarde emphasised to the Parliament that the €750bn EU recovery fund "must become operational without delay"; that call coming after Hungary and Poland voted early in the week to veto the package that was initially agreed to back in July over the details of implementation. Meanwhile, over in the UK Brexit negotiations reportedly made some ground this week, though differences with the EU still remain. The two sides are attempting to strike a trade deal before the transition period ends on the 31 December, but any deal would still need to be ratified by the EU Parliament before that date otherwise tariffs and border checks would start being applied on UK-produced goods entering into Europe.