Macro (Re)view (28/5) | Australian capex upgraded; taper talk

Partial indicators of Australian activity ahead of next week's GDP outcome for the March quarter highlighted events locally this week. Construction work done came in a touch better than the consensus estimate of 2.1%, rising by 2.4% for Q1 (reviewed here). Combined, this was the strongest quarterly lift in output from the sector in 3½ years, though despite this total activity was still 1.1% lower than a year earlier. The main theme was the strength in residential construction where activity is really stepping up on the back of the HomeBuilder scheme, first home owner grants and low rates. Private sector residential work saw its sharpest lift in 6 years, with activity lifting by 5.1% as alterations surged up by 11.3% and new home building advanced by 4.1%. Though for the latter, there is a vast difference between detached housing that is accelerating (up 10.2% in Q1, 10.6%Y/Y) due to the stimulus measures being targeted at the segment as against a weakening higher-density segment (-4.4% in Q1, -9.8%Y/Y) where oversupply is a key factor with the international borders closed. Work in the non-residential sector was reported to have fallen by 1.6% in the quarter, though as we'll cover later this was in contrast with the Q1 capital expenditure data. Elsewhere in the report, engineeering work (2.2%qtr) was turning higher as public sector work (4.3%qtr) was on the rise with state governments bringing forward infrastructure projects to provide support to the recovery effort locally. 

Meanwhile, the strength of the recovery in the national economy from the depths of last year is now flowing through to business investment. Private sector capex outpointed all estimates in rising by 6.3% in Q1, turning growth through the year positive (0.8%) for the first time in more than 2 years (reviewed here). Equipment spending is soaring rising by 9.1%q/q after growth of 7.3% in Q4, with businesses making important upgrades to meet rising demand and to take advantage of the government's expansion to asset write-off provisions. This is most evident in the non-mining sector where equipment investment has rebounded by a little more than 20% off last year's low (see chart below). Capex on buildings and structures lifted 3.8% in Q1, counter to the decline reported in non-residential work in the construction activity data. The reason relates to the difference in methodology between the two: the capex data reports businesses' payments for building work whereas the construction activity data measures the value of work actually completed by builders and is thus the more relevant guide for GDP purposes. Reflecting the rise in business confidence and conditions to record highs in the NAB survey, investment intentions are being revised upwards to capture the upside expected from a positive outlook. Investment plans in the current financial year were lifted by 2.2% to $124bn, while the second estimate of intentions for 2021/22 was upgraded by 7.9% on the figure put forward 3 months ago to $113.6bn, placing plans back on their pre-pandemic trajectory. There are several key events upcoming next week including the latest RBA meeting and Q1's National Accounts (previewed here). 

Chart of the week 

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Offshore, it has been the talk of when the tapering discussion at the Fed might commence that has been leading the narrative. Meanwhile, the Reserve Bank of New Zealand became the latest central bank to take on a more hawkish leaning in communications in a similar manner to the Bank of Canada recently. At the Fed, while officials aren't giving much away, the line from the previous meeting's minutes is being repeated publically that the time to discuss a plan on tapering at the Committee level may be approaching. This was raised by the likes of Vice Chair Clarida and other voting members Quarles and Daly this week. But it is the data flow that will dictate the timing of those plans, and it will be a patient approach taken for as long as the Committee's central view for high inflation readings to prove transitory remains. For now, the Fed's preferred measure of inflation has surged to its strongest annual pace since 1992, with the core PCE deflator rising to 3.1%yr in April from 1.9% on a combination of reopening and base effects. 

Talk of tapering has also been building ahead of the ECB's upcoming meeting on June 10. The brightening outlook in Europe with the economy set to rebound sharply over the summer has prompted a rise in Germany to their least negative level in 2 years, with the thesis being that the better macro conditions would open the door for the ECB to slow the pace of its asset purchases. But that is far from the indications that ECB officials have been giving. President Christine Lagarde, executive board member Panetta and the governors of the central banks in France and Greece in recent appearances have all been in alignment that discussion around tapering is premature before the recovery has re-established itself following the setback it was dealt from the return to lockdowns. Closer to home, the RBNZ had a hawkish surprise for the markets at this week's meeting. All policy settings were left unchanged but there is an increasing level of optimism by the Committee in the economic outlook both domestically and offshore. The Bank's Monetary Policy Statement reintroduced projections for the benchmark interest rate and the path had a rate hike fully factored in for the second half of next year. While there is clearly a lot of conditionality around this it does emphasise the shift in the RBNZ's thinking from last year when during the height of the pandemic it was openly discussing the possibility of taking its policy rate negative. 

Preview: Australian Q1 GDP

Australia's March quarter National Accounts are due to be published by the ABS next Wednesday (2/6). Currently, the median estimate is for the economy to have expanded by 1.1% in Q1. The recovery continued at pace in the December quarter with real GDP rising by a stronger-than-expected 3.1%, which followed the 3.4% rebound in the September quarter as the economy started to reopen. But with the economy contracting by 7.3% over the first half of 2020 under the weight of lockdowns and activity restrictions, GDP was still 1.1% lower than its pre-pandemic level from a year earlier. 

With the nation's vaccine rollout only in its very early stages, snap lockdowns occurred in a few capital cities in the March quarter as a precautionary response to low rates of local transmission of the virus. However, the lockdowns were short in duration and restrictions were eased quickly after outbreaks had been contained ensuring the recovery was not derailed. Despite these setbacks, indicators of household activity and mobility showed that participation in a range of social and leisure activities was continuing to recover to pre-pandemic levels by the end of the quarter. More Australians were also returning to workplaces with the frequency of working home working arrangements declining from the peaks when the lockdowns were in place. 

The widening reopening and eased activity restrictions were leading to a rebalancing of household consumption patterns. Areas of goods-related consumption, while remaining at much higher levels than prior to the pandemic, were now leveling out or slowing as spending on services was rising. High levels of accumulated savings, strong sentiment, the recovering labour market and wealth effects from rising asset prices were helping to drive growth in household spending.  

Housing market activity continued to strengthen supported by low interest rates and stimulus measures from federal and state and territory governments. Additional incentives for first home buyers in a few states were driving very strong demand from that segment. House prices across the major capital city markets and in regional markets lifted further in the March quarter. On the supply side, the strong response to government programs including the HomeBuilder scheme and first home owner grants led to residential construction activity picking up further and the outlook was supported by detached house approvals rising to record highs.

With the heightened uncertainty that defined much of 2020 clearing to some extent through the reopening and the availability of vaccines, surveyed measures of business confidence and conditions had rebounded very sharply to sit at higher levels than prior to the pandemic. Equipment spending by businesses was surging to meet the rebound in domestic demand and as a response to the tax incentives first announced in last year's Federal Budget (and then extended in this year's Budget) that have greatly increased asset write-off provisions. In turn, this was supporting strong growth in import volumes, particularly for new vehicles and capital goods. Meanwhile, elevated commodity prices were generating tailwinds for national income and rural exports had surged following drought-breaking rain last year.    

As it stands | National Accounts — GDP

The momentum generated by the reopening of the Australian economy was sustained in the December quarter with output expanding by 3.1% after the 3.4% rebound in the September quarter. Still, these outcomes left Australian GDP 1.1% below its pre-pandemic level and around 3.8% below its forecast trajectory based on the outlook in the RBA's February 2020 Statement on Monetary Policy. Domestic demand continued to drive the recovery, with household consumption again the leading contributor to growth in the quarter. 

Offshore, growth in OECD economies slowed significantly to 1.0% in the March quarter from growth of 9.3% in the September quarter, largely stalling progress in the global recovery with containment measures being brought back to contain a resurgence in the virus. Quarterly output growth slowed sharply but was still positive in the US (1.1%) and UK (1.3%), though it contracted in the euro area (-0.7%) due to shutdowns being reinstated. China's economy continued to lead the global recovery, with GDP increasing by a further 2.6% in the December quarter. 

In Australia, the containment of the virus, eased restrictions and the tailwinds from policy stimulus measures saw household consumption continuing to drive the recovery with a further 4.3% rise in the December quarter. Contributing significantly to this strength was Victoria where household consumption rebounded with a 10.4% surge on the state's reopening from its extended winter lockdown. The widening reopening across the nation led to increased opportunities for households to spend, reflected by growth in services consumption (5.2%) again outpacing growth goods consumption (2.8%). Strong rises in spending were recorded in transport (includes domestic travel) 19.3%qtr, hospitality venues and hotels 17.5%qtr, household services 11.8%qtr and recreation services 9.1%qtr. However, while goods consumption advanced further, services consumption was still 7.8% below its pre-pandemic level and this was continuing to weigh on the recovery in household consumption overall.

Strengthening conditions in the housing market and policy stimulus from low interest rates, the HomeBuilder scheme and other government incentives were combining to turn the tide in the residential construction cycle from the downturn of the past couple of years. Residential construction activity posted its strongest rise in more than 5 years advancing by 4.1% in Q4, with increases in new home building (3.4%qtr) and alterations (5.2%qtr). Improving domestic demand conditions were the catalyst for the early stages of a rebound in business investment (2.6%qtr) after several years of weakness. Equipment spending (8.1%qtr) was particularly strong following the expanded tax incentives included in last year's Federal Budget. Net exports were broadly neutral in Q4: exports had risen strongly due to a surge in cereal volumes following the ending of the drought and increased commodity shipments, though this was offset by rising import volumes reflecting the rebound in domestic demand.     

Key dynamics in Q1 | National Accounts — GDP 

Household consumption — The mix of household spending is rebalancing as the reopening widened out further, though the pace is likely to have moderated from the very strong rates of growth in the previous two quarters. Retail sales volumes declined by 0.5% in the quarter as more consumption opportunities became available in services-related areas, though snap lockdowns in several capital cities may have also been a factor. Household consumption continues to be supported by eased restrictions, the recovery in the labour market, high accumulated savings, strong sentiment and wealth effects from rising asset prices.

Dwelling investment — Residential construction activity surged higher in the March quarter as the HomeBuilder scheme and other policy stimulus measures gained traction. Private sector alteration work accelerated by 11.3% in the quarter, while new home building advanced by 4.1%, with the strength driven by the detached segment (10.2%).  

Business investment — A sharp rebound in business confidence and trading conditions together with tax incentives for new investment led to growth in private sector capital expenditure stepping up in pace to a 6.3% rise in Q1. Leading the way is equipment spending, which surged up by a further 9.1% in the quarter following Q4's 7.3% rebound. 

Public demand — Strength in public demand continues to be boosted by health-related spending in response to the pandemic, while the investment pipeline is expanding as states look to bring forward infrastructure projects.  

Inventories — Global supply chain issues and key input shortages amid the strength in demand as economies reopen may lead to a run down in inventories following a -0.1ppt contribution in Q4. 

Net exports — The rebound in domestic demand conditions is driving strong growth imports, while expanded tax incentives for businesses are also assisting. Rural exports were strong again in Q1 as the drought-breaking rain of last year has led to a very strong cereal harvest, while resource exports look to have risen a little further as commodity prices continued to surge.  

Australian Capex 6.3% in Q1; 2020/21 investment plans $124bn

Australian private sector capital expenditure outperformed the top end of the range of market forecasts rising by 6.3% for the March quarter. This is being driven by very strong growth in equipment spending, which is supported by the tax incentives in last year's Federal Budget. Forward-looking investment plans were also upgraded with firms becoming more constructive over the economic outlook. 

CapEx — Q1 | By the numbers

• Private sector capex exceeded all estimates in lifting by 6.3% in the March quarter to $31.5bn. Markets had only expected a 2.1% rise, while growth in Q4 was left unrevised at 4.2%. Through the year growth in capex lifted to 0.8% from -7.0% on base effects.  

• Equipment, plant and machinery capex surged by another 9.1% in Q1 from growth of 7.3% in Q4 to $15.3bn (5.6%Y/Y).  

• Buildings and structures capex increased by 3.8% in Q1 (prior: 1.6% in Q4) to $16.2bn but is still down by 3.4% through the year. 

• Forward-looking investment plans on firms' 6th estimate for 2020/21 were upgraded by 2.2% to $124bn, though this is 1.4% lower than at the comparable stage in 2019/20. Meanwhile, estimate 2 for 2021/22 was lifted by 7.9% to $113.6bn, with base effects going back to the start of the pandemic resulting in this figure being 14.9% higher than the estimate put forward 12 months ago.   

CapEx — Q1 | The details

The rebound in capex continued into the March quarter with firms becoming increasingly confident in the outlook with fewer restrictions on trade and the tax incentives included in last year's Federal Budget spurring demand. The 6.3% lift in capex in Q1 was the strongest in 9 years going back to the time of the mining investment boom. 

The non-mining sector is driving the rebound with capex rising by a further 7.1% in Q1 after a 6.2% lift in Q4. This takes non-mining capex to back around its pre-pandemic level. Within the sector, equipment spending is on a tear rising by 17.1% from the lows of last year, helped by the greatly expanded asset write-off provisions available. Investment in buildings and structures has seen a more modest rebound, rising by 1.7% in Q4 and then 4.5% for Q1. Mining sector capex saw a 4.1% lift in Q1, driven by an 8.1% rise in equipment spending with support from a 2.6% increase in buildings and structures. 

From an industry perspective, the full breakdown is shown in the 'By the numbers' section. This discussion will focus on the broad sector perspective. Aside from the mining sector covered above, capex in the goods-related (ex-mining) sector led the way with a 10.4% boost in Q1. The industries driving this were construction (17%qtr), manufacturing (15.4%qtr) and wholesalers (13.2%qtr). Business services capex advanced by 4.8% for the quarter, though it was a mixed picture in the sector with finance and insurance (17.6%qtr) and professional services (9.6%qtr) up sharply, moderated by declines from administration (-5.1%qtr) and telecommunications (-2.1%qtr). Household services capex lifted by 1.6%qtr, driven by reopening dynamics, with rises in arts and recreation (17.3%) and accommodation and food (8.8%qtr).

Turning to investment plans, estimate 6 for the year 2020/21 was nominated at $124bn, which was in line with my expectations. This figure is 2.2% higher than the total firms had put forward 3 months ago, though it also implies that capex for 2020/21 is on track to fall by 1.4% compared to 2019/20. 

The report also included the 2nd estimate of capex plans for 2021/22. A year ago, the intensification of the pandemic crisis saw the 2nd estimate for 2020/21 cut by 9.4% compared to the 1st estimate as the uncertainty over the outlook and a focus on preserving capital took hold. But the strength of the recovery, surging business confidence and considerably less uncertainty around prospects for the economy in general means that firms are now positioning for growth. With this in mind, my expectation was that estimate 2 for 2021/22 would be upgraded by around 9%, reversing the fall that was seen last year. In the end, the scale of the upgrade got close but fell a little short, rising by 7.9% to $113.6bn. Within this, non-mining investment plans lifted by 11.3% to around $77bn to be broadly in line with their pre-pandemic level, while capex intentions for mining were revised up by 1.5% to $10.3bn.  

CapEx — Q1 | Insights

All in all, Q1's capex data was consistent with the strength of the economic recovery underway. Equipment spending is surging with activity in the economy rebounding from the depths of last year and the expanded asset write-off provisions for new investment are clearly gaining traction. This strength should now last a little longer given that the recent Federal Budget extended these provisions by 12 months. Investment intentions are now looking much more constructive, especially in the non-mining sector, and look to have recovered from their pandemic-induced slump.     

Preview: CapEx Q1

Australian private sector capital expenditure data for the March quarter is due to be released by the ABS this morning at 11:30am (AEST). Capex was starting to rebound in the December quarter, with the reopening and expanded tax incentives encouraging firms to boost equipment spending. This is expected to have continued into the March quarter, while forward-looking investment plans are set to be upgraded with the earlier extreme uncertainty associated with the pandemic dissipating. 

As it stands | Capital Expenditure

Capex had been weak for several years prior to 2020. The recession that followed the onset of the pandemic led to a further slump as firms cut back or shelved investment plans in a highly uncertain climate and to preserve liquidity. But with the economy reopening and activity rebounding sharply, capex lifted by 3.0% in Q4 (-7.5%Y/Y) making this its strongest quarterly rise since the period of the mining investment boom around a decade earlier (full review here).

The rebound in capex was heavily weighted towards equipment spending (5.7%q/q) with firms investing to meet strong demand after the lockdowns and as a response to greatly expanded tax incentives for firms in the 2020/21 Budget (which were then extended in the most recent Budget earlier this month). In contrast, buildings and structures lifted modestly rising by 0.7%q/q.

Capex in the non-mining sector advanced by 4.9%q/q to lead the way. Within this, there was an 8.4% surge in equipment investment while buildings and structures were up 0.9%q/q. Mining sector capex remained subdued despite elevated commodity prices, recording a 1.4% fall overall in Q4. 

Firms' 5th estimate of capex plans for 2020/21 was revised to $121.4bn, which was an upgrade of 4.8% on the 4th estimate but 7.1% lower than the total put forward a year earlier in a pre-pandemic economy. Similarly, estimate 1 for 2021/22 was lowered by 3.4% from a year earlier to $105.5bn.   

Market expectations | Capital Expenditure

The capex rebound is expected to have continued since the turn of the year, with the market looking for a 2.1% rise in the March quarter. Individual estimates for the outcome range between 1.0% to 5.0%. 

For investment plans, the 6th estimate for 2020/21 is likely to be upgraded modestly. Over the past 5 years, the average upgrade from estimate 5 to estimate 6 has been 1.3%. Given the strength of the reopening, a larger upgrade seems more likely here to around say $124bn from $121.4bn (+2.5%). 

Meanwhile, estimate 2 for 2021/22 is in line for an upgrade as well from the $105.5bn figure put forward 3 months ago. Going back to last year, the emergence of the pandemic saw investment plans plunge by around 9% in estimate 2 compared to estimate 1. With the reopening widening out and measures of business conditions and confidence at survey highs, this decline may be fully reversed with a 9% rise to $115bn for estimate 2. 

What to watch | Capital Expenditure

The intentions component of today's survey will be of most interest to markets, with the key question being the extent to which firms' investment plans are being upgraded in response to the rebounding economy. This will also pose the question as to how much of the potential upgrade can be attributed to reopening dynamics compared to more structural shifts occurring as a result of the pandemic. 

Australian construction activity +2.4% in Q1

Australian construction activity came in a little stronger than expected in the March quarter rising by 2.4%, making this the sector's strongest outturn since Q3 2017. A surging residential sector is leading the way, with both detached home building and alterations rising strongly in response to pandemic stimulus measures. 

Construction Work Done — Q1 | By the numbers

• Total construction work done (private and public sectors) advanced by 2.4% in the March quarter, better than the 2.1% rise expected. Work done in Q3 was revised to show a larger contraction (-1.5%) than initially reported (-0.9%). This still left activity 1.1% lower through the year (from -2.4%).  
• The headline results were;  
• Engineering work +2.2%q/q to $21.8bn (-0.3%Y/Y)
• Building work +2.5%q/q to $30.2bn (-1.8%Y/Y)
• Residential work +5.1% to $19bn (+4.2%Y/Y)
• Non-residential work -1.6%q/q to $11.2bn (-10.4%Y/Y) 

Construction Work Done — Q1 | The details 

Australian construction activity lifted above consensus in Q1, driven mostly by a strong showing from the residential sector and a more moderate lift in engineering work. Work done by the private sector picked up to rise by 1.7% in the quarter (-1.2%Y/Y), while public sector work advanced at its strongest pace in a single quarter in 3 years rising by 4.3% (-1.0%Y/Y). 

The rise in private work was overwhelmingly led by the residential sector in response to the HomeBuilder scheme and other stimulus measures, which posted a 5.1% surge in Q1 — its strongest quarter in 6 years — to be up by 3.8% through the year. New home building lifted by 4.1% in Q1 (1.8%Y/Y) as alterations surged by 11.3% (17.2%Y/Y). 

However, conditions in residential construction vary significantly between the detached segment, which has been the major beneficiary of the stimulus measures, and the higher-density segment that has fallen out of favour due to the effects of the pandemic and the closure of the international borders. New detached home building surged by 10.2% in Q1 (10.6%Y/Y) while higher-density construction fell by 4.4% (-9.8%Y/Y).

In contrast to the residential sector, the non-residential sector continued to contract, falling a further 5.6% in Q1 to be down by a sharp 17.6% on a year earlier. This is approaching the lows last seen during the GFC and highlights the toll that the pandemic has taken on business investment. Meanwhile, private engineering work was up by 1.6% for the quarter and 3.4% through the year. 

Turning to the public sector, there were rises in both building work (7.1%) and engineering work (3.1%) in Q1. There was a surprisingly heavy fall in work done by the public sector in Q4 (-6.8%), but Q1's 4.3% lift should be more than just a rebound given the lengthy pipeline of projects state governments are bringing through.

Construction Work Done — Q1 | Insights

Today's report was a little better than expected with construction activity picking up on the back of an upswing in the residential sector. The surging residential sector is being driven by a very significant policy response since the onset of the pandemic, which includes low interest rates, the HomeBuilder scheme and other government incentives for first home buyers. The weakness in non-residential work is a cyclical response to the recession and heightened uncertainty of last year. Meanwhile, the rise in public sector work is a policy decision by governments to bring forward infrastructure spending to provide additional support to the recovery.  

Preview: Construction work done Q1

Australian construction activity data for the March quarter is due to be released by the ABS today at 11:30am (AEST). Construction work is expected to turn higher in Q1, led by a robust residential sector on the back of policy stimulus and rising house prices, though non-residential work is still weighed by uncertainty stemming from the pandemic. Meanwhile, with state governments bringing forward projects there is a lengthy pipeline of work coming from the public sector.  

As it stands | Construction Work Done

The construction sector has been relatively less affected by the pandemic than many other areas of the economy more exposed to activity restrictions. Still, construction activity had declined by 1.8% in the September quarter and this was followed by a further 0.9% contraction in the December quarter, leaving its level 1.4% lower than a year earlier (full review here). 

Private sector activity was coming off a 2.9% fall in Q3, in part due to Victoria's return to lockdown, but was unable to rebound with activity stalling in the December quarter (-1.1%Y/Y). The residential sector (2.7%q/q) was starting to pick up on the back of policy stimulus and rising house prices, though this was offset by weakness in non-residential (-2.9%q/q) and engineering work (-1.6%q/q).

Despite a lengthy pipeline of projects, public sector activity surprised with a 3.6% contraction in Q4 (-2.2%Y/Y) with declines in engineering (-4.6%q/q) and building work (-1.1%). 

Market expectations | Construction Work Done 

Construction activity is forecast to have advanced by 2.1% in the quarter on the median estimate, while the range of estimates is between 1.0% on the low side to 5.0% on the high side. 

What to watch | Construction Work Done

Generally, this is quite a low-key release but with the construction cycle turning higher it may attract more interest from the market and the risks do seem to be weighted towards the upside. Policy stimulus and closed borders have helped turn around conditions in the housing market with strong activity from upgraders while government incentives are helping the first home buyer segment. The Federal Government's HomeBuilder program will add significantly to the supply side with detached dwelling approvals rising to record highs, while approvals for alteration work for established houses have also surged in response to the scheme and these are the areas of most interest in today's report. Meanwhile, activity in the non-residential space is likely to have remained weak with business investment slower to recover than other areas of the economy, though public works could rebound after a weak Q4 with state governments bringing forward projects to support demand.   

Macro (Re)view (21/5) | Reopening dynamics continue to play out

While strong progress in the recovery has been achieved since the reopening, this week's data on the Australian labour market confirmed that the goal of the nation's fiscal and monetary authorities to return to full employment likely remains some way off. Employment posted its weakest outcome in 7 months falling by 30.6k in April against a 20.0k rise forecast (reviewed here). The end of March expiry of the Federal Government's JobKeeper wage subsidy may have been a factor behind the weakness, though for now, it is difficult to draw definitive conclusions due to the presence of seasonal factors in April associated with holidays around the Easter period, highlighted by a sharp 0.7% fall in hours worked in the month. 

The end of the wage subsidy that proved highly effective in maintaining jobs and supporting household income through the lockdowns will have resulted in a range of different outcomes, with some people staying on in their current role; others may have switched to a new job; and some may have lost work altogether, but an aggregate level the impact is not yet clear. Even though employment declined in the month, an easing in the participation rate off March's record high of 66.3% to 66.0% equated to a larger fall in the labour force (-64.2k), leading to the unemployment rate declining from 5.7% to 5.5% (vs 5.6% expected). While significantly lower than its mid-2020 pandemic peak of 7.5%, unemployment is still higher than it was pre-COVID, and it is well above where most estimates for the level of full employment sit (around 4 to 4.5%). While there is still a great deal of uncertainty around the transitional effects of the expiry of JobKeeper on the recovery, the labour market is well placed with employment having already rebounded to above its pre-pandemic level and measures of labour demand at elevated levels.

Wages also remain in a period of recovery, with the widening reopening and improving economic conditions leading many businesses to revisit wage reviews that had been put on hold due to the pandemic. With temporary wage cuts and freezes continuing to unwind and with the delayed minimum wage increase for the industries hardest hit by the pandemic going through in the March quarter, growth in the Wage Price Index was a little stronger than expected in Q1 rising by 0.6% (vs 0.5% expected), lifting the annual pace off its record lows to 1.5% (reviewed here). These developments saw private sector wages continuing to recalibrate towards more normal patterns, though at 1.4%Y/Y the pace is considerably slower than prior to the pandemic (around 2.2%), while wage freezes are weighing on growth in public sector wages, which eased to a record low of 1.5%Y/Y (see chart, below).

Chart of the week

The minutes of the RBA's May meeting noted that the upcoming decisions to be made in July around the way forward with its yield target policy and quantitative easing program "would be based on close attention to the flow of economic data and conditions in financial markets in Australia". Here, developments in the labour market are key, and with the Board identifying full employment as "a high priority for monetary policy" and the need for "wages growth to be sustainably above 3%" to meet the inflation target, I continue to think the Board under its current framework that emphasises the importance of actual (rather than forecast) outcomes will come to the view that this is a time to continue with existing settings rather than making them less accommodative. As such, I expect an extension in the maturity of the 3-year yield target from the April 2024 bond to the November 2024 bond as well as a further $100bn of bond purchases to be announced in July. This would also be consistent with the strategy of the fiscal authority, described by Treasury Secretary Kennedy in a speech this week as being in its "first phase" in which the government is focused on boosting spending to secure the economic recovery and bring down unemployment to pre-pandemic levels. 

While consumer sentiment on the Westpac-Melbourne Institute Index declined by 4.8% in May in response to last week's Federal Budget, the monthly reading was the second highest of the last 11 years. Overall, sentiment remains very strong, as do expectations around the economic outlook. Notably, the unemployment expectations index fell by 15.3% in the month, indicating more confidence in the labour market recovery rolling on. Meanwhile, retail sales posted a stronger-than-expected 1.1% rise for the preliminary estimate in April following on from the 1.3% lift in March. Highlighting the ongoing strength in household spending, retail sales in April were 11.8% higher than their level just before the onset of the pandemic.      

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Moving offshore where in the US the minutes from the April meeting by Federal Reserve's FOMC gained plenty of attention with "a number of participants" making the case that a plan for tapering the pace of asset purchases from the current rate of $120bn/mth should be discussed at upcoming meetings. However, this was predicated on the economy making continued "rapid progress" towards its maximum employment and inflation objectives. But since this meeting, it is debatable whether rapid progress has been achieved given the large downside misses in April on non-farm payrolls (266k vs 1m expected) and retail sales (control group -1.5% vs -0.2% expected). Last week's inflation readings were clearly much higher than anticipated, with core CPI coming in at 3.0%yr (vs 2.3% expected), though the Committee's long-standing central view is that high inflation will prove temporary for a time due to a range of pandemic-related issues before sliding back towards 2% over the rest of the year as these effects pass. The April minutes said that the risks around the Committee's inflation outlook were "balanced". Inflation could stay higher for longer if supply-side bottlenecks and disruptions can not be quickly resolved, but the fact that longer-run inflation expectations were around the 2% target was suggesting to the FOMC that its transitory assessment was justified. Despite the more hawkish members of the Committee hinting at the tapering discussion in the minutes, the reaction in the bond markets was limited, perhaps a sign that this is still expected to be some way off from taking place. 

Over to the UK and Europe where things are continuing to look on the up, with accelerating vaccine rollouts enabling those economies to reopen. Preliminary PMI readings for May showed that activity was surging at a faster pace than when lockdowns were first eased mid way through last year. The composite UK PMI advanced from 60.7 to 62.0 (readings > 50 signal expansion) to hit its highest level since 1998, while the gauge in the euro area lifted to a 39-month high at 56.9 from 53.8 in April. The upswing is driven by the manufacturing sector with new orders continuing to flow in at rapid rates from domestic and offshore clients and backlogs are building up. The easing of lockdowns is strongly boosting the services sector with activity in the UK rising at its fastest pace in 7 years, while the euro area is seeing its sharpest lift since 2018. As far as the consumer goes, UK retail sales soared by 9.2% in April (vs 4.5% expected) as the shops reopened, led by a near 70%m/m rise in clothing sales. With supply struggling to keep up with demand, and due to difficulties in rehiring at this stage, cost pressures are building, which is adding to input shortages and supply chain delays. But like the Fed, both the Bank of England and the European Central Bank expect that high inflation will fade as reopenings widen. Data this week showed annual CPI in the UK lifted from 0.7% to 1.5% in April (vs 1.4% expected), while euro area CPI was finalised at 1.6%yr. 

Australian employment -30.6k in April; unemployment rate 5.5%

Australian employment declined by 30.6k in April in a downside surprise on consensus estimates. An easing in the participation rate from record highs meant that despite the weakness in employment, the national unemployment rate moved down from 5.7% to 5.5%. April's report was the first since the expiry of the JobKeeper pandemic wage subsidy, though seasonal effects make it difficult to draw firm conclusions at this stage.  

Labour Force Survey — April | By the numbers

• Employment (on net) declined by 30.6k in April, falling well short of expectations for a 20.0k increase and coming in towards the lower end of the range of estimates (-40.0k to +60.0k). March's initially reported rise in employment of 70.7k was revised up to 77.0k in today's release. 

• National unemployment declined from an upwardly revised 5.7% (from 5.6%) in March to 5.5%, beating the median estimate of 5.6%. 

• Australia's participation rate declined from its record high of 66.3% to 66.0% in April.

• Hours worked declined by 0.7% in April to 1.79bn hours on seasonal effects, with the timing of the Easter period and school holidays meaning that more Australians were taking annual leave than would usually be the case at that time of year. Despite this, base effects dating back to the depths of the pandemic led to annual growth in hours worked surging up by 10ppts to 12.5%. 

Labour Force Survey — April | The details

Australian employment recorded a fall of 30.6k for the month of April, ending a run of 6 consecutive monthly gains and disappointing market expectations for a modest rise (20.0k). The timing of the sampling conducted for this report factors in the expiry of the JobKeeper scheme, though in the commentary that accompanied today's release, the ABS said that it was difficult to identify a discernible impact between the end of the government's pandemic wage subsidy and the fall in employment. Seasonal effects were cited as a factor, with more people taking annual leave than usual in April over the Easter and school holiday period, while the ABS also noted that it had not seen signs in other indicators that would point to the impact of the JobKeeper expiry: there had not been large net outflows from the labour force and the number of employed people working zero or reduced hours due to 'economic reasons' in April (58.9k) was similar to March (56.9k), in line with pre-pandemic levels. Even with the decline in April, employment is still higher than it was prior to COVID, by around 0.4%. 

Part-time employment was down by a sizeable 64.4k for the month, making this the segment's weakest outcome since the lockdowns during the first wave of the virus around 12 months ago. This accounted for all of the fall in headline employment, with some offset coming through from full-time employment, which rebounded by 33.8k after its upswing had hit a bump in the road in March with a 21.1k fall. Employment in both the part-time (0.5%) and full-time segments (0.3%) is above pre-pandemic levels. 

The participation rate came off its record high level in March, easing back from 66.3% to 66.0%. With this leading to a larger fall in the labour force (-64.4k) than the decline in employment (-30.6k), the measured unemployment rate moved down from 5.7% to 5.5% to be around 2ppts lower than at peak of the pandemic but it is still higher than its level from before the crisis. Rates of underemployment (-0.2ppt to 7.8%) and underutilisation (-0.4ppt to 13.3%) declined in April and are now some way below what were already high levels before COVID. 

Total hours worked were sharply lower in April (-0.7%), with a large decline in part-time hours (-2.4%mth) pointing to the impact of Easter holidays and full-time hours (-0.3%) also down with many people taking annual leave over the period, which also aligned with school holidays. Even with this, hours worked in the Australian economy in April were 1.8% higher than before the pandemic (FT hours +1.5% and part-time hours +2.8%), which speaks to the durability and vibrancy of the reopening effort.  

Across the states, employment outcomes were generally weak with declines being recorded in New South Wales (-36.7k), Western Australia (-14.4k), Queensland (-7.4k) and Tasmania (-2.5k), though South Australia (+15.3k) and Victoria (+3.6k) went against the trend. Employment in New South Wales slipped back below its pre-pandemic level, though South Australia has now more than regained its losses from the pandemic. The only states to see a rise in unemployment in the month were Queensland (+0.1ppt to 6.1%) and Tasmania (+0.2ppt to 6.2%), though this come alongside rises in participation rates. Unemployment in New South Wales and Victoria is now at 5.5%, though participation rates have softened a little in both over recent months.    

Labour Force Survey — April | Insights

More data will be needed before definitive conclusions can be drawn around the effects of the expiry of JobKeeper on the recovery in the labour market. Today's result would most likely reflect some immediate impact from the withdrawal of the wage subsidy, but this is something that is likely to play out over several months rather than all coming at once. Elevated levels in job vacancies suggest there is plenty of demand for labour, though labour shortages are not widespread across the economy. All in all, the labor market is well placed to withstand the transition away from JobKeeper, particularly with both the fiscal and monetary authorities making renewed efforts to return to full employment.