Weekly note (11/1) | Powell ‘put’ reassures markets

The first full week of 2019 saw global equity markets rise strongly as risk sentiment improved notably following an unexpectedly dovish shift in communication from the US Federal Reserve. This was also supported by positive reports emanating from trade negotiations between a US delegation and officials from China, while late last week the People's Bank of China announced a new round of policy easing targeted at increasing liquidity in the banking sector to ward off the risk of a slowing growth outlook in the world's second-largest economy.

The turnaround in risk sentiment came last Friday when US Federal Reserve Chair Jerome Powell speaking to the American Economic Association in Atlanta ameliorated market concerns that further policy tightening could accentuate a slowing outlook for economic growth by saying that "we (the Fed) are always prepared to shift the stance of policy and to shift it significantly".   

While key data continues to show strength in the US economy, highlighted by a much stronger-than-expected employment report in December (see here), forward-looking indicators have been pointing towards a slowdown in activity in the domestic economy. In this context, Chair Powell highlighted a preparedness to balance strength in incoming data with the risks of a slower growth outlook, with "muted inflation readings" affording the Fed flexibility in its policy decisions. The comments were well received by markets, who had been left greatly disappointed late last year when the Fed indicated an expectation for continuing with policy tightening in 2019 as covered in our previous weekly.

Wednesday's FOMC minutes then reiterated the change in Fed commentary, which pointed to a patient data-dependent approach in 2019 with the path for policy tightening now "less clear than earlier" due to financial market volatility, which has potential spill-over impacts for consumption and investment, and renewed concerns over the global growth outlook driven in part by trade tensions. From a fundamental perspective, Committee members remain confident in the outlook for the domestic economy with output growth anticipated to run above potential in 2019 driven by household spending and business investment, though assessments will clearly now be more nuanced to the risks that have unsettled markets over recent months.     

Over in Europe, the European Central Bank (ECB) minutes from December expressed both optimism and caution. Confidence in underlying economic conditions — despite a recent weakening in incoming data — had led to the conclusion of its near 4-year long €2.6 trillion asset purchase programme (APP), though risks to the growth outlook while still assessed as broadly balanced were "moving to the downside" due to geopolitical and trade uncertainties and market volatility. In particular, the minutes described the outlook as "fragile and fluid, as risks could quickly regain prominence or new uncertainties could emerge".

While asset purchases have now concluded, the Governing Council's measures to ensure ample stimulus remains in place include; forward guidance for key interest rates to remain on hold "at least through the (European) summer of 2019" and an intention to reinvest payments from maturing bonds purchased under the APP "for an extended period of time" after when it starts to raise key interest rates. Additionally, the minutes indicated that the ECB may revisit providing another round of cheap long-term loans to the banking sector.

Continuing the trend of softening data pointing to slowing momentum in the European growth outlook, a measure of economic sentiment in the region eased for the 12th consecutive month during the week driven by the consumer, services and construction sectors. More positively, euro area data for November showed stronger-than-expected outturns from retail trade and the labour market, where the region's unemployment rate fell to a decade-low 7.9%, which features as our chart of the week.

Chart of the week

At the completion of an optimistic week in markets, equity indexes in the US had risen by around 2.5 to 3.5%, Asian markets gained between 1.5 to 4% and Europe lifted by around 1%. As a proxy for improved risk sentiment in markets, the Australian dollar posted a 1.4% gain against the US dollar this week. The spread between US 10 and 2-year bond yields narrowed from a little above 17 basis points to around 16 basis points over the week.

     

 

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In Australia this week, the data flow was decidedly soft fitting with the trend experienced in other major advanced economies recently. Separate indicators from the Australian Industry Group (AiG) showed activity levels slowed in the nation's manufacturing, services and construction sectors in December. 

The AiG's Performance of Manufacturing Index eased to a sub-50 reading for the first time since August 2016 indicating that activity levels had contracted in December. In the services sector, the AiG's headline measure was still expansionary at 52.1 despite slowing in the month, however the employment sub-index fell sharply to indicate that firms had been reducing staffing levels. The weakest read came from Friday's AiG Performance of Construction Index (PCI), which fell by its sharpest rate in more than 5 years to 42.6. This result was weighed heavily by contracting activity in residential construction for both houses and apartments, which respondents had reported was due to a range of concerns including; tighter financing conditions, falling property prices, soft investor demand and oversupply with projects reaching completion. 

This followed a weak report for building approvals for November that was released by the ABS on Wednesday (for our full analysis see here). Total dwelling approvals fell by 9.1% in the month driven by weakness in house and unit approvals compared to expectations for a broadly-flat outcome. Though statistical volatility likely overplayed the monthly result, the trend was broadly consistent with the PCI data. While the near-term outlook is supported by a highly elevated pipeline of work, residential construction appears likely to become a drag on overall economic growth, possibly towards the back end of 2019. 

In better news, retail sales for November came in stronger than forecast by posting a rise of 0.4% in the month as Black Friday promotions drove a heavy increase in online spending (see our analysis here). The significance of online retail in Australia continues to surge and the November sales promotion period will become of increasing importance to the sector. Recent history indicates that it may also be driving a shift in consumer behaviour by encouraging a bringing forward in spending in the lead-up to Christmas, which then, in turn, may attenuate spending in December.

Lastly, the nation's trade balance was softer than anticipated in November due to rising spending on imports for capital goods (see our analysis here). Both coal and iron-ore export volumes weakened during the month but this was moderated by the surging LNG sector, where export values increased to a new record high $4.56bn in November.  

Online spending drives Australian retail sales in November

A surge in online spending following promotional activities for Black Friday drove a stronger-than-expected result for Australian retail sales growth in November. A similar trend occurred in November in the previous year where spending in the lead-up to Christmas was bought forward but then declined in December.

Retail Sales — November | By the numbers

• Total retail spending lifted by $114.8m, or by +0.4%, in November to $A27.115bn, which outpaced the market forecast for growth of +0.3%. Turnover growth in October was unrevised at +0.3%.    

• Annual growth in retail spending fell from a pace of 3.6% in the previous month to 2.8%, which was impacted by a sizeable base effect as a 1.2% jump in sales growth from November last year fell out of the annual calculation. In trend terms, annual growth has been tracking at a pace of around 3.6% over the past 3 months. 

Retail Sales — November | The details 

The key to retail spending in November was the impact of Black Friday sales and other variations including click frenzy, which sees retailers participating in promotional activities, mostly on online platforms, though there is some spillover into traditional retailing.  

On a seasonally-adjusted basis, total retail spending lifted by $114.8m to $A27.115bn in November. According to the ABS' estimates for online retail, which are not seasonally adjusted, spending surged by 17.8% in the month, or by $286.6m, to $1.892bn. This resulted in the contribution from online spending to total retail sales accelerating by 0.7ppt to a new record-high level of 6.6% in original terms, which is 1.1ppts above its level from a year prior. 

      

Looking across the categories, those typically linked to the online space — such as clothing and footwear and household goods — led turnover growth in the month. Clothing and footwear posted a 1.5% rise, which followed a 2.9% increase last month, while annual growth accelerated from 5.4% to 5.9%. Household goods spending lifted by 1.2% in November, but the annual rate fell to near flat from 3.4%. 

Spending in department stores lifted by 0.4% in November to match the rate of growth in national spending, while spending in cafes and restaurants and in 'other retailing' (pharmaceuticals, books, stationery etc) both fell by 0.1%.     

Food retailing — the largest category at around 40% of total retail sales — lifted by 0.2% in the month, which inched annual growth up to 4.0%. 

    

Removing the impact of the food category, broad-based discretionary retail spending increased by 0.6% in the month, though annual growth fell from 3.4% to 1.9% reflecting the base effect discussed earlier. 

Turning to the state detail, the outcomes were mixed in November. New South Wales led with an increase of 0.8%, which follows two consecutive monthly declines. Annual growth has now slowed to just 1.9% from a recent peak of 4.2% in August. This is despite very strong labour market conditions and solid population growth, potentially indicating some impact from declining property prices. 

Turnover growth was soft for Victoria at just 0.1%m/m, though its annual rate remains the strongest in the nation at 4.6% despite a recent cooling. Victoria's retail sector has benefitted from a very strong population growth and residential construction activity.   

For the other states, Western Australia (+0.6%m/m) and Queensland (+0.4%) posted gains, while South Australia was flat and Tasmania declined by 0.2%m/m.   

The charts, below, show a comparison in annual growth in retail spending across the states. 

Retail Sales — November | Insights  

Positively this was a stronger-than-expected result, though it could turn out to be a repeat from 2016 and 2017 where sales growth had lifted in November before declining in December. More broadly, this could represent a shift in consumer spending patterns in the lead-up to Christmas as they look to take advantage of sales promotions amid an increasing expansion in online spending. We can expect these retail sales data releases to take on increasing importance for markets in 2019 given the well-documented headwinds facing the household sector from low income growth and a likely negative wealth impact from declining property prices. The Reserve Bank of Australia remains sanguine on the latter.   

Australian building approvals roll over in November

Australian building approvals fell heavily in November with weakness evident in both units and houses in the month. Over the past year, the approvals on a nation-wide basis have rolled over sharply driven by factors including; tightening financing conditions, property price declines and an easing in the construction pipeline off a highly elevated level.

Building Approvals — November | By the numbers

• Total dwelling approvals (including the private and public sectors) on a seasonally-adjusted basis fell by 9.1% in November to 15,465, which was much worse than the market forecast for a broadly-flat outcome (-0.3%). Approvals from the previous month were revised to show a 1.4% decline compared to the initial estimate at -1.5%.    

• On an annual basis, dwelling approvals have decelerated by 32.8% having deteriorated from -13.0%Y/Y last month (revised from -13.4%Y/Y) 

• Unit approvals slumped by 18.4% in November to 5,921, which is 53.8% below the level from a year earlier (prior revised: -4.6%m/m, -22.2%Y/Y)

• House approvals fell by 2.3% in the month to 9,543 as the annual pace decelerated to -6.5% from -4.8% (prior revised: +1.1%m/m, -4.8%Y/Y)

Building Approvals — November | The details 

From month to month, the building approvals data tend to be highly volatile, though when overlayed against the trend series it is clear to see that the slowdown is being driven mostly by a rollover from the units, however a softening in house approvals also been occurring. 

With that established, drawing on the granular detail from today's data, the chart, below, highlights that the slowdown in unit approvals has come mainly from the high-rise category, which are now running around 56,000 over the past year having slowed from a recent peak of around 66,000 over the 12-months to June 2018. In addition, low-rise approvals have also slowed.

For the house category, approvals continue to soften. 'New' house approvals have eased to around 120,000 over the past year after peaking a little above 122,000 mid-year. Townhouse approvals have shown a sharper slide to around 33,800 over the past year, which is well down from the peak above 37,000 during late 2017 to early 2018. 

Turning to the state-based detail, the table, below, provides the monthly and annual changes across the states for November for both houses and units.

The chart, below, helps to illustrate the magnitude of the decline in unit approvals in Victoria and New South Wales and to a lesser extent Queensland. Much of this has been focused in the capital cities of those states, particularly in Melbourne where unit approvals have fallen by a staggering 72% over the past year according to the ABS' estimates in today's report and by around 40% in both Sydney and Brisbane. 

Also in today's report, the value of non-residential building approvals lifted by 11.1% in November but sit 8.6% lower compared to a year earlier. Meanwhile, the value of alterations approved lifted slightly by 0.4% in the month to be down by 7.2% across the year.  

Building Approvals — November | Insights 

Today's data was a heavy miss to the downside, though it was impacted by volatility given the large step down in unit approvals. Notwithstanding this, the trend continues to show an ongoing slide in dwelling approvals led by units combined with softness from houses as the impact of macro-prudential policies and property price declines continue to play out. The pipline of work to be completed is still elevated and will underpin activity over the near term, but the slowing coming through in the approvals data points to a weakening in residential construction further out.       

Rising imports narrow Australia's trade surplus in November

For the second straight month, Australia’s trade balance came in below market expectations as the pace of spending on imports outpaced growth in income generated by the export of goods and services. Still, the nation's trade surplus is tracking at a strong level averaging around $2bn per month in the 4th quarter, although this is following a very strong result in Q3 where the average was around $2.2bn per month.

International Trade — November | By the numbers

• Australia’s trade surplus narrowed by $88m in November to $A1.925bn, which was below the market forecast for a surplus of $2.2bn. On revision, October’s initially reported surplus of $2.316bn was lowered to $2.013bn

• Export income increased by $532m, or by 1.4%, in November to $A38.445bn

• The value of goods and services imported increased by a stronger $620m, or by 1.7%, in the month to a total of $A36.520bn

International Trade — November | The details 

Focusing on the export side, income generated increased by $532m (+1.4%) in November to a new record-high figure of $38.445bn. Breaking this down further, 'goods' exports contributed $475m to the overall increase in the month and services added the remaining $57m. 

In terms of goods exported, it was a sharp rise from non-monetary gold of $681m that accounted for the overall $475m increase. Non-rural goods fell by $173m, which was impacted by a sharp fall from coal (-$543m) reflecting weaker shipment volumes in hard coking and thermal coal. There was some offset from metal ores and minerals (+317m) in spite of weakness in iron-ore, while the value of LNG exports continue to rise, incresing by a further $96m to a new record of $4.56bn.

The value of rural goods (meat, cereals and wool etc) exported fell by $34m to $3.738bn, which is around 0.6% lower compared to the level a year earlier, with drought conditions impacting the nation's agriculture sector.

For services, tourism provided a lift of $43m in November to $5.632bn, and 'other services' (such as business services) increased by $14m to $2.064bn.  

On the other side of the equation, spending on imports increased by $620m (+1.7%) to $36.520bn. This increase was led by a sharp rise in capital goods of $433m, which follows a $502m rise in the previous month. Capital goods relate to business investment in items such as machinery and industrial equipment, telecommunications, and transport. Recent data have pointed to an improving trend in business investment led by the non-mining sectors of the economy. Consumption goods imported lifted by $202m in the month, driven by non-industrial transport ($140m) and consumable goods ($71m).

There were modest declines from intermediate goods (-$22m), though fuel was a notable drag (-$145m) following sharp declines in global oil prices over recent months, and services (-$22m). 

From a foreign exchange perspective, ABS data showed the Australian dollar lifted by around 2% against the US dollar and by around 1.9% on a broader trade-weighted basis in November. Though when compared to a year earlier, the domestic currency has fallen by around 5% against the US dollar and by around 2.3% in trade-weighted terms. 

International Trade — November | Insights 

In Q3, net exports added a fairly strong 0.3ppt to overall activity helping to underpin growth in the domestic economy. While the trade surplus remains strong, it is tracking at a lower level compared to Q3 pointing to the possibility of a lower contribution from international trade to GDP growth in Q4, particularly given lower export volumes for coal and iron-ore. However, December's data are still to come and this could improve the outlook.  

Weekly note (21/12) | Fed disappoints markets for 2019 pause

The highly anticipated December policy meeting by the US Federal Reserve was the key focus for markets this week. At the conclusion of its 2-day meeting, the Federal Open Market Committee (FOMC) announced that the benchmark fed funds rate would be increased by 25 basis points (0.25%) to a target range of 2.25% to 2.5% — the 9th rate rise in this tightening cycle that commenced back in December 2015 and the 4th increase this year. Markets had widely expected this to be the outcome and were more focused on the guidance provided by the Committee on their outlook for interest rates into 2019 and beyond. 

The statement announcing the decision highlighted the Committee's confidence in the outlook, assessing there to be the need for "some further gradual increases in the target range for the federal funds rate" providing that the economy progresses in line with their expectations. Those expectations point to growth in the US economy moderating in 2018 (from 3.1% to 3%) and in 2019 (from 2.5% to 2.3%) but still expanding at an above-potential pace out to 2020, supporting labour market conditions and inflation around the 2% target. The moderation in the growth forecasts references uncertainty referred to by Chair Jerome Powell as "cross-currents" from slowing momentum in the global economy and financial market volatility.

In response, and as our chart of the week shows, the Committee's median projections in the revised 'dot plot' now show an implied expectation for 2 rate increases in 2019 — down from an expectation for 3 increases at the Committee's September's meeting — followed by 1 further increase in 2020 before reaching a pause in the tightening cycle. While appearing to be a 'dovish hike', the indication that the Committee will not pause tightening in 2019 clearly disappointed both interest rate and equity markets. That divergence in interest rate expectations has been a key factor in driving the volatility that has battered global markets over the past few months. Alongside concerns around a slowing global growth outlook and geopolitical and trade tensions, major equity markets across the US, European and Asian regions have now fallen by around 15% to 20% from their 2018 peaks. 

Chart of the week 

Over in Europe, there was a resolution to the months-long negotiations between the European Commission and Italy regarding their 2019 budget. Italy made concessions to lower their deficit target over the next three years, including a reduction from 2.4% of GDP to a little above 2% for 2019. The Commission assessed this to be an acceptable proposal and in the process ruled out imposing financial penalties on Italy. 

Meanwhile, the Bank of England (BoE) noted in their latest policy meeting minutes that "Brexit uncertainties have intensified considerably since the Committee's last meeting". While this had resulted in financial conditions tightening and further declines for the Sterling and the domestic equity market, it had also impacted the real economy highlighted by a slower near-term growth outlook due to weakening business investment and a subdued household sector. The Bank made it clear that the outlook for the domestic economy was highly dependent on the nature of the withdrawal of the UK from the European Union. 

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There were several key developments in Australia this week. Firstly, the mid-year update to the federal budget showed that stronger-than-expected economic conditions from employment growth and commodity prices are forecast to boost the budget position by $31.3bn over the next 4 years, resulting in a greatly reduced deficit in 2018/19 of $5.2bn before a return to surplus of $4.1bn in 2019/20 (to read our full analysis see here). 

Tuesday's Reserve Bank Board minutes from the December meeting appeared to take on a more cautious assessment of the domestic economy. The key discussion was around the household sector where the outlook for consumption "continued to be a source of uncertainty because growth in household income remained low, debt levels were high and housing prices had declined". The December Board meeting had occurred the day before the Q3 National Accounts were released, which would ultimately show that the domestic economy expanded by a slower-than-expected pace in the quarter weighed by a soft outturn from household expenditure (see our Q3 GDP review here). The Bank's central scenario is for strength in labour market conditions to support a gradual lift in wages growth to offset concerns around any potential negative wealth impacts.   

On Wednesday, Australian banking regulator APRA announced that restrictions on interest-only residential mortgage lending will be removed from 1 January 2019 (see the media release here). The regulator introduced this measure in April last year, which had placed a cap on banks' interest-only lending at 30% of all new mortgages. This was in conjunction with an earlier measure introduced in late 2014 that had placed a 10% annual cap on the pace of housing credit growth to investors, though this restriction was unwound back in April this year. 

According to APRA Chairman Wayne Byres, the removal of both restrictions had been justified as they had "served their purpose of moderating higher risk lending and supporting a gradual strengthening of lending standards". Last week, the Council of Financial Regulators — a group comprising the RBA, ASIC, APRA and Treasury — in their quarterly statement noted that "members discussed how an overly cautious approach by some lenders to incorporating relevant laws and standards into loan approval processes may be affecting lending decisions". This had followed recent comments from RBA Governor Philip Lowe expressing concern over the economic impact from the restrictive nature of credit standards.

APRA's decision during the week is aimed at addressing these concerns, however it is worth noting that when the regulator removed the 10% cap on investor borrowers earlier this year, credit growth to that segment continued to decline. Other factors to consider that could limit the impact of the removal of the cap on interest-only lending are; the strengthening of standards around loan serviceability criteria; declining property prices weakening demand for credit; and the upcoming report due to be tabled by the Royal Commission in February next year. 

The highlight of the week was the labour force data for November that was released on Thursday (read our full analysis here). While the underlying detail within the report was broadly mixed, the key takeaway is that the nation's labour market remains in a solid state. This was headlined by employment increasing by 37,000 in the month — nearly double what the market had been expecting. The pace of employment growth has cleared slowed over 2018 but remains above growth in the working-age population, while forward-looking indicators from private surveys point to employment rising by around 20,000 per month  — a level that that is broadly sufficient to prevent the nation's unemployment rate from rising. Participation in the workforce also increased further in November to be around record-high levels. 

On the downside, the unemployment rate lifted slightly from 5.0% to 5.1%, though this likely reflected the rise in participation. Of more concern was an increase in measures of excess capacity, which are already at elevated levels and have been influential in restraining a faster pick up in the pace of wages growth. This remains a headwind to the household sector into 2019 and highlights the importance of robust conditions continuing in the nation's labour market.   

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With this our last note for 2018, I want to thank you all for reading my content this year. Your support is humbling given the vast amount of high-quality analysis that is widely available. Here, a special thanks must go to Pete Wargent who has been a big supporter of mine and I recommend you to follow his analysis. I write these posts because they reflect my passion for economics and the markets and they help me to keep track of developments, and I hope they have been useful to you. Please feel free to get in touch if you ever have any comments, feedback or questions. 

Best wishes over the Christmas holidays and for 2019.  

James    

Australian labour market mixed in November

Australia’s labour force data for November provided mixed signals, though underlying conditions appear to remain solid.  While employment growth was stronger than anticipated, the nation’s unemployment rate ticked up to 5.1% and broader measures of spare capacity also increased.

Labour Force Survey — November | By the numbers

·         Total employment increased by 37,000 in November, well ahead of the market forecast for a 20,000 addition (prior revised: 28,700 from 32,800)

·         The unemployment rate increased by 0.1ppt to 5.1%, while the market had expected it to remain at the 6-year low rate of 5.0%

·         The participation rate increased by 0.2ppt to 65.7%, which was ahead of the market forecast for 65.6% (prior revised: 65.5% from 65.6%)

·         Spare capacity increased in November with the underutilisation rate lifting by 0.3ppt to 13.6% and the underemployment by 0.2ppt to 8.5%

Labour Force Survey — November | The details

The headline addition to employment of 37,000 is, on face value, a strong outcome and near double the around 20,000 outcome that is generally required to keep the nation’s unemployment rate from rising. Volatility, however, was evident throughout this release.

According to the disaggregated data, full-time employment fell by 6,400 in November, but part-time employment posted a gain of 43,400 — its strongest rise since January. The net result equating to the headline 37,00o increase. This can be attributed to sample volatility, which can occur from month-to-month depending on the characteristics of the incoming group relative to those of the group it is replacing.

As a result, employment growth in the full-time category fell from 2.77% to 2.12% on an annual basis, and part-time growth jumped from 1.85%Y/Y to 2.7%Y/Y. On an overall basis, national employment growth remains at a robust pace of 2.3%Y/Y, though it has slowed from a very strong rate around 3.5%Y/Y at the start of the year. (click charts to expand)

Still, employment growth continues to run ahead of growth in the working-age population (1.68%Y/Y to November) and with output growth tracking at around-trend pace despite slowing in Q3, these factors are supportive of the unemployment rate remaining around its present level. This is consistent with the latest NAB Business Survey, which pointed to employment growth continuing to run at an around-20,000 pace per month.

Workforce participation remains at a historically strong level and increased further in November. The trend figure is at a record high of 65.7% and the seasonally-adjusted rate of 65.7% is just off the record mark. In absolute terms, workforce participation increased by 49,530 in the month to outpace the 37,000 increase in employment. As a result, the unemployed total lifted by 12,520 to explain the rise in the national unemployment from 5.03% to 5.11% (to two decimal places).

However, of more concern was that the underemployment rate (employed workers wanting more hours) increased from 8.3% to 8.5% and the underutilisation rate (including the underemployed and unemployed) increased from 13.3% to 13.6%. This could also reflect statistical volatility noting that these measures have been steady over the past couple of months. In any case, spare capacity remains elevated in the labour market, which is negative to the outlook for wages growth. This highlights the importance of robust employment growth continuing into 2019.

Another curious aspect from the report was that hours worked fell by 0.2% in the month despite employment rising, which slowed annual growth from 2.0% to 1.1%. Adjusting for the rise in employment, average hours worked per employee in the month fell by 0.5% to 138.6 hours, which is 1.1% lower compared to a year earlier.

Turning to the state-based data and the detail was disappointing — again, though, this can often be affected by volatility. Across the states, the change in the unemployment rates were; New South Wales -0.1ppt to 4.4%, Victoria +0.1ppt to 4.6%, Queensland +0.1ppt to 6.4%, South Australia -0.1ppt to 5.3%, Western Australia +0.8ppt to 6.5% and Tasmania +0.6ppt to 5.8%.  

In terms of employment growth, Victoria led in the month rising by 30,900, with Queensland next best at +21,800. The only other state to post an increase in November was Western Australia at a modest 1,600. Employment declined for the remaining states; New South Wales -12,600, South Australia -2,200 and Tasmania -2,500.  

Labour Force Survey — November | Insights

There were mixed signals throughout these data for November, though for the moment that appears to be impacted by statistical volatility. On the positive side, the economy added nearly twice the number of jobs expected in the month and the pace of employment growth remains robust. On the downside, spare capacity lifted as the pace of wages growth remains persistently slow. The fall in hours worked and weakness in the state-based outcomes were the other negatives.  

MYEFO forecasts lower deficit, higher surplus for 2019/20

The Australian federal government has presented their Mid-year Economic and Fiscal Outlook (MYEFO) to their budget for 2018/19. The Treasurer announced the deficit for 2018/19 is now forecast to be $A5.2bn, or 0.3% of real Gross Domestic Product (GDP), which has been lowered from the initial estimate of -$A14.5bn (0.8% of GDP) from budget night back in May. The surplus forecast for 2019/20 has been upgraded to $A4.1bn (0.2% of GDP) from $A2.2bn (0.1% of GDP). 

The improvement in the budget for 2018/19 is driven by stronger economic conditions, reflecting stronger-than-forecast growth in employment and national income flowing from higher prices for key commodity exports (iron-ore and coal), which have also had an impact over the ensuing years. The impact of stronger economic conditions boosts the budget position by a total of $31.3bn over the next 4 years; $11.2bn in 2018/19, $5.8bn in 2019/20, $7.2bn in 2020/21 and $7.1bn in 2021/22.  

The boost from stronger economic conditions is moderated by the cost of implementing new policy measures, which are a net $16.3bn over the coming 4 years; $1.9bn in 2018/19, $4.0bn in 2019/20, $5.7bn in 2020/21 and $4.8bn in 2021/22. Ahead of next year's federal election, the MYEFO documents show that 'decisions taken but not yet announced' lower revenues by around $9.3bn between 2019/20 to 2021/22 — potentially reflecting the cost of implementing tax cuts. Meanwhile, expenses relating to 'decisions taken but not yet announced' total around $1.4bn between 2018/19 to 2021/22. 

As a result of stronger economic conditions ($31.3bn) and the cost of new policy measures ($16.3bn), the net improvement to the budget is $15.0bn over the next 4 years. The budget position improves by $9.3bn to a deficit of $5.2 in 2018/19, before a $1.9bn improvement in 2019/20 to return the budget to surplus for the first time in 12 years at $4.1bn. The projections then show surpluses of $12.5bn in 2020/21 (an upgrade of $1.5bn) and $19.0bn in 2021/22 (upgraded by $2.3bn). Collectively, the budget is now forecast to be in surplus in the order of $30.4bn out to the end of 2021/22, which nearly doubles the $15.3bn surplus forecast in May's budget.


Turning to the updated economic forecasts, Treasury has upgraded their assessment for nominal GDP growth in 2018/19 by 1ppt to 4.75% to reflect the impact of stronger-than-expected prices for key commodity exports. The forecast prices for iron-ore (US$55/t) and coal (metallurgical US$120/t and thermal US$93/t) from May's budget have proven to be conservative but have been retained by Treasury in MYEFO. Nominal GDP growth for 2019/20 has been downgraded from 4.75% to 3.5%, with the terms of trade now expected to decline by 6% compared to 2.25% reducation that was forecast in May's budget.  

In terms of real GDP growth, the only change was that near-term expectations have been lowered to 2.75% from 3.0%. These forecasts are slightly softer than those published by the Reserve Bank of Australia. 

With output growth forecast to remain at an around-trend pace, the outlook for employment growth has been strengthened by 0.25ppt in each of the coming years. Meanwhile, the nation's unemployment rate is forecast to hold at 5% out to 2021/22. Forecasts for growth in the Wage Price Index have been lowered in 2018/19 and 2019/20 by 0.25ppt but retained at a very strong 3.5% pace in 2020/21 and 2021/22. 

Weekly note (14/12) | Uncertainty the only certainty for markets

Uncertainty continues to be the prevailing theme across global markets and that was reinforced by geopolitical developments this week. In a turbulent week in the UK, Prime Minister Theresa May made a surprise late announcement that the parliamentary vote on her Brexit proposal scheduled for the following day would not go ahead on the basis that it was clear to the PM that the deal would have been rejected. The PM then faced a vote of no confidence, which was subsequently won by May (200 to 117), but conceded she would not stand at the next general election scheduled for 2022. 

The path forward for Brexit is increasingly unclear. It appears PM May will now try to enter into negotiations with the European Union in an attempt to settle on a deal that can gain parliamentary support, though the indications are that there is little scope for this among European officials. Other possible outcomes range from an abandonment of Brexit, through either recision of Article 50 — which would allow the UK to unilaterally end the withdrawal process according to a recent ruling by the European Court of Justice — or by another referendum, to a hard-Brexit scenario, where the UK separates from the EU without an agreement.  

The other major event this week was the European Central Bank's (ECB) latest meeting, where the Governing Council confirmed the conclusion of its asset purchase programme (APP) by year-end. Our chart of the week shows the APP over time, where total purchases have amounted to around 2.6 trillion euros.

Chart of the week

The ECB also maintained its forward guidance that rates are expected to "remain at their present levels at least through the summer of 2019, and in any case for as long as necessary". Meanwhile, the guidance provided regarding the maturing bonds the ECB has purchased under the APP was that they "intend to continue reinvesting, in full, principal payments from maturing securities -- for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary". 

ECB President Mario Draghi highlighted that the focus of this meeting was around risks to the economic outlook, which was still assessed to be "broadly balanced" but "moving to the downside" due to "the persistence of uncertainties related to geopolitical factors, the threat of protectionism, vulnerabilities in emerging markets and financial market volatility".

Overall, President Draghi categorised the ECB's outlook as having "continued confidence with increasing caution". This was reflected in the updated macroeconomic projections, which saw the ECB's expectations for inflation lifted by 0.1ppt in 2018 (to 1.8%), then easing by 0.1ppt (1.6%) in 2019, before rising again to 1.7% in 2020. Meanwhile, expectations for the growth outlook were lowered slightly by 0.1ppt in 2018 (to 1.9%) and 2019 (to 1.7%). 

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It was a quieter week on the data front in Australia following last week’s stacked calendar. Property-related data was in focus early in the week, with housing finance for October posting a surprise increase for both the owner-occupier and investor segments (see our analysis here). This was followed by the ABS’ residential property price indexes, which while a lagged release still provides some useful insight into recent movements in property prices across the nation's capital city markets. Accordingly, property prices on a national weighted-average basis were assessed to have fallen by 1.5% in the September quarter and by -1.9% over the year driven by declining prices in Sydney and Melbourne (see our note here).

The highlights of the week were the NAB Business Survey for November and the latest read from the Westpac-Melbourne Institute of Consumer Sentiment Index for December. Both are closely-watched indicators and can be market moving.

The NAB Business survey showed a further slowing in both conditions (-2pts to +11) and confidence (-2pts to +3) over November. As it stands, business conditions remain above average, though the confidence measure has fallen to a below-average level. The overall interpretation is that businesses are anticipating their assessment of conditions to reduce further in the period ahead. In line with a deterioration to the outlook, forward orders — a leading indicator for domestic demand — fell to a reading of 0 in the month from +3, which is now at a below-average level for the first time in around 2 years.

According to NAB economists, the employment index within the survey was still pointing a solid pace of employment growth at around 20,000 jobs per month, which would be sufficient to maintain downward pressure on the national unemployment rate. Meanwhile, inflationary pressures remain weak with the purchase costs and final product prices measures falling in November. Labour costs lifted modestly, though that also reflects continuing strength in employment growth.

The Westpac-Melbourne Institute Consumer Sentiment Index lifted to 104.4 in December from 104.3 in the previous month. The index recorded its 12^th consecutive month above the 100 level that separates optimists from pessimists. In 2017, pessimists held sway in 10 of the 12 readings. In the analysis provided alongside the release, Westpac’s Chief Economist Bill Evans outlined that consumer sentiment was being supported by an outlook for interest rates to remain steady at their low level, strengthening labour market conditions and falling petrol prices.

The detail within the survey showed that consumers felt less confident that it was a good time to purchase property, though this had followed a sharp rise in the previous month indicating that declining prices were impacting sentiment in potential buyers. Regarding property prices, the Index of House Price Expectations lifted to 100 in December on a national basis indicating an even split of views for the future direction of prices. However, Westpac reported that in New South Wales and Victoria further price declines were still heavily anticipated.

Overall, consumer expectations for the economic outlook over the next 12 months had firmed during December but had deteriorated when broadening that outlook over the next 5 years. Another key point to highlight is that unemployment expectations lifted in the month, and while there has been a strong improvement in this component over the past year, the momentum has slowed and may be indicative of moderating labour market conditions.