Australian Business Indicators Q3: inventories 1.2%

Australia's Business Indicators report for the September quarter contained some constructive detail around discretionary demand, while the result for inventories (1.2%) points to a strong contribution (0.9ppt) from this component to Q3 GDP growth (currently expected at around 0.4%). 

Sales volumes in the third quarter contracted marginally (-0.1%) on a headline basis but lifted modestly (0.2%) excluding the mining sector (-1.8%). This was an improvement for non-mining sales following a 0.1% fall in the previous quarter, consistent with expectations that discretionary-related demand fared better in Q3. Reflecting this, categories such as hospitality (1.5%) and arts and recreation (2.6%) posted their strongest quarterly rises for 2023, likely boosted by the FIFA Women's World Cup, co-hosted by Australia and New Zealand in late July to late August. Retail sales (1.4%) also advanced at their fastest pace in a year. 

A key factor behind the improvement in discretionary demand was a strengthening in real incomes. Aggregate wage costs lifted by 2.7% in the quarter (9.7%Y/Y), outpacing the gains in the prior two quarters (Q1 1.9% and Q2 2.0%) as award rates increased following the Fair Work Commission's 2022-23 ruling. 

Company profits declined at a headline level by 1.3% in the quarter to $131.1bn (-1.7%Y/Y). Adjusted for inventory valuation effects, profits were down by 0.9% in Q3. The decline in company profits was driven entirely by a 7.7% contraction in the mining sector (to $54.9bn), reflecting falls in commodity prices. Non-mining profits lifted by 3.8% (to $76.2bn), rebounding from their Q2 fall (-3.3%). Profits in the non-mining sector are up 15.7% through the year, strongly suggesting that higher input costs have been passed through to consumers rather than being absorbed within margins. 

Inventory levels are estimated to have increased by 1.2% in the quarter to $209bn, completely counter to expectations for a 0.8% decline. This increase points to a sizeable contribution of 0.9ppt to Q3 real GDP. The mining sector was the key driver seeing its inventory levels surge by 8.9% for the quarter. By contrast, retail inventories were flat and declined in wholesale trade (-0.2%) and hospitality (-1.9%).  

Macro (Re)view (1/12) | November to remember

A broad-based rally across markets closed out a memorable November. US equities lifted between 8-11% and Europe by around 8%, coming alongside substantial declines in Treasury yields, at both ends of the curve. This backdrop has kept the Australian dollar supported at 3-month highs. Falling inflation has buoyed optimism for significant rate-cutting cycles in 2024 on the view that central banks will look to normalise monetary policy from the restrictive settings that prevail in many countries presently.  

In the US, comments from Fed Governor Waller indicating that falling inflation opened the door to lower rates resonated strongly in markets. Later in the week, Fed Chair Powell offered some pushback by saying it was premature to conclude that rates had peaked, let alone to speculate on the timing of rate cuts. These assessments appear to reflect the core view of FOMC members, though Chair Powell did concede that rates were "well into restrictive territory", seemingly making additional tightening less likely. The inflation data back this up, with the core PCE deflator slowing from 3.7% to 3.5% at an annual rate in October, a low to April 2021. But in 3-month (2.4%) and 6-month (2.5%) annualised terms, the recent momentum suggests core inflation is on track to be within touching distance of the Fed's 2% target.   

There were several public appearances by top ECB officials this week but downside surprises in November's inflation data spoke loudest of all. Headline inflation declined from 2.9% to 2.4%yr (vs 2.7% expected) - a low to August 2021 - while the core rate came in from 4.2% to 3.6% (vs 3.9%), a 19-month low. These outturns imply inflation is declining on a faster trajectory than currently forecast by the ECB, leading markets to start pricing in rate cuts as soon as April next year. This expectation is driven not only by disinflationary momentum but also by weakness in economic activity. Euro area GDP contracted marginally in Q3 (-0.1%) and recent PMI readings have been consistent with declining output continuing.

Despite its hawkish messaging of late, including from Governor Bullock in Hong Kong this week, the chances of the RBA hiking at next week's meeting have always looked remote. But whatever chance there was of a December rate hike dissipated following this week's data. Headline inflation surprised on the downside falling from 5.6% to 4.9% in October (vs 5.2% exp), with the measures of underlying inflation also softening but sitting in a more elevated range of 5-5.3% (full review here). Meanwhile, retail sales posted their weakest outturn in four months falling 0.2% in October as spending was delayed ahead of Black Friday sales (see here). 

Aside from the RBA meeting, attention next week will be on the Q3 National Accounts. My detailed preview (see here) sets out what is known about how the Australian economy performed in Q3, with GDP growth of around 0.4%q/q anticipated. Partial indicators received this week that feed into the GDP outcome reported stronger than expected detail for construction activity at 1.3%q/q (see here), but capital expenditure by firms slowed to 0.6%q/q, printing on the soft side of estimates (see here). National housing prices according to CoreLogic remained on the rise - albeit at a slowing pace of 0.6% in November - to be nearly 10% above cycle lows. A housing supply shortfall has largely driven this upswing in prices, outweighing the effects of RBA tightening. However, this has not translated to any material improvement in building approvals, although they posted a welcome 7.5% rise in October (see here). 

Preview: Australian Q3 GDP

Australia's National Accounts for the September quarter are due to be published by the ABS today (11:30am AEDT). Headwinds impacting household finances saw momentum in the economy slow over the first half of the year and that is expected to have continued. Real GDP growth is forecast to have remained moderate expanding by around 0.4% in Q3 and 1.8% through the year. 

A recap: Economic growth remained subdued in the June quarter...

The Australian economy expanded by a subdued 0.4% in the June quarter, with year-ended growth easing from 2.4% to 2.1%. From solid growth in the back half of 2022 (1.3%), momentum in the economy slowed over the first half of the year (0.7%) as cost of living pressures and higher interest rates saw households cut back on discretionary spending.  

Australia's population has increased at a rapid pace in the post-Covid period, underpinning economic growth over the past year. But this has equated to weakness in per capita growth, which contracted narrowly in quarterly (-0.3%) and year-ended terms (-0.3%). Another factor that has detracted from the quality of headline growth has been a decline in labour productivity (-3.5%Y/Y), reflecting hours worked (5.8%) expanding at a faster rate than output (2.1%). Unit labour costs have been rising as a result, highlighted by the RBA as posing a key risk to the inflation outlook. 

... as headwinds continued to weigh on household spending

Household consumption came close to stalling in the June quarter (0.1%), slowing year-ended growth to 1.5%. Excluding the Covid period, this was the weakest quarterly growth rate since Q3 2019. Over the past year, household consumption has been driven by growth in essential goods and services - including rents and utilities - with pressures from the cost of living and higher interest rates prompting a winding back of discretionary purchases. This theme remained evident in Q2: essentials advanced by 0.5% as the discretionary category declined by 0.5%.

Aside from a rotation in consumption patterns, pressures on household budgets had also caused a reduction in saving. The household saving ratio declined to 3.2% in the quarter to stand at a 15-year low. However, the stock of savings accumulated by the household sector during the pandemic years remained substantial. 

Services exports rebounded further and had added strongly to growth over the past year, supported by the recovery in the domestic tourism and education sectors. Business investment was defying the broader slowdown, expanding further (2.1%) on the back of momentum in equipment spending as order backlogs eased and firms took advantage of tax incentives. Residential construction activity remained weak overall (-0.2%); while new home building saw a welcome rise (1.2%), higher interest rates and ongoing capacity constraints were headwinds and alterations (-2.4%) continued to moderate from their cycle highs reached during the pandemic. 

September quarter overview: Can consumption defy the headwinds? 

The incoming data for the September quarter points to moderate growth in the Australian economy. Household consumption appears to have been a little stronger in Q3, supported by an improved dynamic around real incomes. 

Although quarterly headline inflation lifted (1.2%q/q), wages growth accelerated (1.3%q/q) as increases decided upon by the Fair Work Commission boosted award rates and the minimum wage. Other factors that supported household consumption were the FIFA Women's World Cup and the RBA holding the cash rate unchanged at 4.1% over the quarter.   

Retail sales volumes posted their first quarterly rise in a year, with broad-based increases coming through across the discretionary categories. Per capita growth in retail volumes continued to contract in Q3 (-0.5%), though at a much slower pace than in prior quarters.  

Labour market conditions remained robust but have eased slightly. Employment growth had slowed to a pace that was broadly matching the rate of growth in the population, resulting in the unemployment rate rising slightly from its cycle lows late last year. But, on the whole, firms appeared to be mainly responding to the slower demand environment by adjusting hours, with hours worked contracting in the quarter.  

Housing prices remained on the rise as housing supply remained tight amid rising population growth and headwinds in the homebuilding sector, outweighing the effects of higher interest rates. 

Summary of key dynamics in Q3

Household consumption — Appeared to fare better in Q3, supported by a pick-up in wages growth. Retail sales volumes (0.2%) rose for the first time in a year with the discretionary categories the drivers, notably department stores (1.5%) and household goods (0.8%). 

Dwelling investment — A rise in alteration work (5.1%) looked to underpin a 1.2% increase in residential construction activity in the quarter. New home building saw a modest rise (0.5%), constrained by higher interest rates and ongoing capacity constraints.

Business investment — Private sector capex slowed to a 0.6% rise in Q3 following strong momentum through the first half of the year. The expiration of tax incentives at the end of the financial year weighed on non-mining equipment investment (-0.5%).   

Public demand — Increases in public spending (1.1%) and investment (2.4%) combined to contribute around 0.3ppt to quarterly output.

Inventories — Expected to add around 0.5ppt to quarterly activity, partially reversing its drag on growth in Q2 (-1.1ppts). Private non-farm inventories contributed an estimated 0.9ppt to GDP but public sector inventories were a drag at -0.4ppt. 

Net exports — Estimated to deduct 0.6ppt from GDP in Q3. Imports advanced 2.1% on the back of strong services demand (8.4%) for overseas travel, while exports declined by 0.7%, weighed by resources (-4.7%). 

Australian dwelling approvals rebound to multi-month highs

Australian dwelling approvals rebounded by 7.5% in October, rising to their highest level (14.2k) in 5 months. This far exceeded the consensus expectation (1.7%) following a 4% fall in September (revised from -4.6%). A surge in unit approvals (19%) drove the headline increase, with house approvals (1.2%) also supporting. Approvals, however, remain at low levels at a time when housing supply in Australia has been pressured by population growth. 

There was a welcome upside surprise for dwelling approvals in October, with a 7.5% increase lifting the monthly total to 14,223, its highest since May. This comes amid housing supply in Australia coming under significant pressure from rapid population growth following the Covid years and capacity constraints holding housing completions to subdued levels. Higher interest rates have been another headwind, although housing prices have risen alongside the RBA's hiking cycle, reflecting the demand-supply dynamics described. This is of course a very volatile series, meaning little signal can be taken from any given month. Taking a 3-month average to smooth the volatility, approvals sit just off cycle lows having declined in the order of 35% from their 2021 peaks. 

Unit approvals surged in October (19%) but that came after declines in 3 of the past 4 months. The underlying detail in the report suggests that the lift this month was driven by major increases in approvals from Brisbane and Perth. By dwelling type, the low-rise segment led the way with high-rise approvals declining. 

Detached or house approvals lifted by 1.2% in October and are broadly in line with the low levels that were seen ahead of the pandemic. These approvals are around 40% below their cycle high in early 2021.  

With new builds - especially in the detached segment - remaining challenged, alterations have remained at elevated levels following their surge during the pandemic. However, the value of alteration work approved fell in October (-3.2%) to be down 2.4% over the year. 

Australian Capex 0.6% in Q3; 2023/24 investment plans $171bn

Capital expenditure by Australian firms slowed in the September quarter (0.6%), coming in below expectations (0.8%) to post its softest outturn since the middle of last year. The winding up of Covid-related tax incentives for equipment purchases at the end of the 2022/23 financial year and weakness in commercial construction were the key factors. This was attenuated by the strongest quarterly rise in mining sector capex (5.6%) in 11 years. Investment plans for 2023/24 remain resilient to economic headwinds, upgraded to a decade high ($171bn) in the latest estimate. 

Private sector capex has risen strongly over recent quarters, but the momentum slowed in Q3. This was driven by a moderation in both equipment (0.5%) and buildings and structures (0.7%). 

Equipment spending looks to have been frontloaded into the first half of the year (6.3%) before temporary full expensing - a measure introduced to support the economic recovery from the pandemic that allowed businesses to fully write off the cost of eligible assets in their first year - wound down at the end of the financial year.

Non-residential construction was also strong in the first half of the year (7.7%) but then weakened in Q3, consistent with yesterday's construction work report.   

 

These dynamics led to non-mining sector capex declining by 1.3% in the quarter, its weakest outturn in 3 years, reflecting falls in equipment (-0.5%) and buildings and structures (-2.2%). By contrast, mining sector capex accelerated by 5.6% to post its strongest rise since Q2 2012. This came on the back of gains in equipment (5.9%) and buildings and structures (5.4%).  

In volume terms, the level of non-mining capex remains elevated, up 12.1% on pre-pandemic levels. Mining sector capex has risen 15% through the year to be near the levels seen ahead of the investment boom in the sector more than a decade ago. 

Firms' investment plans have remained resilient to headwinds to the growth outlook in Australia and offshore. The 4th estimate of expected capex in 2023/24 was upgraded by 8.5% on the previous estimate put forward 3 months ago, rising to a figure of $171bn - a high back to 2013/14. This estimate is also up by 10.3% on a year-to-year basis. But these estimates are in nominal terms, so include the impact of higher inflation. 

Non-mining sector investment plans were revised up by a strong 9.2% ($121bn), driven by a 12.5% upgrade in estimated spending on equipment ($57bn), with buildings and structures rising by 6.4% ($64bn).

For the mining sector, 2023/24 investment plans lifted by 6.9% compared with estimate 3 to stand at $51bn (up 8.5% year-to-year). A 6.6% upgrade came through in buildings and structures spending ($37) while equipment spending was seen 8% higher ($14bn). 

Preview: CapEx Q3

Australia's quarterly update on business investment is due today (11:30am AEDT). The report is based on a survey of around 10,000 private sector firms tracking their capital expenditure (capex) each quarter as well as asking for estimates of their expected investment spending. Business investment has been a notable point of strength in the Australian economy over the past year and that is expected to have continued into the September quarter.    

A recap: Capex continued to accelerate in Q2...

Capex has accelerated over the past year, defying tighter financing conditions and slowing economic growth. In the June quarter, capex lifted by 2.8% to be up by 10.8% through the year, the fastest annual growth rate since the rebound from the Covid recession. 

This upswing has been driven by the non-mining sector (3.5%q/q, 14.2%Y/Y), with mining sector capex up modestly (0.9%q/q, 2.7%Y/Y). Tax incentives and eased pressures in global supply chains have supported equipment spending (1.9%q/q, 6.4%Y/Y); there has also been a sharp rise in the buildings and structures component (3.5%q/q, 15%Y/Y) in response to investment in renewable energy projects and due to tight supply spurring an upturn in the pipeline of industrial property under construction. 

... and forward-looking investment plans have been resilient

Despite the broader headwinds to the economic climate, the ABS's survey reports that firms' investment plans remain on the rise. The 3rd estimate of investment plans for the current 2023/24 financial year was nominated at $157.8bn, an increase of 14.5% on the previous estimate and 7.1% higher than a year earlier; however, these increases are partly boosted by inflationary effects. In absolute terms, investment plans are currently at their highest level since 2014/15.  

A further rise in capex is expected in Q3 

Expectations going into today's report are for capex to have moderated in the September quarter to 0.8% rise. The survey component will see firms submitting their 4th estimates of investment intentions for 2023/24. Over the history of the survey, plans lift on average by around 5% compared to firms' 3rd estimates. Given current trends, I anticipate a stronger upgrade in the order of 7%. This would elevate 2023/24 investment plans to a figure just short of $170bn.  

Australian construction work rises 1.3% in Q3

Activity in Australia's construction sector increased for the 5th quarter in succession, rising by a stronger-than-expected 1.3% in the September quarter. This followed an upwardly revised lift of 2% in the June quarter (from 0.4%), leaving activity up by a robust 8.5% through the year. Engineering work has been the main driver of activity over the past year - as it was in Q3 (2.6%) - as work on the expansive pipeline of public sector infrastructure projects continued. Broadly offsetting outturns came through in residential (1.3%) and non-residential (-1.6%) work in the quarter, segments that have been held back by capacity constraints and higher interest rates.  

Total construction activity increased by 1.3% in the September quarter, driven by a 2.6% lift in engineering work. Building work was broadly flat (0.2%) as a 1.3% rise in residential construction was largely attenuated by a 1.6% fall in non-residential work. Much of the strength in construction work is coming from the public sector (4.2%q/q, 13.6%Y/Y), with the private sector nearly stalling in Q3 (0.1%) but still up by 6.6% through the year.  

Public sector work continues to accelerate, led by engineering work (5.5%q/q, 17.3%Y/Y) associated with the large pipeline of transport and energy-related projects being rolled out by governments across the nation. By contrast, public building (social housing, schools etc) is rising modestly (0.6%q/q, 3.7%Y/Y). 

In the private sector, residential construction posted a 1.2% rise in Q3 (4.4%Y/Y). Alteration work saw a sharp lift of 5.1% (4.2%Y/Y) while new home building was up by a modest 0.5% (4.5%Y/Y). Despite supportive fundamentals of strong demand due to rapid population growth and rising housing prices, residential work has lifted at a moderate pace, suggesting higher rates and capacity pressures remain headwinds. 

Private non-residential construction work contracted by 2.2% quarter-on-quarter, resulting in year-ended growth falling from 8.6% to 1%. This segment saw a strong rebound coming out of the pandemic but that now looks to be complete. That rebound may have lost some momentum due to the effects of tighter financing conditions and cost escalations that may have led to some projects being shelved.  

Australian CPI slows to 4.9% in October

Australian CPI inflation fell back to 4.9% in October, declining from 5.6% in September to be in line with its recent low. This surprised to the downside of expectations (5.2%), likely confirming an unchanged stance on rates from the RBA next week (4.35%) going into its summer break. But the RBA is likely to retain its hawkish messaging due to elevated underlying and services inflation, though both showed signs of easing.    

Headline inflation returned to lows since early 2022 in October, reversing the increases of the past couple of months. Inflation fell from 5.6% in September to 4.9% in October, driven by sharp rises in fuel and energy prices from this time last year falling out of the 12-month calculation, while the federal government's assistance package eased rent inflation. As a result of all this, annual inflation - while still very high - dropped sharply for fuel (19.7% to 8.6%) and electricity (18% to 10.1%) and moderated for rents (7.6% to 6.6%). However, rises in both food (4.7% to 5.3%) and health costs (5.4% to 6.3%) meant cost of living pressures remained on households.   

Stepping back, disinflation in goods prices looked to resume falling from 5.7% to 4.6%, driven by clothing and footwear (-1.5%). Services inflation - a key focus for the RBA - softened from 5.3% to 5%, still elevated but cooling nonetheless to an 11-month low. High services inflation is reflected in what RBA Governor Bullock recently referred to as 'homegrown' sources of inflation. Here, non-tradables prices (6%) far outpaces inflation in tradables (2.5%), whose prices are driven by global factors.     

Underlying inflation showed signs of easing across the various measures in October. The trimmed mean rate slowed from 5.4% to 5.3%; CPI excluding volatile items (food and energy) came in from 5.3% to 4.7%, and if holiday travel is also removed, underlying inflation on that basis was 5% from 5.4% previously.  

Australian retail sales fall 0.2% in October

Australian retail sales declined for the first time in four months falling by 0.2% in October. This was weaker than the expected outcome (0.2%) but followed a strong rise in September (0.9%). October's decline was driven by a pullback in discretionary spending (-0.6%) as households delayed purchases ahead of Black Friday sales. Spending will likely accelerate in November - as has been the pattern in recent years - though it is a little early to be able to gauge the magnitude of this.    

A 0.6% fall in discretionary-related spending drove retail sales to decline (-0.2%) for the first time since June. Declines across the discretionary categories ranged from -1% (clothing and footwear) to -0.4% (cafes and restaurants and 'other' sales). Many of these categories rose strongly in the month prior, with the release of iPhone 15, government energy rebates in Queensland for new appliances and warm weather supporting spending outdoors all factors. Food (0.5%) was the only category to advance in October.   

In absolute terms, retail sales in October were 1.2% higher than 12 months ago whereas discretionary sales have contracted slightly (-0.2%). This spread reflects the pressures on household finances from high inflation and rising interest rates, resulting in discretionary-related spending being wound back. However, discretionary spending still remains at elevated levels. 

Macro (Re)view (24/11) | Australian dollar reaches 3-month highs

Thanksgiving holidays in the US kept markets relatively quiet this week, with cross-asset moves largely contained. Softness in the US dollar supported the Australian dollar to another weekly gain, with the AUD touching highs back to August to be around 4.5% above its October lows. Hawkish messaging from the RBA may have also been a factor, with markets raising the probability in their outlook for another hike in the cash rate. 

The RBA's November meeting minutes highlighted the Board's decision to resume its rate-hiking cycle was prompted by upwardly revised inflation forecasts and broader economic resilience. There was also some discomfort about "a slight upward drift" in inflation expectations and that pricing power amongst firms could prove persistent. In a speech, RBA Governor Bullock noted that while inflation had declined substantially from its near 8% peak to just above 5% currently, this had mainly reflected eased pressures in global supply chains; returning inflation to the 2-3% target from here is expected to take time (forecast for late 2025), due to the assessment that inflation is increasingly "homegrown" and demand-driven, notably in services. Governor Bullock's message was essentially that restrictive policy would need to be maintained to cool demand in the economy, but that it would remain mindful of the employment side of its mandate.

Despite the UK government unveiling around £27bn of new stimulus measures in its Autumn Statement, the OBR projects the overall effect on the fiscal position will be minimal. The major items announced by Chancellor Hunt included tax relief to households and making what were to be temporary asset write-offs for businesses permanent. The cost of these and the other announced measures have been offset by improvements to the UK's fiscal position over the period out to 2027/28. The OBR attributes the stronger fiscal position to 3 factors: resilience in underlying economic conditions, higher inflation and further rises in UK and global interest rates. It remains to be seen how the Bank of England will take on board these developments, but earlier in the week Governor Bailey and other officials appeared before the Treasury Committee where the persistence of inflation was a key discussion point. Despite last week's encouraging inflation report, Governor Bailey pushed against market pricing for rate cuts in 2024. 

The ''proceed carefully'' approach of the FOMC was encapsulated in the minutes of its previous meeting. Key observations were that risks to the economic and inflation outlook had "become more two sided" with rates sitting at a restrictive level; while members were mindful that tighter financial and credit conditions implied further tightening is likely to flow through and weigh on activity. However, upside risks to the inflation outlook had not abated, which continues to see the FOMC maintaining that additional rate cuts have not been taken off the table.     

Similarly cautious at this stage of its tightening cycle, the ECB's Account of the October meeting outlined that the Governing Council elected to pause on increased confidence that rates were now "sufficiently restrictive" to bring inflation back to the 2% target. So as to avoid an "unwarranted loosening of financial conditions" a section of the Council emphasised that keeping the optionality to hike rates was important, depending on the incoming data. Speaking in Frankfurt, ECB President Lagarde said the Governing Council was now at the point where it can take stock of the effects of its monetary tightening on the economy.