Australia's economic outlook is looking a whole lot gloomier

Cameron Spencer/Getty Images for the Invictus Games FoundationSYDNEY, AUSTRALIA – OCTOBER 20: A large storm front makes it’s way towards the city ahead of the Invictus Games Sydney 2018 Opening Ceremony at Sydney Opera House on October 20, 2018 in Sydney, Australia.
  • Momentum in the Australian economy appears to be slowing, and fast.
  • Activity levels in Australia’s services and manufacturing sectors improved at the slowest pace since May 2016 in October, according to the Commonwealth bank’s “flash” composite PMI.
  • Hiring levels remain strong. However, with activity softening and confidence at the lowest levels in years, whether that can continue remains uncertain.

The positive momentum the Australian economy enjoyed in the first half of the year now looks to be reversing, and fast.

Worryingly, the slowdown is being entirely driven by the services sector, the largest employer in the country.

The Commonwealth Bank’s (CBA) “flash” Composite Purchasing Managers Index (PMI) for September, produced in conjunction with IHS Markit, dipped to 51.2 in October, the lowest level since the survey first began two-and-a-half years ago.

This PMI measures changes in activity levels across Australia’s services and manufacturing sectors from one month to the next. A reading of 50 means that activity levels were unchanged from a month earlier. The distance away from 50 indicates how quickly activity levels deteriorated or improved over that period.

The flash report — released one week ahead of the final report — captures responses from around 85% of all firms surveyed.

Based on the early responses in October, the news was not all that crash hot.

Activity levels did improve but they did so at the slowest pace in over two years, indicating a broad loss of momentum compared to what was being reported earlier in the year.

The chart below makes for somewhat ominous viewing, particularly as the movements fit with the trends seen in Australian GDP growth in the first half of the year. If that relationship is maintained, it suggests official economic growth figures may too begin to weaken quite noticeably.

Commonwealth Bank, IHS Markit

According to the Commonwealth Bank, the index is designed to provide “timely indications of changes in output in the Australian private sector”. It uses five weighted inputs — output, new orders, employment, supplier delivery times and stock purchases — to determine the headline index.

Adding to concerns, the latest report found the slowdown was entirely driven by the services sector, a key part of the Australian economy given it employs the vast bulk of Australia’s workforce.

“Growth of services activity in October was the slowest since the survey began in May 2016, while business confidence dropped to a 28-month low,” the CBA said.

However, despite the steep moderation in activity levels, respondents said that did not impact hiring levels which not only increased last month but did so at a faster pace than September.

Whether that remains the case with confidence so low and output softening will be the key question in the months ahead.

The strength in hiring came despite continued margin pressures as input prices rose faster than final prices to customers.

In contrast to the gloomy picture painted by service sector firms, activity levels at manufacturers improved a touch thanks to stronger readings on employment stock purchases and a lengthening of supplier delivery times, helping to offset a deterioration in output and new orders, the latter largely reflecting softening demand from abroad.

Despite the mixed report card, Michael Blythe, Chief Economist at the CBA, said the “the outlook for the remainder of 2018 is still positive”.

“Both sectors are reporting strong jobs growth and new orders continue to lift,” he said.

He noted that “one emerging concern to monitor is that some respondents see downside risks from greater regulation of the finance sector,” a sign that tighter lending standards are not only impacting housing market but also the business sector.

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