A key part of the Australian economy is weakening fast – and the slowdown could be about to get a whole lot worse

Bill Pugliano/Getty Images
  • Australia’s services sector looks incredibly weak in early 2019.
  • Activity levels are deteriorating sharply and the signs are looking even worse for what lies ahead.
  • The weakness is concentrated in those sectors reliant on consumer spending, adding to evidence that falling home prices is leading to a change in household behaviour.
  • Employment across the sector continued to decline while wage pressures eased substantially. Broader margin pressures remain acute.

Australia’s services sector — accounting for around 80% of the economy — is looking fairly dire in early 2019.

Activity levels across the sector are continuing to deteriorate at a decent clip, led by acute weakness in those firms reliant upon household spending.

Worryingly, new orders — seen as a lead indicator on activity levels in the future — have collapsed.

The Australian Industry Group’s (Ai Group) Performance of Services Index (PSI) rose by 0.2 points to 44.3 in February in seasonally adjusted terms, leaving the index just above the multi-year low stuck in January.

The PSI measures changes in activity levels across Australia’s services sector from one month to the next. Anything above 50 signals activity levels are improving, while a reading below suggests they’re deteriorating. The distance away from 50 indicates how quickly activity levels are expanding or contracting.

So at 44.5, activity levels continued to weaken at a decent clip last month, recording the first back to back deterioration since early 2016.

As seen in the chart below, that’s a very different backdrop to what was seen throughout much of 2018.

The February result points to a further loss of economic momentum in early 2019, continuing the trends seen in official data in the final half of last year.

In an outcome that will only help to fuel growing concern about the impact of falling home prices on consumer spending patterns, the Ai Group said the weakness last month was concentrated in consumer-reliant sectors, a stark turnaround to the trends seen late last year when it was Australia’s business-orientated sectors that performed poorly.

“The consumer-focused segments were largely contractionary with weakness in consumer spending across the majority of these sectors with retail and hospitality faring the worst,” said Innes Willox, CEO of the Ai Group.

“However, business-orientated sub-sectors showed more stability to be mostly flat over the month with the exception of shrinking wholesale trade.”

According to the group, the subindex measuring activity levels in the retail sector slumped to 39.9, the lowest result since August 2012 in trend terms. For the hospitality subsector, the PMI plunged 6.4 points to 41.9, signalling a steep deterioration in conditions.

“Services businesses reported weak customer demand in February due to extreme heat and drought conditions in some areas of Australia, flooding in others and a deterioration in consumer spending,” the Ai Group said.

In what is a major concern, sales plunged sharply during the month, logging the fastest decline since August 2013.

Adding to the bleak picture, the subindex for new orders tumbled by 6.9 points to 38.5, the lowest level since July 2013. As a lead indicator on what lies ahead, that result is not good news at all.

With demand incredibly weak, inventory levels rose sharply while employment continued to decline, albeit a marginal pace. Wage growth also eased back, adding renewed uncertainty on the RBA’s view that wage pressure will gradually increase in the years ahead given the sector is by far the largest employer in Australia.

Cost pressures across the sector also remained acute with input costs continuing to soar while final prices to customers went backwards, and fast.

Ai Group

“The contraction in the services sector continues following a period of slowing activity over the second half of last year,” Willox said.

“Consumer sentiment has fallen faster and more intensely than the business-oriented sectors as concerns around house prices, residential construction activity and the all-pervasive talk of slowing economic conditions take hold on consumer sentiment.”

The PSI report suggests the largest part of the Australian economy is not only struggling but incredibly weak in early 2019. If replicated in the official data that arrives in the months ahead, it suggests Australian economic growth will likely slow sharply in the first half of the year, increasing the risk of softern inflation, weak hiring and the potential for renewed stimulus from both the RBA and Canberra.

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