Compared to recent years, the Australian economy is looking pretty good right now.
Of course, things could be better, but as a whole we’re doing all right.
The labour market is strengthening, leaving more Australians in work than ever before, with most of the recent job creation coming from full-time employment. And business conditions, whether measured by the National Australia Bank’s monthly business survey or various PMI reports released by the Ai Group, are also humming along at levels not seen since before the global financial crisis.
Interest rates continue to sit at extremely low levels, helping to lift house prices, especially for those in Australia’s southeastern corner. Collectively, we’ve never been wealthier before, even if it’s only in paper form.
Throw in booming commodity prices and strength in Australia’s major trading partner, China, and there’s not much to dislike in mid-2017, a major achievement given we’re about to exit the largest economic transition seen in many decades.
However, there’s just one problem, and it’s a major one.
Many Australians aren’t buying into the economic recovery story.
That point was rammed home this week with the release of the latest ANZ-Roy Morgan consumer confidence survey.
At 109.2, the index fell to the lowest level in two years, providing evidence that despite the increasing positive news when it comes to the economy, sentiment levels remain depressed compared to usual levels.
While the index is notoriously volatile from week-to-week, it marries up with the separate Westpac-MI consumer sentiment survey where pessimists have outnumbered optimists in each of the past nine months, leaving its index at the lowest level in over a year.
It’s an unsettling read on what is the most important part of the Australian economy, especially during a time when things are looking so strong elsewhere.
If this doesn’t bother you, it should.
Collectively, households are the most important group in the economy, holding a large sway over the outlook for labour market conditions, economic growth, the outlook for interest rates, movements in house prices, government finances and the performance of Australian business, both public and private.
Have no doubt: what happens to households will be felt across the country.
They’re that important.
In the ANZ-Roy Morgan consumer confidence report this week, one thing in particular stood out. Sentiment levels towards the outlook for family finances plunged, leaving them at multi-year lows.
Just look at these two charts from ANZ that puts the scale of the decline into perspective.
The first shows the consumer outlook for their finances looking one year ahead.
And this shows how they see the outlook for the economy five years ahead.
Both are incredibly weak, sitting well below the average level seen in the past, and explain why headline confidence sits at the lowest level in years.
Not exactly a rosy indication on the outlook for household consumption, the largest part of the Australian economy at a smidgen under 60%.
Be it on finances or the economy, Australians right now don’t believe things will improve as time goes on.
While there’s some evidence that suggests dysfunctional politics may be contributing to the recent slide — and let’s be honest, it’s an embarrassment — it appears there’s another factor trumping anything that Canberra can dish up, that is making Australians feel more pessimistic than usual.
Wage growth, or a lack thereof.
Here’s what David Plank, head of Australian economics at ANZ, had to say on the release of the consumer confidence report.
“Overall, despite a strong labour market and robust business conditions, we believe that any recovery in consumer confidence is likely to be capped until households experience a material acceleration in wage growth,” he said.
“Last week’s wage report showed a disappointing deceleration in private-sector wage growth. Though the larger-than-usual minimum wage hike will boost reported wage growth in Q3, we believe that any increase further out is only likely to be gradual, given the level of spare capacity in the labour market.”
Pressure from all sides
That’s a similar view to that expressed by Westpac’s chief economist Bill Evans following the release of the Westpac-MI consumer sentiment report last week.
“Much of the weakness is likely to reflect a mix of weak growth in wages, increases in key costs such as electricity and emerging concerns about rising interest rates,” Evans said in relation to sentiment towards family finances, which plunged to the lowest level since 2014.
“The survey detail suggests increased pressures on family finances, concerns around interest rates and housing affordability in New South Wales and Victoria are more than outweighing increased confidence around jobs.”
As Evans rightfully points out, households, despite recent good economic news, aren’t feeling it because their finances are getting squeezed.
And part of that problem is weak wages growth, the largest source of income for the vast majority of Australian families.
Whether measured by hourly wage growth or changes in annual average weekly earnings, data released by the Australian Bureau of Statistics (ABS) last week demonstrated the squeeze that’s currently being felt by households, especially for those working in the private sector.
According to the ABS, growth in hourly pay rates in the private sector hit a record-low rate of 1.78% in the year to June. With inflation growing by 1.9% over the same period, it meant that real wages went backwards, continuing the pattern seen in the first three months of the year.
The news was even more dire when it came to average weekly earnings for private sector employees.
In the 12 months to May, they increased by a paltry 0.8%, again well below the pace of inflation. That means that for the vast bulk of Australian workers, real wages went backwards over the past year.
Backwards. In other words, rises in the cost of living are outpacing growth in people’s earning power.
They are falling behind.
Throw in steep increases in energy costs, along with out-of-cycle mortgage rate hikes, and it’s little wonder why consumers are feeling more than a little glum.
The question now is whether this squeeze is a temporary phenomenon, or something that is likely to become entrenched.
Given that households will receive little assistance from lower energy costs and interest rates anytime soon, that question will almost certainly be determined by what happens to household incomes, specifically wage growth, in the period ahead.
Will they begin to pick up, or will the trend of over-promising and under-delivering — as seen so often in the Reserve Bank of Australia’s wage growth forecasts — continue?
Again, on that front, it’s anything but certain this pattern will change.
While few dispute that wage growth will likely get a temporary boost from a larger-than-normal 3.3% increase in Australia’s minimum wage rate that kicked in at the start of July, it’s clear from the commentary after the release of last weeks ABS data that few believe we will see a sharp acceleration in wage growth, even with recent strength in official labour market data released by the ABS.
“Outside the direct impact of the minimum Wage increase we see little upward pressure on wages. As such, we are not forecasting wage inflation to accelerate beyond 2.5% by the end 2017,” said Justin Smirk, senior economist at Westpac.
“Private wage growth remains particularly weak, with no signs of a pick-up. While the stabilisation in wages is encouraging, we expect any recovery to be gradual given ongoing spare capacity in the labour market, relatively high job insecurity and low inflation expectations,” added Felicity Emmett, senior economist at ANZ.
And they weren’t alone.
“A gradually improving labour market will probably trigger some small rises in overall wage growth over the next couple of years, but any increases are unlikely to be large enough to significantly boost inflation or relieve the pressure on households’ finances,” said Paul Dales, chief Australia and New Zealand economist at Capital Economics.
Tapas Strickland, economist at the National Australia Bank, was another who said that any pickup in wage growth would likely be gentle in nature.
“Indicators of wages growth suggest only a very gradual increase — but importantly they are pointing to an increase,” he said. “The timing of such a pickup is uncertain and the experience of the US will be instructive given the US is already at full employment, but wages growth has yet to lift in a significant way.”
It’s the last point raised by Strickland that will undoubtedly create some nerves among those predicting a pickup in wage growth, including the RBA.
If recent evidence in other major advanced economies such as the United States, United Kingdom and Japan is anything to go by, just having strong labour market conditions does not guarantee a lift in wage pressures.
Compared to Australia, labour markets in those countries resemble Popeye after consuming a few cans of spinach. Unemployment is ultra low, employment growth is strong yet wages have yet to respond as what would normally have been the case.
That presents a problem for Australia where labour market conditions are nowhere near as tight.
Labour market underutilisation — capturing both unemployed persons and those workers who are employed but who would like to work more hours — still remains near the highest level in over a decade, indicating that there’s still an abundance of labour supply available given previous weakness in the economy and strong levels of population growth.
This, rather than the recent decline in Australia’s unemployment rate which tends to grab the headlines, goes someway to explaining why wage growth remains so weak.
Either demand for labour needs to improve or supply needs to be reduced (or a combination of the two) to see labour market conditions tighten to a point where wage pressures start to build.
And even then, as seen in other nations, if that does eventuate it does not mean wage growth will strengthen in any meaningful manner.
We’re already seeing evidence of that in some specific labour markets in Australia.
While elevated underutilisation is keeping a lid on wage growth at a national level, in New South Wales and Victoria, those states where labour market conditions are far stronger than in other parts of the country, there’s few signs that wage pressures are building, casting doubt as to whether even a modest increase in wage growth will be seen in the period ahead.
In the year to June, hourly wage growth in New South Wales fell to a record-low level of 2.0%, matching the same pace reported in Victoria over the same period.
Neither result was significantly higher than the national average of 1.94%, raising doubts as to how long it will take, and by what amount, wage growth is likely to increase should labour market conditions continue to strengthen.
Throw in elevated levels of job insecurity, low productivity growth, technological change and low inflation expectations, along with the trends in wage pressures in other advanced economies, and it must surely raise some doubts about the outlook for household incomes, and expenditure.
No one can say with any certainty that it will occur, with all of the risks seeming slanted to the downside given the current set of circumstances.
And that’s with both the global and Australian economies looking better than at any time in the past few years.
No one wants to consider what could potentially happen should that trend suddenly start to reverse.