Australian business conditions are booming, but it's too early to start talking about rate hikes

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If the latest NAB Australian business survey is anything to go by, the economy looks set to boom in the months ahead.

In March, the survey’s conditions index jumped to 14.2 points, leaving it at the highest level since before the global financial crisis.

Trading conditions have rarely been better, profitability remains strong, hiring levels firm while lead indicators such as forward orders and capacity utilisation — pointing to activity levels in the future — are also strengthening.

It’s a scenario that would usually signal faster economic growth, an acceleration in employment growth and, courtesy of both, the likelihood of higher interest rate.

Seemingly, things are great, according to the survey.

However, while it says conditions are booming, the survey has consistently been stronger than hard economic data in recent years, suggesting that some degree of caution should be used when interpreting the stellar March result.

These charts from UBS underline the need for caution.

The first overlays the NAB’s business conditions index against real GDP growth.

Source: UBS

While the former has been trending higher, currently sitting at levels normally associated with real GDP growth of around 4%, the latter has actually been trending lower, sitting at around half that level.

It’s a similar story for the labour market, with employment intentions in the NAB survey pointing to annual employment growth of around 2%, more than double the current pace reported by the ABS.

Source: UBS

Perhaps unusually strong employment growth reported by the ABS in late 2015, which likely overstated the true level of hiring seen during that period, may explain the recent divergence between the two indicators.

However, as this final chart shows, while wages growth in the NAB survey has been turning higher, it’s actually fallen heavily in the official ABS statistics.

Source: UBS

That’s not to discount the importance of the NAB survey — it is still seen as the most authoritative guide on trends in Australian business and problems with the ABS labour market indicators are well documented — but as UBS points out, the hard data must start to reflect the improvement in the NAB survey before rate hikes can be seriously discussed.

“Business conditions are arguably in RBA rate hike territory,” says George Tharnou, economist at UBS.

“However, the ‘soft data’ of business conditions have been average or above for the last 2 years, yet the ‘hard data’ of real GDP growth has been stuck trending around a relatively moderate 2.5% year-on-year.

“Indeed, much better reported business conditions have also yet to translate into inflation indicators to the same extent, and hence we still see the RBA on hold ahead.”

Given the strength in the NAB survey it will be interesting to see whether the ‘hard data’ — starting with Australia’s March jobs report released on Thursday — will start to follow suit.

Here’s hoping it will.

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