Australian business conditions fell sharply last month, but it's not all bad news

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It’s one month since the NAB reported that Australian business conditions and confidence surged in January, creating optimism that the economy was gathering steam after a lull in mid-2016.

Business conditions soar to a post-GFC high, seeing confidence levels jump to the loftiest levels since February 2014. And the employment index also jumped, pointing to a sharp pickup in hiring levels in the months ahead. It was a remarkably strong result, and left many wondering whether it was an anomaly or the start of a longer-lasting trend.

Well, now that question has been answered. It was an anomaly, but the news was still broadly good in terms of the outlook for the economy.

In its February installment, widely regarded as the most authoritative report on the health of Australian businesses, the NAB said that both conditions and confidence levels fell, particularly the former which gave back all of January’s gains.

Source: NAB

The conditions measure — combining readings on trading, profitability and employment — slid by 7 points to +9. Despite the sharp pullback, and putting the decline into perspective, the reading still sits well above the survey’s long-run average of +5.

This, says the NAB’s chief economist Alan Oster, still points to solid rates of business activity in the near-term.

“We were not surprised to see business conditions drop back from their multi-year highs, having flagged in last month’s survey that we suspected a number of temporary factors probably underpinned the unbelievably strong result,” he said.

“Even so, conditions are still holding up at levels that would make you reasonably comfortable about the near-term growth prospects for the economy, putting aside some of the concerning trends we are seeing in retail.”

Breaking down the report, shown in the table below, the NAB said a weaker trading conditions, along with a smaller dip in profitability, were largely responsible for the weakness reported.

Source: NAB

The survey’s trading measure fell 10 points to +13 while profitability eased 2 points to +11, levels Oster describes as still “quite positive overall”.

The employment measure also eased last month, dropping to +5 from +7, although it still points to hiring levels sufficiently large to bring down Australia’s unemployment rate, says Oster.

“The trend in employment conditions has improved notably in the past two months, to a point where the index now suggests the economy should be producing enough jobs to bring down the unemployment rate should the participation rate remain steady,” he said.

However, he cautioned that the survey’s employment index has been pointing to faster employment growth than the official ABS jobs report recently.

By specific industry, the NAB said that most are showing solid, or improving, business conditions right now, with the much of the decline reported in February driven by a reversal in conditions in Australia’s largest services industries following a strong result in January.

“We saw the big service industries drive the moderation in business conditions this month, but even after pulling-back a little, these industries continue to lead the non-mining recovery”, said Oster.

Source: NAB

Fitting with that optimistic near-term outlook, the survey’s lead indicators — pointing to where business activity levels are likely to sit in the future — were also positive, hinting that the improvement seen in recent months may extend into the middle of the year.

“Forward orders are pointing to modestly positive near term prospects for activity, although may not be enough to sustain the current levels of business conditions,” said Oster, acknowledging that diminished spare capacity is an encouraging sign for business investment and labour market conditions.

Mirroring the retracement in business conditions over the month, the survey’s separate confidence index also moderated, falling 3 points to +7.

Importantly, this is still above the series long-run average and levels reported in late 2016.

Even with the pullback in conditions and confidence levels in February, the report still points to solid rates of economic growth in the near-term, says the NAB

However, as was the case in previous months, it was not enough to alleviate its concerns about where the economy is likely to head in 2018.

“It is the longer-term growth picture that we are more concerned about, particularly as the contributions from LNG exports, temporarily higher commodity prices and the residential construction boom fade, putting pressure on the labour market,” Oster said.

The NAB is one of handful of major forecasters who are still forecasting a rate cut from the RBA this year, predicting that the bank will likely cut rates in the final quarter of 2017.

However, after changing its previous forecast following the release of its January report one month ago, it too appears to be wavering on the prospect for further easing from the RBA this year.

“The RBA has made it clear that they are putting increased emphasis on financial stability concerns, which is likely to impact the response of monetary policy”, says Oster.

“NAB Economics will release updated financial and economic forecasts tomorrow.”

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