While the vast majority of economists think that the next move in interest rates from the Reserve Bank of Australia (RBA) will be higher, not everyone shares that view.
Sally Auld, chief economist and head of Australia and New Zealand fixed income and FX strategy at JP Morgan, is one who remains unconvinced that the next move will be higher, suggesting that there’s currently more risk that the RBA will cut interest rates, rather than hike in the period ahead.
Like many others, she remains concerned about the financial health of Australia’s household sector, the largest and therefore most important part of the Australian economy.
In her opinion, Australia’s incredibly weak August retail sales report, following an ugly result in July, creates doubts over the ability for household consumption to help power Australian economic growth to an above-trend rate of over 3% in the years ahead as the RBA is currently forecasting.
“The weak August retail print casts a shadow over Q3 consumption, with volumes likely to slump relative to the first-half average,” she wrote in a note released today.
“Any further sense that the consumer is wavering under the burden of slowing house price growth, rising utility prices, tighter lending conditions, and near-flat real wages would reduce the RBA’s confidence that current policy settings are consistent with a return to above-trend growth by mid-2018.”
The RBA’s latest forecasts have GDP growing at 3.25% by the end of next year before accelerating to 3.5% by the end of 2019. Both are well above the 2.75% level that many deem to be Australia’s trend growth rate.
Given those concerns, Auld says that while JP Morgans’s base case is for the cash rate to remain at 1.5% for the foreseeable future, “we still view rate cuts as more likely than rate hikes”.
“While the correlation between the retail data and the national accounts measure of household consumption is far from perfect, the industry data have also underwhelmed, so last week’s retail print cannot be ignored,” she says.
And, unlike other analysts that point to booming employment and population growth as factors that will help to underpin household consumption in the period ahead, Auld says that recent strength in labour market indicators does not accurately reflect the strain being placed on household finances.
“We were somewhat surprised by the strength of retail sales in Q2, with temporary factors such as replacement buying following damaging storms and some one-off fiscal transfers supporting spending,” she says.
“The drop in retail spending in Q3 is consistent with our view that these boosts would fade, as well as further evidence that the upbeat tone of the labor data does not accurately reflect how the household sector is positioned.”
The view expressed by Auld echoes that of analysts at Morgan Stanley who believe that a combination of weak income growth, higher cost of living pressures and a slowing housing market will see discretionary spending from households slow to a crawl in the year ahead.
“We forecast the squeeze on overall disposable income will see discretionary consumption volumes slow to just 0.2% in 2018, dragging overall consumption growth down to 1.1% and well below consensus of 2.5%,” the bank wrote in a note released last week.
Given that pessimistic outlook, Morgan Stanley says that official interest rates will remain unchanged at 1.5% throughout next year, mirroring the view expressed by Auld at JP Morgan.
“Combined with a broader slowdown in the housing cycle, we see the RBA staying on hold at 1.5% right through 2018, in contrast to the market pricing of a tightening cycle commencing [in the second quarter of next year].”
Along with recent weakness in official retail sales reports released by the ABS, other indicators also point to concerning trends in household spending levels.
According to the latest Performance of Services Index (PSI) released by the Ai Group, activity levels across Australia’s hospitality sector — measuring accommodation, cafes and restaurants — declined at the fastest pace on record in September.
“Respondents in retail and hospitality are reporting reduced spending by consumers due to a mix of increased household electricity costs, flat income growth, and relatively poor consumer confidence,” the Ai Group said following the release of the report.
Jo Masters, senior economist at ANZ, is another who has previously warned that it would be difficult to see an acceleration in household spending levels given the “toxic combination of high debt and low income growth”.
“Softening retail sales is consistent with our view that households will struggle to sustain consumption growth above income growth — particularly given weak wage growth and high levels of household debt — and we continue to see the consumer as a key risk to the economic outlook,” she said following the release of Australia’s Q2 GDP report at the start of September.
While retail sales is now a far smaller part of household consumption than was what the case in the past, accounting for around 30%, it’s understandable why so many remain concerned about the recent weakness, especially given it’s now evident in other indicators.
The September quarter consumption figure won’t be known until Australia’s next GDP report is released in early December, but based on the evidence seen so far it’s hardly looking good.
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