Australia's economic recovery is becoming more entrenched as business conditions hit a 10-year high

during the Big Bash League match between the Melbourne Stars and the Hobart Hurricanes at Melbourne Cricket Ground on January 6, 2016 in Melbourne, Australia.

Australian business confidence remained elevated in June, buoyed by the strongest operating conditions in nearly a decade.

That’s the good news to come from the National Australia Bank’s latest business survey, which, along with strength in other business indicators such as purchasing managers indices (PMIs), suggests that the Australian economy is recovering after a sharp slowdown at the start of 2017.

The NAB said that the survey’s confidence index rose to +9 from +8 in May, something Alan Oster, NAB’s chief economist, said provided a pleasant and encouraging surprise.

“We continue to be pleasantly surprised by just how upbeat the business sector is, given the context of a fairly beleaguered household sector that has been weighed down by limited wages growth and record levels of debt,” said Oster.

“In fact, there is even tentative evidence that we are now starting to see some positive spill-overs from the business sector to the broader economy.”

Helping to explain why businesses are feeling so confident right now, the survey’s conditions index — an aggregate measure on trading conditions, profitability and employment — soared to +15, leaving it sitting at the highest level since before the global financial crisis.

Put another way, conditions, according to survey respondents, haven’t been this good in close to a decade.

An impressive result in anyone’s language.

Source: NAB

Oster said that the sudden improvement in conditions, leaving it well above the series average of +5, was driven by stronger readings for sales and profitability.

“The jump in sales and profits suggest we are seeing a much needed lift in demand,” he said.

And while the employment subindex held steady at +7, Oster said that this still points to strong hiring levels in the months ahead, something that suggests the recent surge in hiring seen in the first half of the year is likely to continue.

“While employment conditions did not improve, they remain at levels that would indicate enough employment growth to lower the unemployment rate over coming months,” he said.

“That is important at a time when other indicators, such as the ABS underemployment rate, suggest there is still a fair degree of slack in the labour market”.

Source: NAB

Adding to the positive outlook, the new orders subindex, a lead indicator on activity level in the future, also improved.

“Other leading indicators were robust, with capital expenditure rebounding from recent lows despite some pull-back in capacity utilisation rates, while forward orders drifted up further for the month,” Oster said.

By sector, the strength in June was driven by the wholesale, construction and manufacturing sectors, although, fitting with recent PMI surveys, the NAB said that conditions were also solid across most industries, leading Oster to declare that the recovery is becoming more entrenched.

Source: NAB

And that improvement included the retail sector, the second largest employer in Australia behind healthcare and an industry that has been a the epicentre of concerns given its importance on the outlook for the broader economy.

“The retail industry is showing some signs of improvement, which along with better than expected retail sales and employment growth in May, could mean the disparity in trends between the business and household sectors will resolve itself favourably,” Oster said.

Mirroring the performance from specific sectors, business conditions across all Australian states held in positive territory in June on a three-month moving average basis, again, another outcome that suggests a broad strengthening across the entire Australian economy.

Source: NAB

While things are clearly looking positive at present, Oster says that there’s still plenty of reasons to remain cautious on the outlook for the economy, especially when it comes to the outlook for the household sector, something that will need to strengthen in order to keep business conditions robust.

“There are still significant hurdles to be overcome as the ongoing slack in the labour market which are keeping wages growth subdued, and record levels of household debt pose a significant long-term headwind to consumer spending.

“Given the risks to the outlook, signs of moderation in the housing market, and a reluctance to see the AUD strengthen further, the RBA should be content with keeping interest rates on hold for an extended period until mid-2019.”

Although there are, as Oster says, hurdles to overcome, elevated levels of business confidence bode well on the outlook for consumer confidence , and potentially a rebound in household consumption, the largest component within the Australian economy at a smidge under 60%.

According to research released by ANZ Bank earlier this year, its generally business confidence that tends to lead consumer confidence when the latter is depressed, at least from a historic perspective.

“For the most part, consumer confidence appears to rise toward business conditions when consumer confidence is low, rather than the other way around,” said the ANZ’s economics team, led by David Plank.

“We think the usual dominance of business conditions over consumer confidence reflects the link between business conditions and the labour market,” it said. “If businesses are in an optimistic mood then that usually flows through to the labour market, which in turn will likely boost consumer sentiment if it is low.”

The linkage between the two is easy enough to understand.

Businesses can gauge demand, and, if it’s strengthening, they have tendency to add more staff. That, in turn, improves labour market conditions, making households feel a little more confident when it comes to job security, the prospect of finding new work and, potentially down the line, faster wage increases.

And that relationship is why the NAB’s employment subindex, suggesting that labour market conditions, is an optimistic sign on the outlook for the household sector.

If households feel more confident about their job security, increased spending is likely to follow next. And, if that does eventuate, it’s likely that the Australian economy will have managed to successfully navigate a once in a multi-generational economic transition that many thought would scupper Australia’s record-breaking run without falling into recession.

While things are looking promising on that front, there are still plenty of obstacles to overcome.

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