Here's why business confidence is crucial in determining what the RBA will do next

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If it wasn’t already known prior to today, the outlook for business confidence — hence business spending — is going to play an important role in whether the RBA will continue to lower interest rates in the second half of 2015.

Earlier today RBA deputy governor Philip Lowe delivered a speech to the Corporate Finance Forum in Sydney entitled “Managing Two Transitions”.

Within it he provided a clear indication on what is holding Australia’s potential economic growth rate back — a lack of non-mining business investment.

With a lower Australian Dollar, modest wage growth and falling interest rates all assisting Australia’s economic transition following a sharp slowdown in mining sector investment at present, Lowe suggests one “part of the transition that is taking place more slowly than we had earlier expected is the lift in business investment outside the resources sector”.

In other words, with other factors already assisting economic re-balancing away from the mining capital expenditure boom, the one missing ingredient holding the economy back is a lack of non-mining business investment.

Here’s a chart that shows private non-mining investment as a share of Australia’s GDP. It remains just above levels last seen in the early 1990’s recession.

Here’s Lowe discussing the subdued level of non-mining business investment at present.

“For a few years now, each time we have updated our forecasts, we have pushed out the timing of the recovery in this part of the economy. The latest update was no different. Many businesses tell us that while conditions are okay at the moment, they are not sufficiently strong for them to lift their investment plans. Many feel uncertain about the future and so are waiting until there is a sustained pick-up in demand before committing to new capital expenditure“.

As Lowe also notes, the caution expressed by Australian businesses is also reflected in other advanced economies at present.

“There is no single factor driving this tendency to wait and a similar story seems to be playing out in many other advanced economies. Around the world, many businesses seem concerned about the prospects for consumer demand given high levels of debt and the ageing of the population. There is also uncertainty about what type of capital investment is appropriate in a world where new information technologies are reshaping business models. Many firms also see globalisation of markets as a challenge, especially where increased competition has reduced market power”.

In what will no doubt make markets pay far more attention to business confidence and capital expenditure data releases in the second half of 2015, he suggests “a lift in non-mining investment remains the critical ingredient to stronger growth in the overall economy and to a successful transition. Many of the preconditions for this to occur are in place, although a sustained lift still seems some way off.”

Given the RBA are watching developments in this area closely the monthly NAB business confidence gauge, along with private new capital expenditure figures released on May 28, will be crucial in determining not only the outlook for business spending but also the future direction of domestic interest rates.

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