Australia, don't bank on a business-led economic recovery just yet

Photo: Joosep Martinson/ Getty Images.

The performance of Australia’s corporate sector was the one bright spot in what was an otherwise weak GDP report for the March quarter .

Corporate profits grew 30% on a year earlier, and not just as a result of higher commodity prices boosting mining revenues. Business investment also climbed off the mat, registering a small 0.7% increase during the quarter.

Those positives created optimism that Australia’s next economic growth engine, following mining investment and housing construction before it, may be the corporate sector.

“If this trend becomes more well entrenched, it will give greater confidence in our expectations of a moderate cyclical upswing in non-mining investment in 2018 and 2019,” said Riki Polygenis, head of Australian economics at the National Australia Bank.

That was a similar view shared by Paul Bloxham, chief Australia and New Zealand economist at HSBC.

“The lift in corporate profits helps to explain why business investment is starting to pick up,” he says. “The rise in profits is also extending a bit beyond the mining industry, with profits in the finance and insurance and professional services industries also lifting.”

With the household sector weak, seeing consumption growth slow to just 0.5% in the first three months of 2017, it’s offered hope that Australia’s corporate sector may be able to drive growth in the quarters ahead, potentially helping to boost employment, wages and, as a consequence of both, increase consumer spending.

The question now is will such a scenario play out, particularly with the growth tailwinds from higher commodity export volumes and residential construction likely to turn to headwinds over the next two years.

While there were promising signs on that front from the national accounts, there are already signs that such a recovery may be snuffed out before it truly begins.

According to the latest Business Expectations Survey released by Dun & Bradstreet on Wednesday, sentiment towards operating conditions in the September quarter deteriorated sharply in May, driven by a weak performance in this year’s first quarter.

“The optimism from the business sector at the end of 2016 and the early part of 2017 has not been sustained. Business expectations remain cautious for the September quarter following the particularly weak ‘actual’ outcome for the March quarter,” said Stephen Koukoulas, economic adviser at Dun & Bradstreet.

“The information from the business sector accords with the recent official news on the economy — sluggish growth characterised by weak sales, profits, and capital expenditure.”

Despite the optimistic signs in the national accounts surrounding Australia’s corporate sector, the Dun & Bradstreet survey found that operating conditions for firms fell to a four–year low, driven by lower actual sales, profits, employment, selling prices and investment.

And, as seen in the chart below, the weakness in actual business conditions last quarter likely contributed to weaker sentiment towards conditions in the upcoming quarter.

Source: Dun & Bradstreet

The survey’s expectations index — an average of measures on sales, profits, employment and capital investment expectations — fell to 17.3 points for the September quarter, down from 20.3 points in the June quarter.

Dun & Bradstreet interviewed 800 firms during April and May 2017 for its latest survey.

While only a modest decline, and still elevated compared to levels of a year earlier, the result was cushioned by a strong lift in employment expectations.

It climbed to 15.4 points from 11.6 points in the June quarter, leaving the index at a two-year high.

The survey found that 22.2% of firms expect to have higher staff numbers in the September quarter compared to the same time last year, while 6.8% expect to reduce staff numbers.

All sectors had higher expectations for employment aside from services firms, the largest employers in the country.

“The increase in employment expectations may be linked to the current low wages environment and it fits with the recent ABS labour force data which has shown a solid rise in employment in recent months,” says Koukoulas. “The positive outlook for employment is across almost all industries, which is a favourable development.”

While that’s clearly a positive for employment growth in the official ABS data, Koukoulas says that the gap between actual conditions and expected conditions in the survey is now the widest that it’s been in two years, something he says indicates that firms are failing to realise predicted activity levels.

“The actual performance of the economy reported by businesses for the March quarter was particularly weak as otherwise upbeat expectations failed to be met,” he says.

Businesses have been overly optimistic compared to what has happened in reality, in other words, at least in the survey.

That suggests recent strength in other business indicators — such as the NAB’s business confidence survey which many have pointed to as a promising sign on the outlook for activity levels — may also be overstating the outlook for demand, even if conditions in that survey are significantly stronger than those reported in the Dun & Bradstreet survey.

It’s slightly unusual, and one that creates uncertainty on the outlook for business activity and investment

While there were one-offs in the March quarter GDP report that dragged on growth, particularly from net exports, the underlying theme was that the household sector remains weak, contributing to annual growth slowing to the lowest level since the GFC.

They are the customers that businesses rely upon, and they’re not lifting spending like they used to thanks to weak incomes growth and elevated levels of indebtedness.

Should that trend continue, it’s hard to see business profitability lifting further, nor an increase in business investment.

The labour market will be key in determining what exactly will happen, and that’s where most attention will be directed in the months ahead.

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