This stalemate holds the key to Australia’s economic fortunes

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Australia’s economy is looking better than it has for several years, at least based on recent economic data.

Business conditions are booming, sitting at levels not seen since before the global financial crisis, while the labour market, after weakening noticeably last year, also appears to have turned a corner.

Jobs growth has surged in the past three months, leaving the unemployment at the lowest level since early 2013.

And, coinciding with that improvement, retail sales have also strengthened, registering large back-to-back gains in April and May, a promising sign that the slowdown in household consumption in the post GFC-era may have also reached its nadir.

Amidst all the doom and gloom, green economic shoots are appearing.

However, there’s just one problem.

Households, the engine room of the Australian economy, don’t think the improvement can last.

Just have a look at these two charts from ANZ’s latest Australian consumer confidence report released today.

The first measures confidence in where the economy is heading in the year ahead.

Source: ANZ

And this is a similar chart, only looking five years ahead.

Source: ANZ

The economic outlook, at least in the opinion of those surveyed, is still seen as pretty grim. Both readings are weak, siting well below the survey’s historic averages. It’s also a result that is in stark contrast to what has been communicated by business recently.

It’s a stalemate, and one that will likely determine how the Australian economy will fare in the future when it inevitably breaks.

Business conditions are unlikely to remain strong if household spending is weak. The two groups, after all, are part of a symbiotic relationship.

Put simply, one can’t remain strong while the other is weak, especially for a substantial period of time.

The question that many are asking themselves now is how will this stalemate end? Will surging business confidence and conditions lead household confidence and spending higher, or will dour household spending and sentiment end up scuppering the revival in the nation’s corporate sector?

Alan Oster, chief economist at the National Australia Bank, says there is now tentative evidence emerging to suggest that the first outcome may prevail, noting earlier today that he is starting to see some positive spill-overs from the business sector to the broader economy.

Improved business confidence and conditions is now staring to flow through to other areas of the economy, in essence, leading to the pickup in employment growth and retail spending seen in recent months.

Down the line, if sustained, that could lead to improved consumer sentiment on stronger job market conditions, potentially laying the foundation for increased household spending and wages growth.

Although highly speculative at this point, such an outcome is not unprecedented in Australia.

Indeed, research from ANZ Bank earlier this year found that when there’s been such a large divergence between business and consumer sentiment in the past, it has almost always been business that has acted as the lead indicator when household confidence has been weak.

“We think the usual dominance of business conditions over consumer confidence reflects the link between business conditions and the labour market,” ANZ 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.”

On that front, history looks like it may be repeating again. Businesses are confident and employment growth is increasing, seemingly paving the way for a lift in consumer sentiment.

However, just because it’s happened in the past does not automatically mean that it will happen again. As the saying goes, “past performance is not indicative of future returns”.

Oster, for one, says that there’s still plenty of uncertainty as to whether a self-sustaining, consumer-led economic recovery is underway.

“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,’ he says.

And he’s not alone on casting caution on the outlook for the household sector.

Ben Jarman, economist at JP Morgan, is also not convinced.

“We are treating the prevailing strong tone of the NAB survey with some caution given that the consumption outlook is challenged by rising mortgage costs, a lack of further flexibility in the saving rate, and rising household energy bills,” he says.

“(The) NAB survey respondents also seem yet to reflect on the headwinds to profitability that will occur from the increase in their own energy input costs, a repricing even greater than that faced by household users.”

Morgan Stanley’s Australian equity strategy team share a similar view, suggesting that recent increases in energy costs could derail a consumer-led recovery before it truly gets underway.

“We think its too early to call an upturn for the consumer, with the headwinds to real incomes and credit growth worsening from the second half of this year.”

Those counterarguments suggest that it could be the assessment from households, not businesses, that will prove more accurate as to what lies ahead for the economy.

It’s a complex situation, but one that will eventually determine how the Australian economy will look in the years ahead.

No one knows what the answer is at this point, including the Reserve Bank of Australia.

All we can do in the interim, like the RBA is already doing, is to watch incoming labour, household and housing market indicators for clues as to what’s likely to happen next.