Key insights from the week that was.
This week for Australia, the focus was investment data ahead of next Wednesday’s Q2 GDP print.
The first of these updates, construction work done, reported that building work fell 3.8% in Q2 – a decline almost four times the market median forecast of -1.0%. If this estimate translates one-for-one to GDP next Wednesday, it will take 0.4ppts from quarterly growth and 1.3ppts over the year – reversing the 1.2ppt contribution of the 12 months to June 2018. This weakness has been broad-based, including public sector works and private infrastructure activity, but is most notable in residential construction (–5.1% in Q2, including a 3.3% decline in renovation work). Ahead, the public works pipeline and a lift in private infrastructure commencements should provide greater support to growth. However, the downturn in residential construction has further to run.
From the CAPEX survey, there are two points worthy of note: equipment spending in Q2 surprised to the upside rising 2.5% – offsetting some of the weakness in construction; but, looking ahead, the latest read on expected investment in 2019/20 points to a modest downgrade. Relative to estimate 3 a year ago, the latest update implies a circa 11% gain in 2019/20. However, base effects flatter this estimate. If we instead use average realisation ratios to imply the eventual outcome, the expected gain is much smaller (2.5% nominal and 1.0% real). This is well below the Federal Budget forecast for real growth for 2019/20 of 5.0%, but broadly in line with our own view.
Following these preliminary reports, we have retained our 0.5% GDP forecast for Q2. Of this gain, around 0.4ppts is likely to come from net exports, with growth in domestic demand negligible. The report prints one day after the RBA’s meeting on September 3.
As Chief Economist Bill Evans outlines, we think Q2 GDP is unlikely to impact near-term decision making, with the real question around whether a stabilising housing market and new stimulus shore up the economy in the second half of 2019. This information is unlikely to be sufficiently clear by November – when the RBA next update their forecasts – but in any case, the RBA’s August forecasts already suggest more policy easing is required.
As such, we continue to expect that the RBA will cut in October, and given we expect economic conditions to remain subdued, deliver a follow-up cut in February to a cash rate of 0.50%. A move in October has some advantages, namely reducing the risk of having to cut in back-to-back months later on and consequently damage consumer sentiment – as we saw with the June/July cuts.
On that note, this week saw RBA Governor Lowe appear on a panel at the Jackson Hole Economic Symposium in the US. Governor Lowe first highlighted the power global developments have over our economy and the stance of monetary policy. In short, an increase in global savings has pushed asset prices higher (and yields lower) across the world, while globalisation and technology have increased competition amongst workers and restricted wages growth.
These developments call for greater flexibility when assessing inflation versus target, to prevent unintended consequences for employment, activity, the currency and asset prices. Governor Lowe went on to emphasise that monetary policy is ill-suited to resolving structural problems in our economy. Fiscal policy (infrastructure investment and tax cuts) and structural reform (targeting productivity and efficiency) should instead be the focus.
More broadly on the Jackson Hole Symposium, trade tensions and other global uncertainties were clearly front of mind for all participants. This is hardly surprising given, just as the conference got underway, China retaliated against the US’ prior escalation of tensions on 1 August by formally announcing new tariffs on imports from the US, and US President Trump quickly responded with a barrage of strongly-worded tweets and yet another tariff increase. Later in the week, tensions calmed down as China MOC spokesman Gao expressed a willingness to negotiate and prevent an escalation in the trade war. While we are encouraged by such remarks, we are wary that false signs of conciliation have been all too familiar over the past year with uncertainty still taking its toll on the global economy.
For the US, which has been the strongest of the developed nations, the risks here are high. US business investment prospects continue to deteriorate, while employment and consumption growth look increasingly at risk of a marked deceleration. These developments, along with the promotion of pre-emptive easing by Chair Powell, support our view that the FOMC will cut three more times by year end and that the risks to this forecast are downwardly skewed in 2020.
For Australia, in Q&A following a speech on structural change in Australia’s Balance of Payments, Deputy Governor Debelle again noted that, if these risks crystallise, the RBA has scope to ease further, referencing an effective floor for the cash rate around 0.25–0.50% based on international experience. He also mentioned that additional measures could be looked at if conventional policy easing was seen as insufficient.
Separately in Europe, Italian President Mattarella has given a mandate to Conte to form a new 5-Star/PD coalition government. Conte had previously resigned as PM under the prior 5-Star/League coalition ahead of a no-confidence vote being pushed by the League’s Salvini. Conversely, Salvini now finds himself out of government despite polls suggesting the League is the most popular party in Italy.
Finally on Brexit. This week Prime Minister Johnson upped the ante by asking the Queen to prorogue (suspend) Parliament ahead of a Queen’s speech – an event that sets out the Government’s agenda for the coming term of Parliament. Due to party conferences in late September as well, this effectively means Parliament will not sit for five weeks between the second week of September and October 14. Those who oppose Brexit now only have next week and a few days in late October to push for another Brexit extension and/or to move a vote of no confidence in the Government ahead of the October 17 EU Summit and the current October 31 exit deadline.
Overall, Johnson’s move raises the likelihood of a no-deal Brexit, although probabilities are still relatively evenly split between an extension, an agreeable deal and a hard (no-deal) exit. In the meantime, the UK economy remains in weak shape, and confidence in the outlook is souring.