When it comes to making pronouncements on the economy, it’s good for major institutions such as the Federal Treasury and the Reserve Bank to be upbeat when they can – but the latest set of forecasts from the RBA seem more a case of hope over grounded reality. This affirms my view that the economy is likely to disappoint in 2016 and the RBA will be required to cut interest rates further.
An Economy in Transition
The RBA’s latest Statement on Monetary Policy – released on Friday – detailed how our remarkably flexible economy is adjusting as best it can to the mining bust. While activity in the mining sector has turned down, this has been partly offset by an upturn in household service sector activity (encompassing health, education, accommodation/food and arts/recreation).
The relative employment performance of the major non-mining States of New South Wales and Victoria has also improved relative to that of the mining States of Queensland and Western Australia – though owing to associated population outflows, the rise in unemployment in the mining States has not been particularly large compared to that of the other States.
As noted by the RBA, because service sector activity is relatively more labour intensive (and less capital intensive) than mining activity, this growth transition helps to explain a couple of persistent anomalies in the economy. For starters, it helps explain the remarkable strength in employment growth despite weak overall output growth. Secondly, it helps explain the persistent weakness in non-mining investment intentions despite an apparent upturn in non-mining business conditions.
This growth transition toward services also appears to have opened up opportunities for many previously outside of the workforce – as has been evident by a rise in the participation rate. That said, this transition has also involved a shift from high wage full-time jobs toward lower-wage and more casual forms of employment, which has also helped undermine the growth in household incomes.
Hard to see how growth can pick up
So far so good, but given the nature of the economic transition underway, it is also hard to see how the economy will pick up in the way the RBA envisages over the coming year. Specifically, the RBA expects annual economic growth to pick-up from 2.0% in the year ending June 2015, to 2.5% in the year ending June 2016, to a trend-like 3.25% in the year ending June 2017.
That’s despite the fact the RBA expects mining investment will fall by a further two percentage points of GDP over the next two years, after having already fallen by 3 percentage points of GDP over the last three years. At the same time, the RBA concedes already high building approvals likely means that dwelling investment will grow at a “gradually moderating rate.” The RBA also notes intensifying land shortages could also further constrain home building.
So what will cause the growth acceleration? The same usual suspects the RBA has relied on in the past – consumer spending and non-mining investment – both of which have so far proved disappointing.
As concerns consumer spending, the RBA argues “low interest rates and further growth in employment are expected to continue to support a pick-up in household demand, and the household saving ratio is expected to decline gradually”. The problem with this scenario is that employment growth (so far at least) is taking place in low-wage sectors, which is undermining growth in household income.
And the fact growth is taking place in mainly low capital-intensive sectors also suggests non-mining investment will continue to disappoint, not helped by what the RBA concedes are “weak underlying conditions in the commercial property market”.
All up, while the economy is transitioning as best it can in the wake of the mining investment downturn, the reality is that overall growth remains sub-par and most new activity is in areas where wage levels and capital needs are relatively low – which is constraining the growth in household income and business investment. Despite the RBA’s hopes to the contrary, it is hard to see immediate catalysts for a change in this situation, especially given mining investment is set to fall further and the dwelling sector’s timely contribution to economic growth is set to moderate.
To my mind it will take materially low interest rates and/or a materially low Australian dollar before growth prospects take a notable turn for the better.