Economy in Transition

Retailer Roger Corbett may not be quite so delighted, but at its first meeting of the new year to be held tomorrow, the rest of the
Reserve Bank board should be well pleased with the changing shape of growth in the Australian economy. The transition from domestic demand to exports and from household spending to business spending is now well under way.

Economic data released last Friday, February 3, showed exports continuing to improve after the third-quarter downturn, while retail trade remained subdued. Compared to a year ago, exports are up 23%, the fastest 12-month growth in five years. Imports are now growing at less than half the annual rate of exports and over the whole of last year, retail turnover increased 4% '” just a
little better than retail price inflation.

The board might be alarmed if domestic demand was slowing too rapidly, but it is not. Approvals for new residential construction fell in December, for example, but the pace of decline has slowed. Approvals are well down on the level two years ago, but are not much changed from the level of one year ago. Residential construction may well be close to the low in the second half of the year, and that low will be a lot higher than in earlier downturns.

Within domestic demand, more is business investment and less is household consumption. In the December quarter of 2005 the growth of business credit overtook the growth of household credit, a change confirmed in last week’s December numbers. For the year to December, housing lending growth slowed to 12.3%, while business credit growth accelerated to 16%.

In the year to the September quarter, real business investment was a higher share of GDP than it any time in the past 50 years. Over the year business investment increased by 17%, and household consumption by 2.7%.

The overall GDP growth rate is below trend, but these transitions from domestic spending to exports and from consumption to investment are very much more important in sustaining the resilience of the expansion, now in its 15th year. It is all the more satisfactory to the RBA because despite low unemployment, high oil prices, and rising labour costs, headline retail price inflation is now back within the 2–3% target band and core inflation is around the 2.5% mid point.

I think rising wages growth, slow productivity growth and rising import prices will push inflation up in the second half of the year, but the RBA will wait for compelling evidence before it concludes that rising inflation does indeed present a problem. Because the direction of labour costs is now critical, the December quarter labour price index, to be released on February 22, will be unusually important.

There are plenty of serious long-term issues in the economy, and the first and foremost in our view is that the burden of servicing foreign debt will continue to increase faster than GDP until Australia manages to run a permanent trade surplus. But these are issues beyond the remit of the RBA board, which tomorrow will cheerfully tick governor Ian Macfarlane’s proposal to leave the cash rate unchanged.

In 26 months the RBA has changed the cash rate only once, and then it was by just 25 basis points. This is a pace of activity to which Mr Corbett will need to adjust, but in each case the decision to do nothing has been the right one.

John Edwards is Chief Economist of HSBC Bank Australia.