HSBC's chief economist Paul Bloxham tells Business Spectator's Alan Kohler and Stephen Bartholomeusz:
– The disparity between the strong Australian economic data and the negative anecdotal evidence from business about productivity is due to the substantial structural shift that is taking place in the economy.
– About two-thirds of investment in the mining industry is taking place above the Tropic of Capricorn, where only 5 per cent of Australia's population lives, but some of that income is flowing through to other parts of the economy.
Alan Kohler: Well Paul, let’s analyse the national accounts this week. Now, you’ve been saying that the economy is stronger than most people think for a while now. You must feel vindicated a bit this week.
Paul Bloxham: Certainly somewhat vindicated, yes. Our view has been that the parts of the economy that are growing most quickly at the moment are the ones that we least frequently see in the official statistics and so we only get irregular updates of what’s going on. When we get those updates we find out the economy as we found out this week is a bit stronger than those other partials have been suggesting. Of course that’s because the mining investment boom is a very big part of the growth story.
AK: Well, in fact there’s more to it than that, isn’t there? I mean the household consumption part of the boom, which is also the other strong part of the national accounts, seems in part to be due to lower prices caused by the high Australian dollar. So, can you talk a bit about how you see the household sector going as well and what are the implications out of the national accounts about that?
PB: Yeah, absolutely. So, what we saw in the national accounts was that we got very strong growth in mining investment as we had expected. The upside surprise was the strength we saw in household consumption. The household consumption story, I think, is in large part due to the fact that prices have been fairly low, inflation has been fairly low. In particular, the strong Aussie dollar has been putting downward pressure on imported goods prices and what that has meant is it seems that households have been able to consume more volumes of those goods that they’ve been purchasing. In addition to that, and this is where the story all gets very complicated of course, is households are actually changing their consumption behaviour. They are spending more on services. They are spending more services, more on things like international travel and those things also look strong in this week’s national accounts.
Stephen Bartholomeusz: Paul, since the end of the March quarter we’ve seen some changes in the external circumstances, particularly in Europe, but also within the domestic economy. Retailers are talking about the significant downturns in April. Do you think that kind of growth that we saw in that March quarter has been sustained into the first part of the next quarter?
PB: Well , it’s fair to say that we saw a very strong growth in the first quarter. That 1.3 per cent would be the envy of the rest of the world. I think there are quite a few developed world economies that would be happy just to get that for a whole year and we got it in one quarter. It’s fair to say that I don’t think that pace of growth will be sustained. But if you look through the numbers and you take the previous quarter, the December quarter, and the March quarter together, that suggests a pace of about one per cent per quarter, about four per cent per annum. We think there’ll be a bit of a slowing from there on the back of what’s happened in terms of the global conditions, but we still think we’re going to see some fairly solid growth in Australia in coming quarters. So, one of the key things we’re expecting to see, is some rebalancing of growth. The RBA has now cut interest rates by 125 basis points. The exchange rate has now come off its peaks. Both of those factors are likely to support some parts of the economy that have been weaker recently, the ones that are exchange rate sensitive; the manufacturing industry, the tourism industry and the education exports industry and indeed retail sales. And lower interest rates from the RBA should also provide some support for the housing market. So, we’re still fairly upbeat about the growth outlook for Australia.
SB: Given that underlying optimism in your commentary, did the RBA move too much too early?
PB: Look , I think the RBA has taken advantage of the fact that because inflation has been low and that in part is really because the RBA had lifted rates earlier. It got them up to above neutral and held them through above neutral for most of last year. Because they’ve been able to do that and get inflation low, they’ve been able to buy some insurance against the possibility that the global downturn is sharper than we’re currently expecting, that those risks play out to be more of a central scenario. So, I think it’s fair to say that the RBA, having gotten inflation down, is now in a position, in an enviable position of being able to buy some insurance against the possibility of a further downturn in the global economy.
AK: So, that means you think they’re right. They were right to have cut rates this month and 50 basis points last month?
PB: Well, I think it’s fair to say that they are in pretty good shape. They were right to have gotten rates up last year. They were right to have held them at the levels that they were at through last year, above neutral – up until November of course – and they got a lot of criticism for keeping rates as high as they were. I think the fact that they’ve cut rates at the moment, they’ve been able to do because inflation is low enough to let them do that. Only with retrospect, 12 to 18 months down the track, will we really know whether this was the right move, but I think with the current global environment it was certainly a prudent move for the RBA to be cautious and to have gotten rates down a bit in the face of this potential global slowdown.
AK: So, what’s your outlook for rates now? The market is pricing in another one per cent cut, I think, over the next twelve months, so do you think that’s right?
PB: Oh, we think that’s been too much for quite some time. What was interesting of course around the national accounts this week was just before they came out, markets were pricing a hundred and fifty basis points in over the next year and now they’re pricing as you say closer to a hundred basis points, so there was quite a big shift already. Clearly, the markets are pricing in the possibility of a sharper global downturn. That’s not part of or central scenario. We in fact expect in particular that Chinese growth will pick up in the second half of this year, so if that comes to pass, and indeed that is our central view, I don’t think the RBA has got a whole lot more to do yet. I think they’ve got a bit of scope to remove some more rates a little bit further and so we’re still pencilling in one more cut from the RBA in the third quarter of this year, but I think that might be it. I think the RBA will then be on hold and comfortable that rates will provide support for the economy to the extent that’s necessary.
SB: Paul, you come out of that RBA environment. Would there have been discussion within the bank about hanging onto the firepower just in case Europe does blow up?
PB: Look, there are two ways to argue this, especially around the last meeting. One potential choice was to keep your powder dry, leave rates at 3.75 per cent, just in case you really need to cut them aggressively at some point in time. That’s one argument. The alternative argument is you don’t want to be behind the curve, perhaps you should be cutting rates now, so that you stay ahead of the game. And I think what tends to happen is both those arguments get run and what you find is the second of those arguments, the let’s get ahead of the game argument, tends to win. And I think that’s what we saw happen on Tuesday. We saw that they would have discussed the possibility of leaving rates where they were to keep their powder dry, discussed the possibility of we might get behind the curve if we don’t move fairly soon, and in the end the end they decided to cut which I think was consistent with me recollection of what tends to happen.
AK: One of the things that came out of the national accounts this week was indications of a big jump in productivity. Do you believe that?
PB: Look, I think with any quarterly results or any monthly results or any of the statistics you’ve got to take with a little bit of a pinch of salt. I think productivity looks as though it has been improving a little bit, but it’s still fair to say that labour costs have been rising quite strongly as well and that comes through in the national accounts also. So, it is fair to say that I think that concern about unit labour costs running too quickly, that concern about the non-tradable goods inflation story is still with us. The thing that’s been pushing inflation down or has pushed inflation down in recent quarters has been the strength of the Aussie dollar – the appreciating Aussie dollar through 2009 and 2010. What we do know is the cost base in Australia has continued to grow quite solidly and what we know is domestically produced inflation is still somewhat of a concern. And so, indeed that’s one of the reasons we don’t think the RBA has got a whole lot more to do is because they may not feel they have a whole lot more room to move given those domestic cost pressures. And that does come back to productivity. The only way you solve that problem is to have strong growth in productivity and I think you’ve got to think that even if productivity is improving, it’s still not showing really strong growth yet.
AK: Well, that’s the thing. I mean I think it’s quite a big increase in productivity in the national accounts, but against that you’ve got businesses all over the place complaining about rising costs of both construction and operating and the Business Council is coming out today with a study on it. I mean they’re really kind of complaining loudly. I mean in fact in many areas there seems to be quite a difference between the official statistics and the anecdotal evidence from the ground.
PB: That's absolutely right. And I think there’s a number of stories there or a number of explanations. The first is that the economy is going through some pretty massive structural changes at the moment. The Aussie dollar has been just recently around a 30-year high. It’s been putting a lot of pressure on various sectors of the economy. I think the second part of that story is income growth has been very strong up until very recently because of course the terms of trade had been rising, and that has turned around, so we’ve now seen the terms of trade start to fall, so income growth is weak, but volumes growth seems to be quite strong. There are quite unusual circumstances that we’re facing right now and so it does make sense the statistics seem quite different from what’s going on in the economy. I think it’s hard to read because of that structural change. I think to some degree it also makes it hard to measure, and that was one of the points I made earlier, is that it is hard to measure the economy when it is tracking in a different way from how it has done in the past. We’re used to watching households, in particular, and used to watching their house prices rise. We’re used to watching an economy that is driven more by what’s going on with household behaviour and we’ve had a massive change in the economy. The economy is now being driven more by what’s going on in the resources sector and more what’s going on in investments than it has done ever before. So that I think makes it hard to read and it does mean that the feel of the economy might be different from what the statistics are portraying, but I think overall you’ve still got to be reasonably confident because however you cut it the GDP numbers look pretty good in the first quarter of this year and the labour market numbers are also showing a similar sort of trend. They’re saying overall that the unemployment rate is pretty close to full employment.
SB: If you lived in Victoria or New South Wales though Paul, you’d look at those numbers and scratch your head, wouldn’t you?
PB: That’s absolutely right. And that’s another part of the story. I mean another part of the story is that, and we’ve done some estimates on this, if you divide Australia into those areas that are above the Tropic of Capricorn and those that are below it, about two thirds of all the mining investment going on right now is above the Tropic of Capricorn, but only a little under 5 per cent of the population live above there, so really what we’ve got is a lot of activity happening in the Australian economy that is outside of where the bulk of the people live. There is income is flowing through to other parts of the economy, but it’s pretty clear that we have a very uneven growth in the Australian economy right now.
SB: Paul, a little earlier you were quite sanguine about the outlook for the global growth. Does that mean you don’t expect Europe to blow up?
PB: Look , Europe is a big question mark at the moment and no one can really work out exactly which way it is going to go because it really does come down to political decisions. But look, our view is that it’s the devil and the deep blue sea and what they’re going to choose is to stick with what they know and in all likelihood we’ll see that the euro will stay together. If that’s the case, it’s still the case that we’re expecting Europe to be in recession this year, but we just don’t expect it to fall off a cliff. You’ve got to keep in mind that European growth, although it’s important for the world, is not a key driver of global growth and indeed what’s been happening recently is the emerging economies have been the main driver of global growth, and in particular of course what’s going on in China. Now, China has been slowing, but we think that they’ve got the capacity to provide support for their economy in the form of their policy tools. We think that they will cut their reserve requirement ratio a number of times yet before the end of the year and also provide a bit of fiscal support. That’s the key story for Australia. So, when you’re thinking about the global economy and the Australian perspective on the global economy, you’ve really got to weight it by our trading partners. The bulk of our exports go to China. Over seventy per cent go to Asia. It’s really an Asian story for us and we’re still reasonably upbeat on the Asia outlook.
AK: It’s been great talking to you, Paul. Thanks very much.
PB: No problem.
SB: Thank you, Paul.
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