Retail still needs rates therapy

The retail growth trend remains strong, but its momentum comes amid an unusual context and is unlikely to persist once business investment is more seriously challenged.

Households are splurging on household goods and eating out but can the momentum persist? Growth may be strong in the March quarter but the economy has yet to face its sternest test and that’s why rates should not rise just yet.

Retail sales rose by 0.2 per cent in February, narrowly missing expectations, to be 4.9 per cent higher over the year. The modest result was not a surprise following the particularly strong January outcome when sales rose by 1.2 per cent.

Graph for Retail still needs rates therapy

Taking the average of the past two months provides a pretty good indication of how well retail sales are travelling. Data from January and February is tracking around 2 per cent higher than the December quarter last year. On that basis, real consumption growth may track within the 1.2 per cent to 1.4 per cent range in the March quarter.

The household sector is full of inconsistencies at the moment. On one hand we have rising house prices and retail spending but we also have lacklustre personal credit growth and subdued employment conditions. Even accepting that housing is mostly an investor phenomenon and labour markets can be backwards looking, it is still an usual set of circumstances.

Retail spending continues to be supported by strong demand for durable goods -- which is usually a sign of a cyclical upswing – and ‘other’ retailing. Cafes and restaurants rose modestly in February but have climbed by around 10 per cent over the year -- I wonder to what extent the strong upward trend has been driven by the excessive number of cooking shows on television?

Graph for Retail still needs rates therapy

Spending at department stores fell sharply in February, following solid gains in January, and is now 4.2 per cent lower over the year. That’s not great news for our biggest retailers, who have yet to really benefit directly from low interest rates and higher spending.

At the state level the strongest performers over the past year have been New South Wales and Tasmania. However, both states had poor results in February with sales in New South Wales up by only 0.1 per cent and in Tasmania down by 1.4 per cent. But we shouldn’t be too concerned -- a soft month is to be expected after a number of strong months.

Graph for Retail still needs rates therapy

Retail spending growth in Western Australia has slowed significantly and adjusted for inflation has probably declined over the past year. This is not entirely unexpected and is actually what we might expect to see as the economy rebalances -- not only away from mining investment but also away from Western Australia in general.

Household consumption will be strong in the March quarter and with household spending accounting for around 60 per cent of the economy that points to strong growth in GDP as well.

The big question though is whether this growth is sustainable? My concern is that the retail sector will make significant gains now but that growth will return to more normal levels around the time that business investment collapses. Strong growth in household spending is great for the economy but the timing just isn’t quite right and the momentum is unlikely to persist.

That is one of the main reasons that I cannot support higher rates right now even if March quarter growth and inflation are elevated. Rates were set low in the first place to facilitate a rebalancing of the Australian economy away from a reliance on the mining sector. Although that process has begun – and initial signs are good – the process has yet to meet its sternest test: the impending collapse in business investment.

The RBA has taken a forward-looking approach to rates and I don’t think it will compromise that now simply because the economy has gained momentum. It has set rates with next year in mind and a knee-jerk reaction to past data would only make it more difficult for the economy to maintain momentum next year.

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