The challenges underlying retail's rebound

The value of retail sales continues to grow but stagnant income growth will pose some obstacles, while our exports sector will provide little relief.

Retail trade has rebounded somewhat over the past couple of months but can the household sector overcome declining real wages and rising unemployment? Similarly, while exports improved during July, that market isn’t without its challenges. Can our smaller iron ore producers overcome falling commodity prices and keep their heads above water?

Retail trade

The value of retail sales rose by 0.4 per cent in July, consistent with expectations, to be 5.9 per cent higher over the year. Annual growth remains reasonably strong, supported by solid growth last year, but the near-term outlook is still fairly soft. Annual growth should ease to around 4.5-5 per cent by the end of the year.

Graph for The challenges underlying retail's rebound

Our dining boom continued in July, with spending at cafes and restaurants rising by 1.4 per cent in the month, to be 10.8 per cent higher over the year.  Food retailing, which accounts for 41 per cent of total retail trade, increased 0.5 per cent in July.

Growth continues to be driven by New South Wales and Victoria. Our two biggest states have accounted for almost 80 per cent of the rise in household spending over the past year. By comparison, retail spending in Western Australia remains subdued, highlighting the slow but steady shift in economic activity towards the east coast.

The outlook for retail sales will largely be determined by income growth and conditions in the labour market. At the moment, real wages (wages adjusted for inflation) are declining modestly and putting some pressure on household budgets. The unemployment rate is also at its highest level in a decade, and is causing particular problems for younger Australians, who tend to spend a higher share of their income than other age groups.

The terms of trade is also weighing on household budgets and declined by a further 4.1 per cent in the June quarter. With commodity prices easing further in recent months and the iron ore price dropping to a five-year low, conditions for the household sector are likely to ease further before they improve.

International trade

Australia’s trade deficit narrowed slightly to $1.36 billion from $1.56bn in June to continue a fairly ordinary stretch for international trade. The result follows yesterday’s national accounts, which saw net exports subtract 0.8 percentage points from real GDP in the June quarter (Population growth can’t fuel the economy forever, September 3).

Graph for The challenges underlying retail's rebound

The value of exports rose by 1.0 per cent in July, to be 2.1 per cent higher over the year. Growth has suffered in a large part due to falling commodity prices, combined with the Australian dollar remaining stubbornly high.

The Reserve Bank’s commodity price index has declined by 15 per cent this year but it did tick up slightly in August, providing some upside risk for exports next month. However, that may prove to be a brief reprieve for our resource sector, with more recent developments indicating that export prices will continue their descent in September. 

Graph for The challenges underlying retail's rebound

Exports to China, which account for 33 per cent of total merchandise exports, rose in non-seasonally adjusted terms but are down 1.4 per cent over the year. Growth in July was largely driven by the UK, where exports more than doubled during July. I expect this unusual result will correct itself next month.

It almost goes without saying that the main risks to exports centre on China. Of particular concern is the Chinese residential property market, an area that ought to be reported on more frequently in Australia.

It is early (and certainly not without precedent), but that market is looking increasingly shaky. If that persists then it will quickly feed through to Australian exports and prices and genuinely represents an existential threat to our smaller resource producers. The Reserve Bank recently said: “At current prices, there is a sizable amount of coal and iron ore production that is unprofitable”.

Both indicators posted reasonable gains in July but the bigger challenges are ahead. Can the household sector overcome falling real wages and higher unemployment? And how will the mining sector respond to lower iron ore prices and conditions deteriorating in China’s property market? The answer to both these questions will dictate how successfully the Australian economy rebalances and what the Reserve Bank does next.  

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