Against a backdrop of sub-trend growth, the March quarter ACCI-Westpac Survey of Industrial Trends gives cause for concern.
Our Westpac-ACCI Actual Composite fell sharply in the quarter, from 50.4 to 46.0 – a sub-50 reading signals contraction in the manufacturing sector. This is the weakest reading for the Actual Composite since June 2009's 39.1 print; also, this outcome follows just six months of modest expansion, the only such period in the past two years. The past two years have seen respondents remain optimistic despite persistent contractionary actual outcomes. The March quarter was no exception, with the Expected Composite edging higher to 53.2.
Consistent with the above-50 Expected Composite reading, manufacturers' expectation of business conditions over the coming six months also improved in the March quarter. A net 8 per cent of respondents now expect conditions to improve during this period. Manufacturers' confidence has likely been buoyed by greater market optimism over the global outlook and the signs of life evident in residential construction in the second half of 2012.
That said, the volatility inherent in this series continues to point to a heightened sense of uncertainty among respondents. Turning to the labour market, the March quarter survey suggests that the labour market will remain in a weak state in coming quarters. The Labour Market Composite fell to negative 7.1 in the March quarter, a level consistent with annual employment growth of around 1 per cent. Relative to working age population growth of around 1.9 per cent for the year (as at February), employment growth near the projected 1 per cent figure would see the unemployment rate rise through 2013, as we have long expected.
The detail of the Labour Market Composite gives further cause for concern. In net terms, the March quarter saw a further deterioration in actual employment and overtime. The expected employment measure pointed to further job shedding in the next three months, while overtime is expected to rise – arguably, this is another sign of a drive for efficiency among manufacturers.
Respondents also reported a marked improvement in the availability of labour in the March quarter as well as a significant decline in wage expectations relative to the previous wage deal. The deterioration in wage expectations looks to have boosted firms' profit expectations for the coming 12 months. However, this improvement in profit expectations is marginal: over the past two years, this series has oscillated around an average of 1 per cent, versus an average of 16 per cent for the two years to March 2011.
It is clear that the weak conditions faced by the sector – due to the high Australian dollar and soft non-mining growth – have impacted profit expectations. And it is also evident that rising input prices continue to put ever-more pressure on the sector's profitability. In the March quarter, a net 11 per cent of firms reported a further deterioration in selling prices. In contrast, a net 21 per cent of respondents reported an increase in unit costs – little changed from three months ago. Together with the general absence of pricing power, persistent growth in input costs is harming manufacturers' profit margins.
Faced with narrowing margins and an uncertain outlook, it is little wonder that wages and employment are coming under pressure, and that firms' are seeking to maximise the efficiency of their workforce through the use of overtime rather than maintaining their head count. Given their apparent concern over their profitability and the outlook more generally, it is also unsurprising that firms are continuing to rein in their investment plans. In the March quarter, a net 6 per cent of respondents reported a further reduction in their plant and equipment investment intentions (10 per cent reported a decline three months ago).
Spending plans for buildings were also reduced again in the March quarter: a net 11 per cent of respondents reported a decline in the quarter; this is the eighth consecutive negative reading for this series. Clearly manufacturers perceive limited potential for expansion. The outcome from this survey is consistent with the substantial deterioration in 2012-13 manufacturing investment expectations reported in the Capex Survey. The December quarter release of this survey indicated that manufacturing investment was set to collapse by 29 per cent in the 2012-13 financial year. This is very concerning on its own, but all the more so due to the rapid deceleration in mining investment growth currently underway – in 2012-13, mining investment is now only expected to grow by 9 per cent, half that forecast three months ago.
Together with continued job shedding and weak profitability, the ongoing deterioration in investment intentions points to growing concerns over the outlook. The rate cuts delivered in the past 18 months have been of benefit to manufacturers exposed to residential construction, but the aggregate impact of this easing has been limited. As a result, Australian manufacturers continue to struggle amid adverse circumstances. Despite the improved tone of Chinese data and greater market
optimism over the North Atlantic region, conditions in the global economy remain a downside risk to domestic conditions. Also, the continuation of alternative easing measures in the US comes at a significant cost: enduring strength in the Australian dollar.
Domestically, with the peak in the mining investment boom quickly approaching, there is a real need to foster stronger growth in the non-mining economy. Without it, weaker employment outcomes and a deterioration in consumer and business confidence could quickly follow, making trend growth that much harder to achieve. The level of the exchange rate may be more dependent on the actions of foreign policy makers, but the Reserve Bank still has the capacity to mitigate the impact of the end of the mining investment boom and help Australia weather any international storms.
Elliot Clarke is a Westpac economist.