Weekend Economist: Jobs pivot
Sentiment surveys this week have sent conflicting messages around our views on the state of the economy and the likely monetary policy profile. However, the
January employment report seems more consistent with the downbeat message from the consumer sentiment report.
In earlier notes we have highlighted the certain headwinds, which the Australian economy will be facing in 2014 and 2015:
1. The slowdown in mining investment will subtract directly around 0.5 percentage points from growth in 2014/15 and a further 1 ppt in 2015/16. Overall that profile indicates a turnaround of 2.2 ppts of GDP between 2011-12 and 2015-16. Partially offsetting that (in a GDP context) will be a lift from resource exports of around 0.9 ppts of GDP between those two years but the negative multiplier effect from the investment downturn, particularly through the labour market and incomes, will be substantially larger than the implied net direct effect on GDP.
2. Governments, both federal and state are committed to plans for fiscal consolidation over the next few years. Current budget projections indicate that the contribution to GDP from public demand is expected to be around half its long-term average. With projections beyond those immediate years being recently assessed by the IMF to see expenditure growth being the fastest among 17 advanced economies there will be pressure in the upcoming Federal Budget to wind back expenditure, including even slower growth in the near term.
3. Westpac expects Chinese demand to be below current consensus while global supply of bulk commodities is lifting in response to high prices over recent years. We expect further falls in commodity prices in 2014 and an associated deterioration in our terms of trade with the appropriate negative impact on incomes.
On the other hand, record-low interest rates are stimulating residential housing construction and, nationally, house prices have lifted by 10 per cent in 2013. These developments provide a boost to spending through construction and an uncertain boost through the wealth effect associated with higher house prices. Application of a "standard" wealth effect, spending around 3 per cent of the boost to wealth would see a spending boost in 2014 that would easily fully offset the dollar value of the government spending and mining investment headwinds.
So the growth outlook will be significantly affected by the extent of this wealth effect. That in turn will be dependent on households' confidence around the future, in particular a preparedness to lower their savings rates which would support consumer spending at a faster pace than income growth. In turn income growth will be determined by wages growth and employment growth. In 2013 wages growth and employment growth were near 20-year lows. Labour income growth slowed to 1 per cent in real terms.
In the February Westpac-Melbourne Institute consumer sentiment report the consumer sentiment Index fell by 3 per cent. It is now down by 9.5 per cent since the September high and 7.5 per cent over the last year. In particular the index of unemployment expectations increased a further 2.3 per cent (a measure of respondents' confidence around job prospects/security – the higher the index the more concerned will be the respondents). The Index is now 9.2 per cent above its level in September last year and 7.5 per cent above its level a year ago. It is at its second highest level since July 2009. Furthermore, the component of the index measuring consumers' expectations for the economy over the next 12 months is at its lowest since March 2012 and 5-year expectations are at their weakest since February 2009. In addition 60 per cent of respondents expect interest rates to rise over the next 12 months.
Households seem to be sending a clear message. Why are they facing a deeply contractionary budget with interest rates likely to be lifted when the labour market is so weak?
On face value this survey signals that the important fall in the savings rate, which will be necessary to boost spending seems unlikely as households are likely to remain cautious.
That concern has been further elevated with the January employment report showing that the unemployment rate has jumped from 5.8 per cent to 6.0 per cent, with another month of job contraction.
However, another survey – the NAB survey of Business Conditions is signalling cause for more optimism.
The NAB business survey reports that both business conditions and business confidence ended 2013 and began 2014 at above average levels. The previous occasion both were above average was April 2011.
In January, the conditions index rose 1pt to 4 and business confidence rose 2 pts to 8. The conditions index averaged 0, dating back to 1989, while confidence averaged 5 over this period.
The January survey was in the field from 28 January to 3 February. We do caution that the reliability of updates at this time of year is not as great as usual with many on, or just returning from, summer holidays.
Detail in the January survey was generally positive.
Each of the three components of business conditions were positive in January, for the first time since March 2012. The employment index improved to 1 from –4 in December; trading conditions (sales) printed at 7; and profitability edged 1pt lower to 3.
Forward orders jumped 8 pts in January to 6, the strongest reading since December 2009. The low point in forward orders was around March 2013, with a trend improvement in line with that of conditions. We caution that seasonal adjustment is difficult at this time of year – this is particularly true for forward orders.
A trend improvement in business conditions is evident across each of the 8 broad industries covered by the survey. Moreover, the low point for each industry was typically around last August. Mining ( 18pts) and manufacturing ( 20pts) report the strongest lift, with gains varying between 7 pts and 13 pts for the remaining six industries.
The pessimism of households around the jobs outlook, which lies at the heart of their caution around the economic outlook, is reflecting the current weak employment conditions. This survey is pointing to some improvement in employment conditions although it is not definitive as to whether firms will opt to service stronger perceived demand by increasing hours worked; taking on part time workers, which has been the norm in this cycle or actually opting for full time workers.
The risks around the outlook is that while they are seeing better demand conditions they will persist with the cost cutting; productivity focus; uncertainty driven approach which has so crippled the labour market.
Without evidence of a genuine healing in the labour market, households are likely to remain cautious and the promising boost to demand which firms have been experiencing will fade particularly under the weight of the headwinds described above.
A subsidiary issue around business conditions concerns inflation. The Reserve Bank has been surprised at evidence that businesses have been able to widen some margins even in the non traded sector. Further they have been surprised that recent soft wages growth has not put more downward pressure on inflation. Their revised inflation forecast indicates an implied forecast of 0.8 per cent for underlying inflation in the March quarter. That forecast seems too high based on the partials we assess. When the next inflation report prints on April 23 the central bank is likely to receive a pleasant surprise and markets are likely to cool their current fervour for rate hikes.
Conclusion
The dynamic which has been most important to our view that further interest rate relief will be necessary has been around ongoing labour market weakness which is likely to constrain spending (through confidence and soft income growth); widen output gaps; ease inflation pressures; especially in the context of other known headwinds.
The survey results for February emphasise that dynamic from the perspective of the consumer but highlight a more positive business sector which, if sustained, could support some upside surprises on the labour market, settle households' concerns; lower savings rates; and eventually boost employment and wages growth. Such an outcome would drive quite a different profile than we currently envisage for monetary policy.
For now, the risk is that the promising signs from the business surveys do not resolve in genuine jobs growth. The data flow, over the next few weeks, will provide a much clearer picture and help resolve this issue.
The January employment report, showing that the unemployment rate lifted from 5.8 per cent to 6.0 per cent is consistent with the dynamics we envisage. It is likely that news of the highest unemployment rate for 10 years (higher than during the GFC) will further unnerve consumers. Whether business confidence is sustainable in such an environment will be tested over future months.
Bill Evans is Westpac’s chief economist.