CommSec: Patchwork economy in reverse; manufacturing shrinks


National accounts

  • The Australian economy fell by 1.2 per cent in the March quarter. And while the downturn can be largely explained by the disruption to coal exports caused by Cyclone Yasi, it only takes a small fall in output in the June quarter to produce a “technical recession.” In short, there are no grounds for complacency.The economy didn’t grow in the September quarter before lifting 0.8 per cent in the December quarter and then contracting in the March quarter.
  • GDP per person fell by 1.5 per cent in the quarter – the second contraction in the past three quarters.
  • The biggest drag on growth was net exports (exports less imports; a reduction of 2.4 percentage points) followed by inventories (0.5pp). But spending on machinery added 0.4pp with household consumption and dwelling investment both up 0.3pp.
  • Eight of the 19 industry sectors contracted in the March quarter. While mining output fell 6.1 per cent, agriculture, forestry & fishing slumped 8.9 per cent and “Other services” fell by 3.1 per cent.

What does it all mean?

  • Let’s not sugar coat it – it is a big decline in output. The Reserve Bank thought it “likely” that the economy would have gone backwards in the March quarter, but if it factored in a drop of 1.2 per cent, its language would have been more definite. Clearly Cyclone Yasi was the key influence, stalling Queensland coal exports. But now the focus is on the June quarter result. And so far the prospects are not bright. Investment forecasts have been scaled back, home prices and building approvals have fallen, manufacturing is contracting and lending is flat. The economy will probably rebound in the June quarter, but there are still headwinds to be breached.
  • As always, we shouldn’t put too much emphasis on one quarter’s figures, especially as the March quarter result was so significantly weather affected. But it’s worth noting that the economy recorded no growth back in the September quarter before lifting 0.8 per cent in the December quarter and then going backwards by 1.2 per cent in the latest quarter.
  • While we shouldn’t over-react to the GDP shock, we also shouldn’t be complacent. It is clear that the Australian economy has lost momentum. The medium-term outlook looks OK, but the short-term prospects are muddied by the reluctance of consumers and businesses to spend, borrow and build.
  • The Reserve Bank indicated it would “look through” (in essence, ignore) the weather impact on the economy. But it can’t look through the more recent partial indicators that show the economy struggling for momentum. The Reserve Bank needs to stay on the interest rate sidelines until the economic situation becomes clearer. There is clearly too much noise at present – and thus potential for mistakes – to be moving interest rates in any direction.
  • Interest rates are still more likely to rise in the future, than fall. But a batch of stronger economic readings will be required before the Reserve Bank could be comfortable with lifting rates. We are still pencilling in a rate hike in August, but the timing may need to be put back a few months. Clearly the June quarter inflation numbers will be pivotal to any decision to lift rates in August.

Performance of Manufacturing

The manufacturing sector has contracted for the eighth time in nine months with the Performance of Manufacturing index (PMI) easing 0.7 points to 47.7 in April. Any reading below 50 indicates that the manufacturing sector is contracting.

What does it all mean?

  • It’s not rocket science. It would be clear to anyone who has reviewed economic data readings over the past month that the economy is struggling. Manufacturing has been consistently going backwards over 2011, housing finance is at decade lows, consumers aren’t spending and approvals to construct new buildings remain below longer-term averages.
  • The downturn in manufacturing is broad-based with nine of the 12 sectors going backwards. In short, it’s not an aberration or a mirage – there are deep-seated problems caused by a high Aussie dollar and reluctance byconsumers to spend.

What do the figures show?

  • The PMI fell by 0.7 points to 47.7 in April. Any reading below 50 signifies that the manufacturing sector iscontracting. This is the eighth time in nine months that the PMI has been below 50.
  • Nine of the 12 manufacturing sub-sectors reported declines in activity in May led by clothing & footwear and the chemical, petroleum & coal products sub-sector.

What is the importance of the economic data?

  • The monthly Performance of Manufacturing Index is the Australian equivalent of the US ISM manufacturing gauge. The PMI is one of the timeliest economic indicators released in Australia. The PMI is useful not just in showing how the manufacturing sector is performing but in providing some sense about where it is heading. The key ‘forward looking’ components are orders and employment.

What are the implications for interest rates and investors?

  • The Reserve Bank must acknowledge that the domestic economy has hit a flat spot. While a recovery is likely later this year, an absence of consumer and business confidence has sapped momentum from the economy.
  • Cost pressures are easing for manufacturers. Input costs eased in the past month while selling prices rose modestly, boosting profitability.

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