Overview

The CPI is generally considered to be a de‑facto cost of living index. It is the measure of inflation that most policymakers and commentators refer to when making statements about changes in the cost of living. Real wages, for example, are calculated as nominal wages deflated by the CPI. But there is a massive flaw in using the CPI as a proxy for changes in the cost of living. The index ignores price changes in the single biggest purchase a person (or household) is likely to make in their lifetime – a dwelling. For households that do not own a dwelling and aspire to purchase one, the CPI is a very poor measure of changes in the cost of living.

In this report we look at the justification for the omission of dwelling prices in the CPI. We then create a theoretical CPI that includes dwelling prices for illustrative purposes. We conclude with a brief discussion on the relationship between monetary policy, inflation and house prices.

Read the report.

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The quarterly report analyses how the States and Territories are performing across a range of economic indicators and detail our key economic forecasts for each region.

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Overview

Investment is essential to both long run job creation and productivity growth, which ultimately drives real income growth. For most economies, investment is generally divided into two groups – public and private.

In Australia, however, we tend to think of capital expenditure as split into three strands – mining and non‑mining private investment (such is the size of the resource sector) and public investment.

Over the past few years, capex in Australia has been falling as a share of the economy. Mining investment was always going to decline as the once‑in‑a‑century mining boom ended. But non‑mining investment has not picked up over that period despite incredibly low interest rates and a significantly lower AUD.

At the same time, public investment has also been soft. There are a myriad of reasons why non‑mining investment has been weak and we covered them back in February.

But the same constraints don’t apply to public investment. Given soft private investment and robust population growth in Australia, it makes economic sense for public investment to fill some of the capex pothole, particularly given the overreliance on monetary policy to stimulate growth.

In this note, we shine the spotlight on public investment to look at what has been happening over the recent past. We then trawl through the latest budget papers to examine what we can expect over the period ahead.

Our findings lead us to conclude that the contribution to growth from public investment will be around 0.4ppts in 2016/17.

We argue that more can (and should) be done, particularly given borrowing rates are at record lows, monetary policy is being stretched and the economy is operating below its potential. It requires, however, the political will and a co‑ordinated policy response between the three tiers of government.

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For the past few years, economists and policymakers have assumed that a lift in non‑mining business investment was forthcoming. A trawl through RBA documents and speeches shows that policy officials have been anticipating a lift in non‑mining investment for a few years. And yet despite incredibly low interest rates and a significantly lower AUD, the lift remains elusive. It has felt a lot like waiting for Godot.

Fortunately, however, there has been a greater than expected pickup in services activity which has generated a fall in the unemployment rate despite weak non‑mining capex. This has supported the economy and employment growth over the past two years. But for the productive capacity of the economy to lift over the longer term, a lift in business investment outside of the resources sector is required.

In this note we ask the question why non‑mining business investment has been so weak. We propose a number of reasons why we are yet to see a lift in capex. And we argue that the reason for a lack of investment goes beyond the level of interest rates and the AUD ‑ these cyclical drivers of business investment are at levels that support rather than hinder investment. Rather, it is a range of other forces at play which are holding investment back. We then take a look at the outlook for business investment in 2016 and what it is likely to mean for growth and monetary policy.

What’s been happening?

There is no shortage of information and literature covering Australia’s mining investment boom. In a nutshell, Australia had a once in 150yr mining investment boom that saw business capex as a share of GDP soar to a record high. During the mining investment period, non‑mining investment fell. But there was an assumption amongst policymakers and economists that non‑mining investment would lift again once mining investment peaked. Low interest rates and a lower exchange rate would help.

The mining investment peak has occurred (late 2012), but since then there has not been a pickup in non‑mining capex. RBA estimates conclude that in the year to QIII 2015, mining investment fell by 28.9% while non‑mining investment fell by ‑0.1%. So non‑mining investment has been flat over the past year which means it has fallen as a share of GDP. Naturally, the question to ask is why? We explore a few possible explanations.

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This report digs below the headline numbers and compares outcomes across Australia’s States and Territories.

CBA Economics analyses how the states and territories are performing across a range of economic indicators and details their key economic forecasts for each region.

This report is published quarterly.

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RBA Assistant Governor Chris Kent delivered a speech on “Recent Labour Market Developments” at an Economic Society luncheon in Brisbane.  Kent was frank in his admission that, “the labour market has been adjusting more smoothly over the past year than we [the RBA] had been expecting.”

Kent’s speech reiterated the RBA’s opinion that the unemployment rate should be “little changed from recent levels over the next 18 months or so, before declining in 2017.”   Previously the Bank was of the view that the unemployment rate would gradually rise to around 6½% by mid‑2016.

A significant chunk of the speech was devoted to reconciling the “better‑than‑expected labour market outcomes” with below trend GDP growth.  Four possible explanations were put forward: (i) softer population growth; (ii) sharply slowing wages growth; (iii) a shift in the composition of growth towards more labour intensive sectors; and (iv) labour force / national accounts data issues.

Outside of the mining sector, the compositional change in demand towards more labour‑intensive industries in Australia has been underway for decades.  But as Kent noted, the fall in the AUD has encouraged, “Australians and foreigners to direct more of their spending to Australian tourism, education and business services.”

This clearly goes some way to explaining the disparity between below trend growth and a flat unemployment rate.  For example, the tourism industry accounted for 2.7% of GDP in 2013/14.  But it represents 4.6% of total employment in Australia.  The evidence of the compositional change shows up in Australia’s services exports which have risen steadily over the past two years.  Services imports, on the other hand, have declined.  We expect this trend to continue largely as a result of AUD weakness.

In our view, trend growth in Australia has fallen in recent years.  This means that there is probably less spare capacity in the economy than some commentators assume.  And if we are correct, it means that there is potentially less wriggle‑room for the RBA to cut rates further without putting some upside pressure on underlying inflation.

Overall, last week’s speech doesn’t shift the monetary policy dial.  If anything, it further cements the RBA’s view that we are at the peak in the unemployment rate.  We agree with that assessment and it’s essentially our views on the labour market that underpin our thinking on the cash rate.  While rate cuts are still “on the table”, the Bank’s assessment that the unemployment rate should be “little changed over the next 18 months” means the risk of a near term rate cut look low.  In addition, the AUD now looks quite content to be in the low 70s which we view as the ‘sweet spot’ for the RBA.  We see the RBA on hold at 2.0% from here.

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• Total credit to the private sector rose by 0.6% in January.  Annual growth stepped up to 6.2%.
• Housing credit was up 0.6% over the month and sits 7.1% higher on year ago levels.  Growth in the investor component has breached the 10% threshold APRA has set.
• Business credit rose by a respectable 0.8% in January and there are firm signs that commercial lending growth has lifted.

Low interest rates, firm population growth, investor speculation and expectations of capital gains continue to drive housing credit growth which is running at its fastest annual pace since February 2011.  And business credit growth has lifted also on the back of record low borrowing rates.

The Australian Prudential Regulation Authority (APRA) has said that credit growth to housing investors should not exceed 10%.  Media reports suggest that APRA will release data later today showing housing lending levels by each Australian bank.

Housing credit growth is running well above national income growth which means that the household debt‑to‑income ratio is lifting.  It is currently at a record high.  Lower commodity prices and weak wages growth are weighing on national income growth.

Business credit rose by a decent 0.8% in January and stands at 5.5%pa.  A lift in business credit growth would be consistent with the expected pickup in non‑mining capex over the near term.  Yesterday’s capex survey indicated that non‑mining capex should lift over 2014‑15, but beyond that the outlook is less positive and indeed less clear.  It may be that a softer AUD is encouraging some businesses to lift capital investment.  These developments will be welcomed by the RBA and perhaps there are some indications that we may be seeing a lift in ‘animal spirits’ – time will tell.

Other personal credit was flat over January and stands at just 0.8% higher on year ago levels.  Soft personal credit growth reflects some fragility in consumer confidence and job security concerns.

Private sector credit aggregates were the last data release for February and we now head into March with a full data suite coming out next week and also an RBA meeting.  The market looks largely split as to whether the RBA will cut rates next Tuesday.  Notwithstanding today’s pickup in credit, the data flow has been soft over the past month and the two most important prints for policy since the RBA last met (unemployment rate and capex expectations) point towards further policy easing.  In addition, the AUD has traded largely sideways over the past month and it’s clear that the RBA wants to see it lower to help the Australian economy rebalance.  In that context, we favour a rate cut next week.

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Just a minor lift in Aussie dwelling prices.

Australian dwelling prices took a breather in September after posting solid rises over the previous three months.  The small 0.1% increase means that prices are now 18.8% above the May 2012 trough and exceed the previous peak in October 2010 by 10.0%.  Annual growth has eased from a peak of 11.5% in April 2014.

Australia’s two largest cities, Sydney and Melbourne, have been driving the lift in national house prices.  Dwelling prices in Sydney rose by 0.8% in September while they fell by the same amount in Melbourne.  Prices rises in Sydney have shown no sign of slowing and are being fuelled largely by investor interest.  In Melbourne, however, dwelling price momentum has cooled largely in response to a lift in supply.  The forward looking indicators suggest that a lift in supply is forthcoming in Sydney.

Low interest rates and the expectation of future capital gains mean that investors in Australia are currently the major driver of the property market.  Lending to investors has risen substantially over the past year.  One consequence is that rental growth is likely to be weak as the proportion of dwellings available for lease lifts.

Policy makers have been showing increasing signs of concern at the investor driven property price surge.  Last week, the RBA published its semi‑annual Financial Stability Review (FSR) which echoed concerns in the September Board minutes around increased leverage on house price speculation.   The Bank has revealed it is in discussion with APRA and others about what steps “might be taken to reinforce sound lending practices”.  The debate about macroprudential policy has taken off as a result.

The RBA will front the Senate’s economics committee tomorrow for a special hearing on Thursday to explain the risks associated with the housing boom and the potential for macroprudential policy to be introduced.  We will be watching that space closely.

From a rates perspective, the rhetoric from the RBA around house prices has taken any further cuts right off the table and together with other factors will ultimately put rate hikes onto the agenda.

Table 1: RP Data‑Rismark Dwelling* Prices, September 2014

*All dwellings, median price.**Values are for houses only up to August

Click here to read the report.

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• 

  Commodity prices on the decline

  The May trade figures showed a large deficit of $1.9bn

• Declining commodity prices and an elevated AUD over the month weighed on export receipts.
• Exports of goods and services were down by 4.6% over the month, driven by falls in iron ore and coal.
• Imports fell by 0.6% due to a big fall in capital goods, primarily as a result of the pullback in mining related capital expenditure.
• A stabilisation in export prices and below‑trend domestic demand growth should see the trade balance return to surplus over coming months.

The May trade deficit came in a lot larger than the market had been expecting.   The market consensus was looking for a small deficit of $200m {CBA (f) ‑$500m}.  The May result was the second consecutive deficit following three big monthly trade surpluses over QI.  The widening in the trade deficit from an upwardly revised $780m shortfall in April reflects a sizeable fall in goods exports and a small decline in imports.

The fall in exports over May was driven by a big decline in metal ores and minerals (‑$760m or 9%).  The plunge in the spot price of iron ore over May was not coupled with a fall in the AUD over the month.  As bulk commodity exports are priced in US dollars, the net result of a decline in prices and a flat AUD weighs on export receipts.  Other mineral fuels fell by a sizeable $352m over the month (‑13%).  Rural exports declined by a more modest 2%.  Services exports bucked the trend and were virtually unchanged over the month.  On a positive note, tourism exports are up around 8½% on year ago levels.  It looks to us like a slightly softer AUD and a pickup in the advanced economies is supporting the domestic tourism sector.  We expect this to continue over the period ahead as global growth lifts.

Imports recorded a small 0.6% decline over May.  The fall was driven by a 4% fall in capital goods imports, which continue to trend lower as the construction‑intensive part of the mining booms unwinds.  This will be a familiar theme over the year ahead.  Consumption goods imports were largely unchanged over the month.   An elevated AUD helps to contain growth in import costs and therefore receipts.  It also helps to keep a lid on tradables inflation which has lifted over the past year.    

Goods exports to China accounted for almost 38% of total goods exports over the past year and highlight both the importance of and dependence on the Chinese economy to Australia.  Resource exports to China will continue to dominate the trade story ahead.  But service exports will also be important.  Tourism is the 3rd biggest export earner at present and education is the 5th largest. The emergence of the Asian middle income consumer brings the huge potential for an acceleration in both goods and services exports.

Looking ahead, we expect to see the monthly trade balance return to surplus.  In our view, export receipts will lift due to higher volumes and a stabilisation in commodity prices.  And import growth is expected to remain soft as the decline in mining capital expenditure weighs on capital goods imports.  Consumption goods imports, on the other hand, are expected to trend higher in line with a lift in household expenditure.

From a GDP perspective, net exports made a massive contribution to QI quarterly growth of 1.4ppts.  A combination of a surge in export volumes, buoyed by some good weather, and a fall in imports underpinned the result.  The story looks like it will be a little different over QII.  We expect to see a bit of statistical payback in export volumes while import volumes are being supported by an elevated AUD.  The net effect means that net exports are unlikely to drive growth over QII.  But we do expect them to be a significant contributor to growth over H2 2014.

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• Consumer sentiment rose by a small 0.2% in June but is 8.8% below year its year ago level
• Confidence is still being adversely impacted by the negativity around the Federal Budget.
• The positive news is that job security fears receded marginally.  The unemployment expectations index has now fallen for three months in a row, though consumer fears over job loss remain elevated.

The Westpac‑Melbourne Institute Index of Consumer Sentiment was largely unchanged over June.  Sentiment plunged in May following the Federal Budget and is sitting at its lowest level in almost three years.  There is a risk that prolonged weak consumer confidence negatively impacts on household spending and borrowing appetite.

There are many economic, social and political influences on consumer sentiment.  The state of the jobs market is one of the biggest influences on consumer confidence.  In that context, the recent pickup in employment growth and small fall in the unemployment rate would normally have produced a lift in consumer sentiment.  But improvements in the labour market have been overshadowed by the doom and gloom surrounding the Federal Budget.

The consumer response to the Federal Budget is quite clear – they don’t like it and confidence around family finances has fallen as a result.  In the six months to April, consumer spending growth picked up and the household savings rate fell marginally.  Both of these outcomes were a sign of improved consumer confidence.  And they were also both a positive sign for businesses and the Australian economy more generally.  There is a genuine threat to retailers from the big fall in sentiment since May.  This is compounded by warmer weather having delayed traditional seasonal purchases like clothes and household goods.

Looking through the detail reveals that three of the five component indices increased in June.  The largest increase was in family finances in the year ahead (+5.0%) and economy one year ahead (+3.0%).  These were partially offset by family finances year ago (‑5.4%) and economy five years ahead (‑2.3%).  The time to buy a major household item index rose by 1.0%.

The June sentiment release also contains quarterly estimates of consumer preference for the wisest place to put savings.  There were small lifts in the proportions of respondents preferring to pay down debt (17.3%) and invest in equities (9.9%).  Conversely, there were small falls in the proportions of those preferring bank deposits (27.5%) and real estate (24.5%).  The responses are generally reflective of consumer caution, although the proportion of respondents favouring real estate indicates that there is still a reasonable degree of optimism around the housing market.  In addition, the trend down in those preferring bank deposits suggests that consumers are a little less risk adverse.

The Westpac‑Melbourne Institute unemployment expectations index was also published yesterday. It was the main positive in yesterday’s figures and showed that fears over job losses receded marginally over the month.  Notwithstanding, concerns over job security remain elevated.

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