ABC: Economy ‘Deteriorating’ – MacroBusiness
CBA’s Gareth Aird is the banking economist to watch these days.
Today’s S&P Flash Australia Composite PMI is likely to have policy makers worried. The headline index printed just below 50, indicating contraction in business activity during the month of August.
The August RBA board minutes noted that “the board expects to take further steps in the process of normalizing monetary conditions over the coming months, but it is not on a predefined path. It seeks to do so in a way that keeps the economy in balance. The path to achieving this balance is narrow and subject to considerable uncertainty.
Today’s PMIs underscore just how narrow that path is. And they signal that if the RBA continues to tighten policy aggressively, the private economy will likely shrink. This is not what the RBA is trying to achieve.
The composite PMI was last printed below 50 in January 2022. But that’s when the Omicron wave coupled with more people than usual on work stoppage caused a sharp slowdown in private activity. The January 2022 result was complemented by strong results in December 2021 (54.9) and February 2022 (56.6). The January data was therefore noise and not signal.
Today’s result is different. The composite PMI has softened over the past four months. Moving into contraction territory in August was just a continuation of the recent trend (the composite PMI was 51.1 in July and 52.6 in June).
It was in the services sector in Australia that demand fell in August, although weaker growth in activity in the manufacturing sector was also recorded. Australia’s services sector eclipses the manufacturing sector in size, meaning activity in the services sector is largely driving the composite PMI.
According to S&P on the services side, “Inflationary pressures and recent interest rate hikes would have contributed to the further decline in business activity. Panelists also linked deteriorating consumer confidence and uncertainty to the contraction.
The August MI/WBC consumer sentiment data (very weak) was at odds with the July NAB Business survey (reasonably strong – see here). But the August PMIs, which are a quicker read of the private economy, narrow the gap between consumer and business survey data. Indeed, S&P noted today that business confidence has fallen to its lowest level since April 2020 as optimism among manufacturers and service providers has weakened.
The survey’s inflation indicators indicate that price pressures remain significant. That said, they have eased from recent highs. We expect inflationary pressures to remain firm over the remainder of 2022 and the annual inflation rate to continue to rise.
But inflation is a lagging indicator and monetary policy works with a lag, especially when it comes to inflation. There are tentative signs that the inflationary pulse is slowing down a bit. This is a positive point in today’s version.
Regular readers will recall that we have written extensively about the significant dichotomy that currently characterizes national economic data. The cross-currents in the data will stay with us for the rest of the year. Looking back labor market data will be strong, wage growth will pick up and inflation will remain high. But forward-looking data has deteriorated and further weakness is expected (this includes consumer sentiment, house prices, home loans, building approvals and PMIs). Our latest internal consumer spending data, which is a coincident indicator, also showed that spending growth is slowing (see here).
Today’s PMI data supports our RBA call. We see the cash rate target peaking at 2.60% at the end of 2022 (a level we consider restrictive). And we have two rates of 25 basis points cuts in pencil for H2 23. We believe that provided the RBA pauses in its tightening cycle when the cash rate is around 2.60% (close to the 2.5% level the RBA has referred to as its neutral estimate, which is about 100 bps above our neutral assessment), the data will indicate that there is no need to continue raising the policy rate. Indeed, a rise in the cash rate would likely lead to a hard landing in the economy.
As a reminder, the RBA has already achieved an incredible amount of tightening in a very short time (175 bps over four meetings, or three months). And there is a lag between changes in the cash rate and the impact it has on monthly cash flow for borrowers on a variable rate mortgage. At CBA, for example, by December, the impact of previously announced rate hikes on the monthly cash flows of mortgage holders will be quadrupled compared to July.