While a slowdown in economic momentum is not really a big surprise, the degree of the current sharp slowdown in household consumption surprised financial markets.
The slowing economic conditions were confirmed last week with the weaker than anticipated December quarter GDP figures with the annual growth rate of real GDP now at 2.3%. Consumers holding back on spending, the ongoing impact of the drought, the tapering of the high levels of mining capex programs and the sharp downturn in residential construction all contributed to the weaker than expected numbers.
The slowdown in economic momentum has now fallen from around 3.8% annualised in the first half of calendar 2018 to around 0.9% in the second half. Therefore the average annual real GDP for 2018 was 2.8%, a reasonable outcome. However, the sharp decline in consumption, a function of the slowing housing construction cycle, in late 2018 is clearly a concern if this trend continued.
Looking at the positives within the numbers, the price and wage readings within the GDP breakdown are rising in the second half of 2018. This is an important point to highlight as it is not getting the attention in the broader debate. The rise in profits in recent years is finally delivering on the wage front. It is a low base, but just like the recovery in the profit cycle, the early signs of sustainable wage growth is underway.
However, like many other economies around the world that are exhibiting strong employment growth, there are increasing expectations for wage growth to be higher than the current rise in inflation. This is not ideal for productivity going forward. Ultimately sustainable wage growth is a function of a strong profit cycle. While the current lag is frustrating, the momentum in wages growth is beginning to finally accelerate.
When various political and economic commentators discuss the lack of wage growth in recent years, it is fair to say that some amplify certain parts of the debate given the emotive nature of wages at the household level. It tends to be low hanging fruit and creates the predictable instant emotional reaction. Unfortunately, the current economic debate is not as rigorous as it needs to be.
While the annual wage growth rate in Australia is now just over 2%, and confirmed to be growing from the recent national accounts, there are other parts of the income debate to be considered. Income tax cuts combined with lower interest rates (ie. lower mortgage servicing costs) are also important factors to reflect on the total household income. While falling house prices are not ideal for wealth effects going forward, there are good signs of reasonable growth in household income via wages, tax cuts and lower mortgage servicing costs. Further, any signs of a further severe slowdown in the housing cycle potentially impacting employment, will result in the RBA delivering additional stimulatory rate cuts.
The income debate must also include the minimum wage which was increased by a healthy 3.5% mid last year by the independent Fair Work Commission. The strong profit recovery can sustain this increase and it may do so again this year. The independent process looks like it is delivering to households that need it most.
While wealth effects will be challenged well into 2020 on the back of falling house prices, there are some signs that total household incomes are starting to consolidate following fiscal (tax cuts), monetary (lower mortgage rates), wage growth (improving profit cycle) and the higher than CPI increases in minimum wage via the independent commission. However, expectations at the household level are high and while they do not set policy, they appear to be demanding greater income growth than the economy can sustainably deliver.
CIO | Atlas Capital
Director | Salter Brothers Asset Management (SBAM)
As seen also in Herald Sun, Thursday March 14, 2019.