RBA Cash Rate June 2021: Inflation Risk – How Bad Is It?

Hello, and welcome to the June economic and RBA update.

My themes for this month are:

• Settle down, people, settle down – there’s too much commentary about the inflation risk story, so I want to go there.
• This month it’s all about the positive business data as they join the economic party.
• And finally, well, we’re back in lockdown for the fourth time here in Melbourne. As I record this in lockdown, we’re here.

The World Economic Story

I’ve got more to say about that, but let’s firstly move to the world economic story, and I wanted to focus in on the commodity prices story at the moment. We did see crude oil moving higher, copper prices hitting a record high, as did the iron ore spot price before retreating during the month of May. So lots happening there.

Now, the rising commodity prices are a sign of the global economy is moving forward.

And obviously, the big spending programs have meant that it’s boosting demand for commodities as we learn to live pretty much with this COVID story and the vaccine program starting to roll out. One trend we also are starting to see clearly come up with the higher commodity prices is around the prices and the demand for cleaner and greener renewable energy. So, hence the copper and also some of the rare earth minerals, iron ore is the steel story, but unlike the fossil fuel commodities, we’re definitely going to see those commodity prices under strong demand as we move to a cleaner, greener economy.

Let’s talk COVID update…

Now, obviously, there’s been severe outbreaks in India at the start of the month; some horror stories over there, and also growing outbreaks in Thailand, Vietnam. We’re seeing lockdowns in Malaysia and Japan. And so we’ve still got to be reminded that COVID is a very serious pandemic and there’s still a fair way to go before we open up completely, so this is going to take some time. And as I mentioned earlier; yes, here we are in lockdown number four here in Melbourne. So it’s seven days, but given the amount of exposure sites that are growing, I’m probably predicting that we’re going to see another extension in regards to that.

Now my message on the COVID front is obviously around getting vaccinated, people, if you are eligible to get vaccinated. And I want to just share the story, love to do the numbers here, so for those people 70 years or over, just look at the stats, okay? These are important stats for you. So if we’re talking about the AstraZeneca vaccine, we’re talking about a 1 in 100,000 chance of developing the red blood clot disorder. Now that doesn’t mean it’s going to either be fatal as well; that’s important to know, yet someone who’s over 70 who gets COVID has a 1 in 10 chance of passing away or dying.

So let’s do the numbers again… 1 in 100,000, and still not necessarily dying, or 1 in 10 chances of dying, so that should tell you the story there. So I want to make sure that we get that message out there. Also, as we all start to get vaccinated, the science is telling us is there’s a reduced chance of contagion, and that obviously means the reduced amount of spread going on. But we are seeing different variants that are happening around the world, so it’s something that we’re going to have to live with. So if we all get vaccinated, it’s going to benefit us all. So just remember, we’re all in this together, as the saying goes.

United States

All right. Now, let’s talk to the United States data. Their economy continues to move forward. GDP in the March quarter was unchanged at 6.4%, annualised in its second estimate, although personal consumption was revised higher, from 10.7% to 11.3%, which is a good news story. The latest weekly initial jobs claims were higher than or better than expected, hitting a post pandemic low of 406,000. So we want that number to be low because that’s the jobless claims, which means more people are getting work.

On the property front, I’ve touched on this a few times, but new home sales in April fell 5.9% to an annualised rate of 863,000 units as dwelling prices surge to meet a tight supply for houses. Indeed, the median new house price saw 20.1% in the year to April to $372,400. On a year ago, sales are up 48.3%. Now the pandemic has disrupted labor supply of raw mills and ports, causing shortages in lumber, as they call it; lumber, that’s timber on our end, and other raw materials. This is limited to the builders’ ability to ramp up construction of new homes because of this industry… inventory challenge, I should say. So that should fix up as the weather gets better and they open up.

The PMI services rose to a record 70.1% in May, while manufacturing was solid at also 61.5%. The survey noted that the surge in new orders, as well as supply shortages and cost pressures, which is adding to the whole inflation debate, and further proposing spending stimulus by the Biden administration. So, speaking more to my inflation story theme at the start, the Consumer Price Index in the US rose 0.8% in March to be up 4.2% on the year, the strongest monthly growth since 2009. The data was well above analysts’ expectations of a 0.2% increase in a month; core inflation jumped 0.9% in a month and 3% in annual terms. The sharp pickup partly reflects a base effect of the low levels of inflation at the start of the pandemic.

The increase was mainly driven by hotels and airlines, some of the industries hardest hit by the pandemic, reinforcing most economists’ belief that a rise in inflation is temporary.

That’s right, people – we need to take a chill pill when it comes to the inflation story. We’ve got to remember that we did see the base number go significantly lower, so these percentages increases are coming off these low bases.

That’s why we introduce things like seasonally adjusted, but it’s very hard to do a seasonally adjusted number reading for a pandemic, so we’ve also just got to put this into context. We think it is temporary. I certainly do as well, and so hopefully we will move through that as well.

Taking a quick look at the China story, the services sector expanded at the fastest rate in five months in April as new business saw strong growth, both at home and abroad. The services PMI index rose to 56.3 in April from 54.3 in March. This outcome is stronger than the series average of 54.1, remembering anything above 50% is expandatory. Meanwhile, the composite output index rose from 53.1 in March to 54.7 in April, signaling a rise in business activity ahead.

China

Other important data for the month showed that China is extended its impressive trade performance in April. Exports accelerated by 32.3% in the year to April, as stalled factory production in other countries hit by COVID help prop up demand for Chinese goods. Imports were also impressive, rising 43.1% for the year earlier, the fastest gain since January of 2011. China had a trade surplus of $42.9 billion, which beat consensus forecasts.

Japan

Japan, as we move into the Olympics period, their GDP contracted by 1.3% in quarter one, according to preliminary estimates. The annualised pace of decline is 5.1%, which has pretty much been COVID infections that are up, and obviously with the Olympics around the corner, so the government has extended the state of emergency, putting the brakes on personal spending and thus hurting the economic activity overall. So challenging economic conditions are currently in Japan.

Europe Zone (Eurozone)

In terms of the Europe zone, so eurozone economy contracted by 0.6% in the March quarter and shrunk by 1.8% in the year to the March quarter. Also, the labor market deteriorated to the March quarter with unemployment falling 0.3 in this period, and an annualised pace decline of 2.1%, again on the back of the COVID lockdowns.’

The Equity Markets

Turning our attention to the equity markets, US and Australian equity markets remain in or around their record territory. And although the European economies haven’t been great, their share market hit their new highs in May on the back of anticipated economic recovery to come from warmer months, and obviously the population’s starting to move around and spending again. So as we always know, the equity markets normally are a prediction tool about predicting what’s kind of happening, so they see economic conditions in Europe improving.

Australia

Back home in the Land of Oz, today the RBA announced no change to the cash rate, which we know is going to be the case for a long time.

And on the bond buying program, they announced last month that they will be discussing the topic at their next meeting in July. They will be discussing whether to extend the yield curve controls and quantitative easing buying program, and this will all be revealed from next month.

One other interesting, subtle change in the wording – not in this statement, but in the May statement – prior to that, the original statement read, “It did not expect conditions to meet the hike in the cash rate before 2024.”. However, in last month’s statement, the RBA did say “unlikely”, so slight change from “did not expect” to “unlikely”. This would be until 2024. So this is a little signal to the market that if the economy keeps outperforming and we get the wage growth and then inflation where we want it, then the market could see rates rising earlier than the three years away that is currently being talked about. So I call that as a bit of a hedging bet, and also that a market’s signaling at the same time.

On the RBA front, in terms of some of the economic forecasts, we did see them improve their numbers. They’re going from big to bigger, so let’s work through some of those. So GDP growth to be 4.75% over 2021, well above trend and up from 3.5% previously. Growth in 2022 still remains forecast at 3.5%, subject to any significant lockdowns or extended lockdown periods where we might see that slow down. Unemployment is expected to fall to 5% by the end of the year, down from its current levels of 5.6% and well below the previous forecast of 6% at the end of the year.

Finally, the RBA now expects underlying inflation to hit 2% in mid 2022 – sooner than previously anticipated. So inflation is coming, but that’s what we want – it’s not necessarily going to get out of hand.

May was also a Federal Budget period, so we did see obviously, Australia’s strong economic rebound has certainly helped the government with a projected of a smaller deficit for the 2021 of $161 billion. For 2021/22, a deficit of $106 billion is forecast.

Some of the highlights in the budget:

Consumer spending has been more resilient than first thought. Unemployment numbers have rebounded faster than expected, meaning less government spending on unemployment benefits and more income tax rolling in. Also, on the revenue side we did see soaring export prices, particularly iron ore, also helped deliver improved tax revenues to the government. So the economic situation is definitely better than expected. The government hasn’t left anything to chance by continuing their spending program, with new initiatives total to be a bit over $18 billion in 2021/22, rising to $29.3 billion in ’23/24. So more spending, more money going in, in terms of monetary policy and also fiscal policy, so that is positive in terms of the economic growth.

My final word on the budget is around some other commentary that we’ve seen out there, which the conservative forecast for unemployment wages, iron ore prices, means that they want to basically give you a little bit of a surprise on the upside coming into an election period. So they want to prove to you that they are the better economic managers, and so that should see that come through. Now, they’re hedging their bets if obviously lockdowns occur; they can say that they forecast correctly, but if they forecast on the downside and everything obviously improves above that, they’ll be seen as the best manager of the economy. And hopefully they want your vote as part of that.

The Unemployment Story…

The April labor market data was the first look at the numbers post the JobKeeper, and once again, the jobs cliffs, as many were sprouting hasn’t materialised at all. Yes, unemployment… or employment, did decline by 30,600 jobs in April. It’s the first drop in employment in seven months driven by 64,400 decline in part-time employment, but here’s the kicker: full-time employment rose by a solid 33,800 jobs. So, that’s important to know. Interestingly, the unemployment rate declined to 5.5% in April from 5.7% in March on the back of the fall in the participation rate, to 66% from the record high 66.3%, as people took a break over the Easter holidays from looking for work.

Importantly, the leading indicators for employment is still surging. SEEK is reporting large increases in job listings, and the ANZ job ads reported last month also showed strong demand in the labor market, rising 4.7% month-on-month in April.

That’s 11 straight months of monthly gains on that reading, and it now sits 27.8% higher than the pre-pandemic levels.

Wages Growth

So good news there on the employment front. Talking about wages growth, there are still a few commentators out there who are a little bit impatient with how quickly the wages growth is responding. We need to understand that it’s going to take a little bit of time. The trend, to forget a lot of businesses do annual wage reviews in June, July; well, that hasn’t showed up in the data yet, so that will take a bit of a while for that to come through.

The RBA has also stated on many occasions that it will take this time for the unemployment rate to fall below 5%, and then we started to see further wages growth. And that makes sense. Whilst business is still conservative on wages growth as the pandemic is still lingering, we will be seeing that Melbourne lockdown is also still possible, so it still might take a further full year or more before wages growth to flow through to the whole economy. So again, my message here is: patience, people, patience. We will start to see wages growth come through in that.

In terms of the latest data, wages growth did actually grow by 0.6% in the March quarter, to take the annual rate to 1.5% and up from 1.4% in the previous quarter. In quarterly terms, private sector wages picked up by 0.6%, while public sector wages grew by 0.4%. In year ending terms, public sector wages growth slowed to 1.5%, a new record low. Private sector wage growth was 1.4% over the year.

So, for me, it’s this time next year where the wages story will be a more positive one, subject to our economy remaining open. I do see some positive stories there, but it’s just going to take a little while for that to translate through to some solid wage increases.

Consumer Confidence and Sentiment

Consumer confidence and sentiment… The Roy Morgan Survey of Consumer Confidence increased 2.3% to 114.2 based on May 23 results. This is the highest level since September of 2018. It tells us that consumers remain upbeat about the economic outlook, which should help support consumer spending and economic activity. The other indicator, which is the Melbourne Institute-Westpac Survey, monthly survey, measured the consumer sentiment. It did fall by 4.8% to 113.4 in May, from 118.8 in April. The index is now at its second highest level since April of 2010, and follows an 11% rise over the previous three months.

So even though it had a fall recorded, it’s still unbelievably strong. Now, obviously those recordings were taken prior to the Melbourne and Victoria being forced into a COVID hotspot lockdown, and so I do expect that we will see that confidence reading not only in Victoria, but also more generally, as a bit of a wake up call for everyone that those consumer confidence figures might have a little bit of a softening effect based on what’s happening down here in Melbourne.

Retail Spending

In terms of retail spending, the value of retail sales rose by 1.3% in March after a fall of 0.8% in February. On a year ago, retailing is up 2.2%. Low interest rates, low unemployment, and a housing boom will continue to support further growth in retail spending. Preliminary numbers for April now also showed retail trade increased by 1.1% in April, beating expectations of a 0.8% increase. So certainly, retail spending is up and about.

Business Conditions

Here’s the other big theme that I wanted to talk about – let’s spend a minute talking about business investment and conditions…

Let’s start with the AIG Construction Index declined to 59.1  in April, coming off the record high of 61.8 in March. The index is still strongly expansionary territory. Again, with reading above 50 implying positive growth. Business conditions, confidence; both hit new highs in April, pointing to ongoing jobs growth and a continued recovery in business investment, as the server has been running since 1996, folks. So these are record numbers. So let’s go through them…

Conditions:

Conditions increased to a plus nm 32 from a plus 24 in March. Each of these three underlying components, which is trading conditions, profitability and employment, rose to new record highs.

Confidence:

Confidence rose to a plus 26 in April, up from a plus 17 in the previous month. This implies conditions will remain strong in the near-term.

Capacity:

Capacity utilisation also hit a new high in April, increasing to 85.3% from 82.5%. High capacity utilisation is associated with an increase in business, investment and jobs. Adding to this very good news story, forward orders also climbed to new highs in April, pointing to solid pipeline of future work.

And now let’s look at the money that’s starting to flow in…

I talked about this many, many times. We need to see that business investment, and where is that going to be coming from? Are businesses starting to borrow and expand their operations? So let’s look at the private capital expenditure, jumped 6.3% in the March quarter alongside a continued improvement in the economic outlook. The results were well above consensus expectation. Businesses appear to be more optimistic now. Activity and productivity is bouncing back and tax incentives are also spurring to help investment. Spending on machinery and equipment led the rise, surging 9.1%. Investment in building and structures lifted 3.8% in the quarter, although remains 5.3% lower previous than the pandemic, potentially as a result of lower demand with changing work habits. Investment in non-mining industry rose 7.1% in the quarter. Mining investment increased by 4.1% over the quarter too.

Spending plans have been upgraded, from the latest forecast on spending for 2021 and 2022. So let’s go through. The 2021 was $124 billion, indicating a pickup of around 7% since the last estimate. And this is the big one here: capital expenditure is also expected to pick up after a quicker-than-expected economic recovery. And it’s worth keeping an eye out for the next estimates when they’re released, because we should see also capital expenditure. So all in all, businesses turned up and is joining the economic growth party, and this is a great sign, okay? Because obviously it means for the next couple of years, as the pandemic retreats, our borders open and the global economy gets back into full swing, we could be back into that Roaring Twenties, and that could turn out to be that way. So really, really positive story there.

Turning our attention to the Property Market…

We’ve got all things property now. Construction data is also strong, so we saw construction activity rise 2.4% in the March quarter. Over the year, construction work is still down 1.1%, but obviously we had a lot of downtime there at the first stages of the pandemic. Residential construction jumped 5.1%, renovation surged 11.3%, and new building work increased by 4.1%; all the results of lower interest rates and the HomeBuilder program. We can expect these types of numbers to continue, as the pipeline of residential construction work remains strong. And I will demonstrate that in a minute, when I get down to the building approval numbers. Housing lending, the value of new home loan, excluding refinances, rose by 5.5% in March. Housing loan commitments are now up at a very strong 85.1% from them lows in May of 2020, and are also well above the pre-pandemic, pre-COVID peaks.

Investors are also back in the game as well, with an increase of 12.7% in lending to investors in March. This is the strongest monthly growth rate since July of 2003. Lending to owner-occupiers also increased by 3.3% in March, and they still remain the driving force behind the latest property surge. That’s where the demand is still coming predominantly, from owner-occupiers. The proportion of first-home buyers among owner-occupiers, however, has declined. And this might be due to bringing forward the demand that we saw with all the government incentives of which, for those of you who are first-home buyers, some of those incentives are finishing up at the end of this month. So depending on which state you’re in, check it out and see if you want to get into the property market to take advantage of some of those incentives.

Building approvals, as I hinted just a moment earlier, around the construction pipeline. Building approval numbers jumped up by 17.4% in March. Total building approvals are now at their second highest level on record, exceeding only by November of 2017. The pickup was driven largely by a 63.6% surge in approvals for private multi-dwellings. That’s right; apartments and townhouses, especially in New South Wales and Victoria. But my tip is that they’re just not going to be in the CBD, which is normally where those types of approvals materialise. In terms of private sector, house approvals edged up marginally to a new record high and are now 60.9% over the year. So we are also seeing private, freestanding dwellings moving quickly.

Turning our attentions to Property Prices…

Well, as I record this we haven’t got the May results from CoreLogic yet, but in the last reading that I saw prior to the release that’s also coming out today… I am prerecording today because of May movements… in terms of the national pricing, it does suggest that we are seeing around a 2% to 2.1% increase in house prices across the nation. Now that’s on the back of a 1.8% increase in April, so we did see… everyone was talking about a slowing in April and as the market was cooling down, but we’ve picked up again. So that 2% to 2.1%, we’re basically picking that up again.

So what that could mean is that the April number might’ve been adjusted because of the Easter break in there, and maybe the quality of properties that were being sold over that Easter and school holiday period wasn’t as strong. So we’re now definitely started to see price growth continuing to accelerate. And that’s also evidenced by auction selling markets, is still showing auction clearance rates above that 75% through the course of the month. So we are still seeing Melbourne, Sydney and Canberra and Adelaide markets also have been quite strong on those auction markets as well.

So that’s telling us that there is pent up demand still in the property market for both owner-occupiers and also investors.

And conditions will still remain very favorable for property as we currently expect these conditions to continue into 2022. And also news of rental vacancies starting to fall, which is another good sign for investors and a good sign for the property market in general, as people start to get their mobility back.

So vaccinations hopefully starting to increase. Hopefully we stay out of lockdown for reasonable periods of time; our borders remain open, supporting economic activity. And if that is the case, then we still see low interest rates and property prices still doing some pretty good, heavy lifting in terms of price growth over the next couple of years.

So in summary, I just wanted to talk about the key themes…

Business conditions and confidence is very much on the improve. Generally speaking, there’s real positive signs in the economy. Obviously with lockdowns, certain parts of the economy are affected more than others, so we might see some further government support in those areas. The lockdown really is the big challenge, along with supply shortages, in terms of how quickly the economy can keep on its momentum. So there’s certainly a lot to be looking forward to, there.

In terms of inflation, I’m still saying, look, I think it is transitory, like most of the other economists are saying, because of these shortages.

Until the economies start to open up again, we might see this pressure in the inflation area, but I think that it will ease as we start to see more of that supply chain starting to open up.

Finally, as I close out this month’s economic and RBA update, I just wanted to let everyone know that I’ll be taking a long service break for July and August, so there’ll be no updates over this time, I’m sorry. I suspect it will be business as usual for the RBA, with no changes to the cash rate, but as mentioned earlier, they will be looking at the bond buying program so there could be some news on that in the next month, so keep an eye out there.

The Melbourne lockdown could be problematic if it continues as we enter into winter. One can only expect further community transmission outbreaks to occur, which will only put risks on further economic expansion, so hopefully we can get on top of that. All in all, however, I still see that the economy is very well-placed to see above-trend growth this year and next. I also look forward to giving you the next update in early September on my return.

And for all of our Empower Wealth clients, please keep an eye out for the exciting news around our new tax and personal accounting division.

It will be opening in days, and that will basically allow us to be helping you through this year’s tax return season. So we are going to be able to provide tax returns for our clients, which is super exciting from where I sit. So until September, folks, my next installment of the economic and RBA update, please remember this: knowledge is empowering, but only if you act on it. Stay safe and I’ll catch up with you in September.