Leads and Lags
The core economic forecasts of the RBA repeated in the latest quarterly Monetary Policy Statement released last Friday are that GDP growth will slowly gather pace over the next two years to around 3% y-o-y. Two key spending components, housing and household consumption spending will lift over the next two years and support better GDP growth. The unemployment rate will be sticky initially, just above 5% before edging below 5% in about a year’s time. Annual wages growth will be slow to lift above the current 2.2% y-o-y and annual inflation will lift slowly to a little above 2%.
These core economic forecasts look reasonable to us but there are some analysts looking for Australian economic growth and everything that runs off it to be weaker than what the RBA is forecasting. Some of these weaker economic growth forecasts seems to ignore the leads and lags that will always occur in the wake of economic policy changes or from disasters whether related to drought, fire and flood such has occurred in Australia or contagion as has occurred from the coronavirus outbreak, implying a more than temporary detraction from economic growth from disasters and failure to lift after economic policy stimulus.
We briefly review policy changes in Australia since mid-2019 and more recent disasters and what to expect allowing for leads and lags. In mid-2019 after the Federal election, there was a modest fiscal stimulus of which the most notable component was the doubling of the low-and-middle income tax rebate to $1,080 payable shortly after personal income taxpayers submitted their 2018-19 tax returns. Between July and October, most taxpayers received the higher tax rebate boosting household disposable income.
The issue for analysts at the time was what proportion of the tax benefit would be spent? High household indebtedness and weak growth in wages could prompt caution causing households to save a high proportion of the tax cut. Weak household consumption spending growth in Q3 and comparatively soft retail sales numbers in August (+0.5% m-o-m), September (+0.2% m-o-m), and October (+0.1%) prompted assessments that households were mostly saving the tax rebate rather than spending.
An alternative was that households were taking time before spending and waiting for an opportunity. That opportunity presented with the Black Friday sales in late November prompting a 1.0% m-o-m lift in retail sales in November and contributing to a 0.5% q-o-q lift in real retail sales in Q4 2018, the strongest quarterly increase since Q2 2018.
Q1 2019 retail sales will have been negatively influenced by the extensive bushfires, offsetting the impact of the tax cuts and we may never know whether analysts were too hasty declaring little benefit for retail spending from the tax cuts.
Some analysts also questioned the benefit of the three RBA rate cuts delivered in the middle months of 2019. Always interest rate cuts work with long and variable lags. The most immediate effect of lowering the cash rate is softness in the Australian dollar exchange. Other transmission effects through lower borrowing interest rates, reduced interest debt burden, incentive to borrow more, higher asset prices boosting wealth take time – sometimes many months to show through.
There appears to be mounting evidence that the rate cuts of mid-2019 are showing positive effects. The Australian dollar exchange rate is lower than in mid-2019, down around 4% against both the US dollar on a trade weighted basis. House prices have risen sharply over the same period initially on low sales turnover, but continuing to increase albeit at slower pace on much higher turnover over the past month or so. Owner-occupier housing finance commitment have risen every month since mid-2019 and are up 10% y-o-y. At the end of 2019, monthly home building approvals started to trend higher and in six months or so, housing commencements should lift too.
Higher household wealth generated by higher house prices should contribute to stronger household spending later this year. In short, the strongest positive impact from the RBA’s mid-2019 rate cuts should be evident and entrenched in the second half of 2020. Monetary policy takes that long to work, but it still works according to signposts showing in the housing market.
As for disasters, the impact runs initial loss of spending causing a dip in GDP growth. The coronavirus outbreak and the quarantining procedures affect trade in goods and services. In Australia, restrictions on entry for Chinese residents hit education and tourism. Once it becomes clear the spread of coronavirus has peaked and/ or a vaccine is developed there is likely to be a recovery in tourism numbers and inbound students. At this stage the negative impact on Australian GDP growth is likely to be contained to Q1 and Q2 2020 with a possibly pronounced recovery in Q3 and Q4.
In terms of bushfire impact the negative impact is concentrated in Q1 2020 with recovery spending starting to boost Q2 and beyond. There is a high chance that heavy rain in Eastern Australia has brought the bushfire season to an early close and has also broken the lengthy drought in some regions. The turn from drought to better seasonal conditions also has a long and lagged (12-18 months after drought-breaking rain) positive impact on rural activity.
Putting all the leads and lags together, Australia is likely to suffer weak and possibly negative Q1 GDP growth (immediate consequences of bushfires and coronavirus) followed by soft Q2 GDP growth. The second half of 2020 is likely to be much stronger assisted by the lagged positive impact of the mid-2019, coupled by official interest rate cuts and recovery spending after the coronavirus and the recent bushfires.