Household spending has slowed significantly over the past few months and, with declining real wages and budget cuts weighing on the household budget, I expect spending to be fairly soft over the remainder of the year.
Meanwhile, building approvals rebounded in May, driven by the volatile units sector, but that is likely to provide only a temporary reprieve. Housing construction will support the economy over the next couple of years but is unlikely to have a significant effect given its small share of real GDP.
With the trade balance deteriorating during the June quarter and household spending positioned to fall sharply, real GDP is set to contract for the first time since March 2011. It is time for the Reserve Bank of Australia to recognise that the economy needs a further boost and is poorly placed leading into the mining investment collapse. It should seriously consider cutting rates in the next few months.
The value of retail sales fell by 0.5 per cent in May, missing market expectations, to be 4.6 per cent higher over the year. This marks the second consecutive monthly decline in spending, with activity well below expectations over the past four months. This follows fairly strong growth over the second half of 2013.
Spending in April and May is 0.2 per cent below the March quarter average but we should remember that this reflects the value of activity rather than the volume of goods purchased. Even with a strong outcome in June, which seems unlikely, it appears as though consumption will contract from real GDP growth in the June quarter.
Spending on clothing & footwear and in department stores fell sharply in May, with more moderate declines for household goods and other retailing. Households are looking to cut back on discretionary spending, with spending on household goods declining for the last three months.
At the state level, the decline was driven almost entirely by Victoria and New South Wales, with the other states posting mixed but relatively small changes in spending. Both Victoria and New South Wales have experienced particularly strong growth over the past year -- potentially explaining some of the recent weakness -- and have accounted for almost 80 per cent of total spending growth over that period.
Building approvals rose by 9.9 per cent in May, easily beating market expectations, to 14.3 per cent higher over the year. Nevertheless, building approvals have declined in six of the last eight months and are well below their peak.
Much like the recent weakness, the pick-up in May was driven by approvals for higher-density living. They increased by around 25 per cent in May, following combined losses of 30 per cent over the previous three months.
Given the obvious monthly volatility, it is better to focus on the trend estimates. These show a sharp decline for units, while approvals for housing have stagnated in recent months and may have passed their peak.
From an activity standpoint, apartment projects typically take longer to complete and should support residential investment and the Australian economy over the next few years. On the downside, these projects are typically far riskier and more likely to be postponed or even cancelled as economic conditions change.
Based on strong population growth, housing investment should improve significantly over the next couple of years but those expecting construction to drive the Australian economy should probably temper their expectations.
If the Australian economy grows at around 2.5-3 per cent over the next two years -- optimistic in my view but consistent with the RBA’s current outlook -- residential investment would need to rise by over 20 per cent for its share of GDP to rise by 0.5 percentage points. The unfortunate reality is that housing construction is hopelessly outgunned as we try to rebalance our economy away from the mining sector.
The household sector continues to slow and we have growing evidence that the housing construction boom will not be as great as commonly expected. Residential investment will continue to support the Australian economy over the next few years but is too small to do much of the heavy lifting.
That will be left to household spending and exports, the first of which has slowed significantly throughout 2014 and appears poorly placed over the second half of the year. Real wages are declining and the federal budget has left many households spooked. Job prospects are relatively poor and, as I noted previously, the mining sector is set to shed jobs at a record rate (The jobs picture is starting to look ugly, July 2).
The second factor, exports, has declined significantly over the past few months but should rebound somewhat over the remainder of the year (Making sense of a trade deficit blowout, July 2). Nevertheless, the economy is facing an economic contraction for the first time in three years. With mining investment set to collapse, the RBA will need to cut rates to free up the household sector and encourage the dollar to depreciate further.