Cliff Notes: In Need of Capacity

Key insights from the week that was.

In Australia, the Monthly CPI Indicator rose to 3.6%yr in April, from 3.5%yr in March and 3.4%yr in January and February. By sub-category, there were various differences relative to expectations which offset one another – a notable increase in prices for clothing and footwear (+4.0%mth) and a pull-forward of the health insurance premium increase met by another fall in electricity prices, principally due to another round of energy rebates in Tasmania (–1.9%mth). While the latest figures point to a slight upside surprise for the Q2 CPI, subsequent updates – especially the quarterly services components next month – will be crucial for gauging the balance of risks into mid-year.

This week’s consumer and housing updates came in on the softer side. Growth in nominal retail sales printed a feeble 0.1% (1.3%yr) in April, continuing the past six months’ very subdued trend. Falling retail prices in certain segments may be partially to blame, though underlying volumes clearly remain weak. Meanwhile, the –0.3% decline in dwelling approvals points to a fragile outlook for new dwelling investment, at odds with the needs of a rapidly growing economy.

In the lead-up to next week’s Q1 GDP report, the ABS also released two partial indicators of investment.

Construction activity surprised materially to the downside, contracting –2.9% in Q1. Declines were recorded across both private and public sectors (–2.4% and –4.3%) and were broad-based across segments, with non-residential building works particularly weak (–7.0%). The sharp decline in hours worked in the sector was the likely culprit behind the moderation in activity. That said, there remains a sizeable pipeline of construction projects yet to be completed and, given the extra boost to the pipeline from recent Federal and State Government budgets, construction activity has scope to remain at a high level.

The Q1 CAPEX survey subsequently reported a 1.0% lift in capital expenditure. Spending on machinery and equipment, which feeds into GDP, posted a solid 3.3% lift, while building and structures moderated, –0.9%, the mining sector acting as a drag across both segments. On spending intentions, the second estimate for 2024/25 CAPEX plans remained optimistic, up 13% compared to the second estimate a year ago. In our view, this implies an 8.3% rise in nominal CAPEX spending over the financial year, or roughly 5.25% on an inflation-adjusted basis. Constructive for the medium-term outlook, businesses still see a need to build capacity and alleviate constraints.

Our Q1 GDP preview will be published later today on WestpacIQ. Looking further out, Chief Economist Luci Ellis’ essay this week investigates the key risks Australia and its policymakers face as we seek to return inflation to target and foster a recovery in GDP growth to or above trend.

Following Australia’s Budget a fortnight ago, this week it was New Zealand’s turn. Spending and revenue forecasts have both been lowered, and the return to surplus delayed. For all the detail, see Westpac New Zealand Economics’ Budget report.

In the US this week, the Federal Reserve’s May Beige Book pointed to subdued conditions across the economy. 10 of 12 districts reported “slight or modest growth”, and the remaining 2 no growth. Retail spending was little changed, with “lower discretionary spending ” observed. Growth in housing demand was also modest, population and the labour market were supportive but affordability and borrowing capacity remain significant headwinds.

The Beige Book’s view on labour market momentum remains at odds with nonfarm payrolls but in line with the household survey, eight districts reporting “negligible to modest job gains, and the remaining four Districts reported no changes in employment”. Commentary around headcounts suggests a mixed picture. Some districts reported businesses increasing headcounts, while others allowed headcounts to shrink through natural attrition. Businesses are seemingly taking down the ‘need help’ sign as the economy slows.

Helpfully for services inflation, “Several Districts reported that wage growth was at pre-pandemic historical averages or was normalizing toward those rates”. Price increases were considered modest, consumers pushing “back against additional price increases “. Evident here is that discounts are becoming necessary to entice consumers to spend.

Looking at the economy as a whole, US Q1 GDP growth was revised marginally lower in the second estimate to 1.3% annualised (prev 1.6%), primarily as a result of softer consumption. After a strong 2023, consumption growth in Q1 is now estimated at a below-trend 2.0% annualised. What’s more, April retail sales (released earlier in the month) suggests this moderation in growth continued into Q2. A moderation in growth to, or slightly below trend, will alleviate remaining concerns over inflation and allow the FOMC to ease from late-2024.

Over in Europe, the unemployment rate edged down to 6.4% in April. Continued strength in the labour market data highlights lingering risks for wage growth and services inflation. We expect the ECB to begin their cutting cycle next week at their June meeting, but subsequent easing will be modest in scale and pace, with momentum and risks to be assessed meeting by meeting.