Households hold the key to economic growth

Australia's official cash rate remains at 1.5 per cent, where it has been for the past 15 months. Despite the pickup in October retail sales, 3Q17 GDP growth was below expectations, providing more evidence the cash rate is likely to stay at 1.5 per cent for many more months, perhaps until this time next year.

Retail sales grew 0.5 per cent month on month (m/m) in October, above expectations of 0.3 per cent, but the overall trend remained soft. September sales were revised from flat to up 0.1 per cent following negative readings in August and July. Resources regions Western Australia, Queensland and the Northern Territory continue to lag major east coast states.

The level of sales matched those of May at $26 billion. October's growth matched that of May, pushed along by recovery in cafes, restaurants, and takeaway food with growth of 1.7 per cent. Department store sales grew by 0.5 per cent with widespread discounting well before the peak Christmas season.

Household goods was the weakest industry sector, reflecting falling auction clearance rates and housing turnover, sluggish wages growth and high household debt. Falling house prices, albeit marginal at this stage, are also impacting the wealth effect, a powerful psychological influence on spending habits.

Year-on-year growth increased from 1.5 per cent in September to 1.8 per cent with little or no growth in real terms. Deflationary pressures are likely to become a permanent feature with online disrupters, new entrants and technology combining to make price increases difficult to introduce and sustain.

Depreciation in the A$ will lift import prices, but increases may have to be at least partially absorbed, adding to already intense retail margin pressure.

The bounce in the A$/US$ rate to 0.765 was hard to justify. There are few reasons for the A$ to appreciate against its US counterpart with the Australian 2-year bond yield below the US 2-year yield.

As the US economy gathers steam, Australia's high-yielding currency and bonds are becoming less attractive to international investors, particularly the Japanese. This will gradually play out in currency markets with A$ weakness likely to gather momentum into 2018.

Not surprisingly, 3Q17 GDP growth misses expectations

Growth in Australia's economy slowed to 0.6 per cent in the September quarter, below expectations of 0.7 per cent and down from 0.8 per cent (but revised to 0.9 per cent) in the June quarter. But, year-on-year growth jumped to 2.8 per cent from 1.8 per cent at June as the negative 0.5 per cent 3Q16 dropped out. Hardly reason to rejoice.

The 24-hour currency honeymoon ended abruptly with the A$/US$ sliding to 0.757. Commentary suggested economic growth "slowed a touch". The touch was in fact a 33 per cent slowdown quarter on quarter (q/q) from 0.9 per cent to 0.6 per cent. What adjective would be used if the growth was, say 0.3 per cent?

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Peter Warnes is Morningstar's head of equities research. Any Morningstar ratings/recommendations contained in this report are based on the full research report available from Morningstar.

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