Cliff Notes: in pursuit of capacity
Key insights from the week that was.
The first of the two key releases received this week for Australia was the Q1 construction work done survey. Activity in the sector disappointed expectations in Q1, with a fall of 0.9% reported against expectations of a modest gain circa 0.5-1.0%. Disruptions related to the omicron wave of COVID-19 and poor weather, particularly in Queensland and New South Wales, are believed to be behind the miss. Note however that the Q4 2021 outcome was revised up as part of the Q1 release, from -0.4% to +0.6%; also, Victorian construction showed strength in Q1, +2.6%, the state economy rebounding strongly following last year’s delta wave.
Looking ahead, there is a sizeable pipeline of work to be completed across the economy. However, additional disruptions may delay progress. The most notable risks are the difficulties associated with sourcing necessary construction inputs and Australia’s very tight labour market. Highlighting the effect of both, construction costs rose by 2.4% in Q1 and 7.6% over the 12 months to March, the strongest gains since 2008.
Equipment investment, as estimated by the CAPEX survey, also disappointed in Q1, albeit less so than construction, with a 1.2% gain recorded (WBC forecast +2.0%). Total CAPEX (includes buildings and structures as well) fell 0.3% in Q1 across both mining and non-mining. For non-mining, the equipment spend was essentially unchanged in the 3 months to March, while buildings and structures construction was down 0.6%. Mining meanwhile saw a strong 7.7% gain for equipment, offset by a 3.3% fall in buildings and structures work.
Despite intense uncertainty over the global economic outlook, CAPEX plans for FY2021/22 were broadly unchanged in Estimate 6, implying a 14% lift in investment from FY2020/21. Pleasingly, FY2022/23 plans were revised up in Estimate 2 to now suggest investment will lift 10% in that year. However, note that these are nominal figures and so include cost increases. Over the year to March 2022, CAPEX investment costs were reported to have risen 6.6%.
Having assessed these two surveys, we have confirmed our forecast for Q1 GDP of 0.2%/2.5%yr for next Wednesday’s release. A full preview will be made available in our Weekly on Westpac IQ today. But, in short, strong support from household spending is expected to be largely offset by a sizeable subtraction from net exports. We perceive there to be downside risks to this view given the weakness seen in hours worked in the quarter.
Turning to New Zealand, the RBNZ delivered to Westpac’s and the market’s expectations at their May meeting, voting in favour of a 50bp hike in the cash rate to 2.00%. Our New Zealand economics team continue to expect another two 50bp increases in July and August, then two 25bp increases in October and November to a peak cash rate of 3.50%. The RBNZ meanwhile project a higher top of 4.00% in 2023. In short, as per the Westpac MPS Review, the RBNZ are worried high inflation will become embedded in expectations and actions, and so are looking to take on a contractionary policy stance until demand is more in line with available supply/ capacity. For full detail on the expectations of Westpac NZ economics and the RBNZ, see Westpac’s Bulletin.
Data for the US this week has been limited and secondary in significance. However, the May FOMC meeting minutes are worthy of note. On display in the discussions of FOMC members was clear belief in the strength of the US, the economy seen as “very strong” and the labour market “extremely tight”. Unsurprisingly, inflation was characterised as “very high” and the primary source of risk for the outlook.
Still, in their discussions regarding policy, the Committee referred to the importance of an expeditious move to ‘only’ a “more neutral monetary policy stance”, with an outright restrictive stance requiring an unfavourable evolution of the outlook/ risks. These comments speak to a belief that supply-driven inflation will pass if given time and assuming demand and expectations are well managed. Indeed, “many participants” subsequently noted that the current “removal of policy accommodation would leave the Committee well positioned later this year to assess the effects of policy firming and the extent to which economic developments warranted policy adjustments” – i.e. by the end of the year, the FOMC may have scope to, at least, pause rate hikes.
Westpac remains of the view that the peak fed funds rate will be seen at year end at 2.625%, below the market’s 2023 peak expectation. The above views fit with this expectation and highlight clearly that gauging policy tightening in the US is not so much about the timing of each fed funds rate hike, but rather the cumulative impact on term interest rates. Notably, the 2,5 and 10-year Treasury yields, which act as base rates for private borrowing rates across the economy, are all currently in the top half of the FOMC’s neutral range of 2.0-3.0%, flagged after the May meeting. This highlights the extent to which policy has already tightened, well ahead of peak fed funds.
Finally on China, Premier Li Keqiang made clear this week both the need to and intent to stimulate the economy with no delay. This week 33 new easing measures were announced across the economy to aid households, reduce business costs and encourage hiring. This follows last week’s decision to cut the 5-year loan prime rate, a benchmark for mortgage rates. Clearly, with the COVID-19 situation in Shanghai improving and steady in Beijing, there is a need to accelerate growth and make up for lost time. Such concerted action can still see authorities achieve their 5.5% annual growth target, assuming further lockdowns are not seen and global developments also do not reduce support for China’s economy. Sentiment amongst households will take considerable time to repair and rebound and so, for the time being, momentum will continue to be driven by the public sector and, to a lesser extent, private business investment.
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