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Annual business profitability conditions hit 4-year low

NAB Business survey; Weekly consumer sentiment; Reserve Bank speech

Business survey: The NAB business confidence index rose from +2.3 points in June to +3.9 points in July. The long-term average is +5.9 points. But the business conditions index fell from +3.6 points in June to +2.4 points in July. The long-term average is +5.8 points.

Profit pressure: The 12-month moving average of the NAB profitability index fell to a 4-year low of +4.95 points in July, down from +5.76 points in June. The long-term average is +4.6 points.

Jobs market loses momentum: The 12-month moving average of the NAB employment index fell to a 2-year low of +5.36 points in July, down from +6.26 points in June. The long-term average is +2.0 points.

Consumer confidence: The weekly ANZ-Roy Morgan consumer confidence rating fell by 0.3 per cent to 115.5 points. Consumer sentiment is still above the average of 114.5 points held since 2014 and the longer term average of 113.1 points since 1990.

Reserve Bank Assistant Governor speech: Assistant Governor (Financial Markets) Dr. Christopher Kent delivered a speech titled “The Usual Transmission – Monetary Policy and Financial Conditions.”

The business survey has broad implications for investors and the economy. The consumer confidence figures have implications for retailers, and other consumer-focussed businesses. Speeches from the Reserve Bank can provide guidance on interest rate settings.

What does it all mean?

• The latest business survey reflects tepid operating conditions and cautious investment spending intentions across Australia. The NAB report supports recent Reserve Bank moves to cut interest rates, while potentially increasing the likelihood of further cuts in the coming months, especially if business investment weakens.

• Aussie businesses are facing mounting profit margin pressures as rising operating, input and labour costs weigh on already constrained balance sheets. In fact, the NAB profitability conditions index hit the lowest level since April 2015 in 12-month moving average terms in July.

• Cash-strapped Aussie firms are faced with increasing costs, including rising fuel, electricity, insurance, rent and regulatory fees. The minimum wage has also been lifted. And as of yesterday, 13 out of 21 ASX200 listed companies had reported a fall in statutory profit in the latest earnings season.

• Consumer confidence was little changed last week, despite the value of the Aussie dollar hitting decade lows against the greenback and the Aussie sharemarket (S&P/ASX200 index) closing-out its worst week (down 184 points or 2.7 per cent) since November.

• Most Aussies, however, are busily compiling and lodging their income tax returns in anticipation of receiving a chunky tax offset from the federal government. And household borrowers have seen around 44 basis points shaved-off their average standard variable mortgage rate in the past two months. Unsurprisingly, consumers’ views towards their ‘family finances over the next year’ has lifted to the highest level since late May, according to Roy Morgan and ANZ.

What do the figures show?

National Australia Bank Business Survey

• The NAB business confidence index rose from +2.3 points in June to +3.9 points in July. The long-term average is +5.9 points. But the business conditions index fell from +3.6 points in June to +2.4 points in July. The long-term average is +5.8 points.

• The survey was conducted in the period July 19-31 2019.

• The rolling annual average business confidence index fell from +3.8 points in June to +3.6 points in July, below the long-run average of +5.8 points.

• The rolling annual average business conditions index fell from +8.2 points in June to +7.2 points in July, above the long-run average of +6.0 points.

• Key Components: The index of trading conditions fell from +6.8 points to +6.1 points; employment fell from +5.1 points to -0.2 points; profitability rose from -1.4 points to 0 points; forward orders rose from -3.7 points to -2.9 points; stocks were steady at -0.4 points; exports fell from +1.0 point to -0.1 points.

• Inflationary indicators: The monthly reading of labour costs rose at a 1.1 per cent quarterly rate in July after a 1.5 per cent rise in June. Purchase costs rose at a 1.0 per cent quarterly rate (previously +0.7 per cent). Final product prices rose at a 0.5 per cent quarterly rate (previously +0.2 per cent). Retail prices rose at a 0.7 per cent quarterly rate (previously -0.7 per cent).

• Capacity utilisation fell from 82.1 per cent to 80.9 per cent, above the long-term average of 81.1 per cent.

• The proportion of firms reporting that they did not require credit fell from 45 per cent to 40 per cent.

• NAB reported: “Business conditions declined slightly in the month. As we have noted in previous months, the decline in business conditions since early 2018 has been broad-based and has continued to track at below average levels in recent months. This is concerning, because while conditions remain positive, it points to a significant loss in momentum in the business sector”.

• “Business confidence ticked-up in the month, following an easing last month, but is also below average. While there were some positive signs with a post-election lift in confidence, this bounce now looks to have been short lived with confidence also tracking at below average levels in the two months since the election.”

• “Business confidence in the retail sector saw a reasonable lift, likely related to the government’s tax cuts, but quite worryingly there appears to have been little boost to activity in the sector with conditions weakening further – the sector is currently facing recessionary levels of activity according to our measure.”

• “Forward-looking indicators remain weak. Forward orders edged higher in the month but remain negative and well below average while capacity utilisation unwound its sharp spike last month and is now again just below average.”

• “Looking at the components of the survey that provide an indication of conditions going forward, we see little improvement. With both forward orders weak, and capacity utilisation a bit below average – both capex and employment growth are at risk.”

Consumer Sentiment

• The weekly ANZ-Roy Morgan consumer confidence rating fell by 0.3 per cent to 115.5 points. Consumer sentiment is still above the average of 114.5 points held since 2014 and the longer term average of 113.1 points since 1990.

• Three out of the five major components of the index fell last week:

The estimate of family finances compared with a year ago was up from +7.3 points to +10.1 points;

The estimate of family finances over the next year was up from +24.7 points to +27.7 points;

Economic conditions over the next 12 months was down from +5.1 points to +0.6 points;

Economic conditions over the next 5 years was down from +13.2 points to +12.9 points;

The measure of whether it was a good time to buy a major household item was down from +28.9 points to +26.3 points.

• The measure of inflation expectations rose from 3.7 per cent to 3.9 per cent.

Reserve Bank speech: “The Usual Transmission – Monetary Policy and Financial Conditions”

• Reserve Bank Assistant Governor Dr. Christopher Kent (Financial Markets) said that recent interest rate cuts are flowing through the financial system and economy, contributing to the depreciation of the Aussie dollar, while supporting domestic demand.

Key quotes from the speech

• Monetary policy: “..the transmission of monetary policy in Australia to financial conditions is working in the usual way.”

• Interest rate cuts: “…the change in the stance of policy has underpinned the decline in risk-free rates along the yield curve.”

• Easing of financial conditions: “It [rate cuts] has also contributed to a decline in the cost of funding in corporate bond markets, supported equity prices, and lowered the cost of funding for banks, including through lower rates on bank deposits. Much of the reduction in banks’ funding costs has been passed through to business and household borrowers.”

• Aussie dollar and commodity prices: “…the Australian dollar had depreciated over that period when commodity prices had been rising. That implies that the effect of monetary policy on the exchange rate has been broadly working as usual…the decline in interest rates in Australia has contributed to the depreciation of the Australian dollar.”

• On housing conditions: “If housing conditions continue to improve in the coming months, we would expect to see a further rise in loan approvals.”

• Support for the economy: “That broad-based easing in financial conditions in Australia will provide some additional support to demand in the period ahead.”

What is the importance of the economic data?

• The monthly National Australia Bank business survey is valuable in providing a timely reading about the health of Corporate Australia. Key indicators of business conditions such as orders, employment, profitability and capacity use are covered together with a gauge on confidence levels.

• The ANZ/Roy Morgan weekly survey of consumer confidence closely tracks the monthly Westpac/Melbourne Institute consumer sentiment index but the former measure is a timelier assessment of consumer attitudes and is now closely tracked by the Reserve Bank.

• Speeches by Reserve Bank officials provide a guide to the Board’s thinking on interest rate settings.
What are the implications for interest rates and investors?

• Business investment is contracting globally due to uncertainty around the US-China trade war and softening economic growth backdrop. While spending intentions remain broadly positive in Australia, business owners continue to report a decline in profitability. And annual hiring conditions have hit two-year lows, signalling a slowdown in jobs growth in the coming months.

• That said, Dr. Kent highlighted today that interest rates on loans to Aussie businesses have declined “to very low levels” – freeing up cashflow. While interest rates for smaller businesses are relatively higher than larger firms, it is hoped that lower borrowing costs will encourage firms to increase spending on capital and equipment. Private sector businesses, however, appear constrained when it comes to lifting workers’ pay.

• CommSec expects the Reserve Bank to assess the impact of previous rate cuts before deciding further moves on cash rates.

Published by Craig James, Chief Economist,CommSec