Two pieces of economic news yesterday sets the scene for next week’s Mid Year Economic Forecast and the associated spending cuts required to make up for the weak growth in tax revenues, especially company taxes.
Yesterday we had confirmation, if any were needed, of the extent of the mining boom with a shock surge in the value of construction work done in the quarter: a 12% rise in the three months to $47.5 billion, or six times the market estimate. That included a 22.6% surge in engineering work to just over $28 billion, 49% up on the third quarter of 2010.
The figures also showed a 1.1% fall in residential construction to $11.4 billion in the quarter, down 3.5% from a year before. That led some analysts to moan about the two-speed economy, but they also know that if we had a booming home building industry and the sort of growth in engineering and construction reported yesterday, then we would have high inflation and much higher interest rates.
The Reserve Bank increased interest rates a year ago to try and get that sort of trade-off between housing and commercial property construction, and the gathering pace of construction activity in the resources sector, especially iron ore, LNG in WA, coal seam gas and LNG in Queensland and the coal industry in NSW and Queensland. That we have been able to accommodate the explosion in construction and engineering, and see inflation fall in the September quarter, tells us that the Australian economy is better placed than all the moaners and rent seekers concede.
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And yesterday David Jones reported an 11.2% plunge in first quarter sales and forecast a profit fall of up to 20%. As we’ve shown before, department stores are in the low-growth end of the retail industry. But another context for the softness in some retail sectors is that the economy must be well balanced to have coped with the explosion in activity in resources in the past year and not trigger the usual Australian inflationary surge which destroys all the gains.
On that basis, there is room for the government to cut some spending, especially if it makes smart cuts that move the budget onto a better long-term footing.
The problem remains the rest of the world, which is now slowing amid growing signs of a credit freeze that now seems to have captured Germany, the key economy for the survival of the eurozone and the euro. The most worrying development was the failure of Germany to sell all of a 6 billion euro auction of 10-year bonds earlier this week. It attracted bids for just over half of that from the market, forcing the Bundesbank (the German central bank) to take up the 39% of the offering that was unsold. That shocked markets across Europe and the US and sent shares lower, as well as commodities like gold, oil and copper.
Yields on German 10-year bonds, the bellwether security for all of Europe, jumped a nasty 0.20% yesterday after the failure, to close at 2.08%. That’s plainly still way under the 7% plus on Italian 10-year debt, but a reminder that the most credit worthy economy in Europe is now under increasing suspicion. Germany now joins the rest of the eurozone in facing higher yields at a time when the various economies are now probably in recession.
Overnight, at a France-Germany-Italy summit (Europe appears permanently in summit mode these days), Angela Merkel continued to rule out any change in role for the European Central Bank to enable the ECB to become a lender of last resort, now regarded as the only immediate hope of bringing the crisis to an end. The break-up of the Eurozone — not just the establishment of a two-tiered, north-south zone — is now being routinely discussed.
All this is smashing the European economy. Figures on Wednesday showed that industrial orders in the eurozone suffered the biggest single-month fall since December 2008, when it and much of the rest of the world was slumping into recession. New orders plunged by 6.4% in September from August, according to Eurostat, the European Union’s statistical office. Leading the way was Italy where orders fell a terrible 9.2% between August and September. But France and Spain saw drops of 6.2% and 5.3% respectively, and Germany saw a 4.4% fall as well.
But there was also concerning news from China: the November survey of the country’s manufacturing showed a sharp fall to 48 from 51 in October, a move that rattled confidence with the Financial Times reporting on strikes by around 100,000 workers in factories in the south of the country over pay cuts caused by falling export orders. A 48 reading on the survey gives industrial production at an annual rate of 11% to 12%, according to HSBC economists, and growth of 8% to 9%.
What was the problem? What worried markets was the sharpness of the fall, and then the news of the growing labour unrest in Guandong and other southern industrial areas.
And there was retrospectrive bad news from the US, where third-quarter growth was cut back to an annual 2% (0.5% quarter on quarter) from the first estimate of 2.5%, with weak inventories and imports the biggest reason for the fall.
Quite what judgment call Treasury and its political masters make about the extent of their spending cuts will be fascinating to see next week. It’s great for Australia to be experiencing economic conditions so very different from the rest of the world, but it makes for immensely difficult budget framing for local policymakers.