by David Bassanese

It’s fair to say this week’s National Australian Bank July business survey was a welcome respite from what was starting to become a drumbeat of negativity surrounding the economy – so much so that financial markets were getting excited at the prospect of another potential official interest rate cut later this year.

In what was a welcome surprise to me personally, the NAB index of business conditions – which is the single most important indicator in the survey – surged to an above-average reading of 8.2 from a relatively more sombre 2.5 reading in June. 

Business conditions have bounced nicely in the past two months – restoring the broader trend recovery in sentiment following from the Federal election inspired lows of mid-2013. We now seem to have safely negotiated a “mini-correction” in business sentiment caused by all the talk earlier this year of Federal budget crisis and drastic spending cuts to come.

Note that while survey measures of business conditions did hold up relatively better than those for consumer confidence in the wake of the Treasurer Joe Hockey’s attempt at a horror budget, corporate Australia were not immune to a bout of jitters.  

Indeed, let’s not forget the NAB index of business conditions had recovered to a (close to average) reading of 4.7 in January this year – from a low of -8.3 in June 2013 – only to then tumble to -0.4 in May.  It’s now recovered along with the rebound in consumer confidence, perhaps in part because the new Federal Senate appears intent in blocking many of smoking Joe’s harshest new measures.

But we can’t thank the Senate alone. 

Retailers have also suffered in recent months from warmer than usual winter weather – causing consumers to hold back buying the usual things they use to keep warm. But the return of cold winter in July produced a snap back in retail spending which also appears to have improved sentiment among shop keepers.  

Of course, retailers still say their business conditions are relatively subdued, and there’s a risk that consumer confidence and household spending could ease back if last week’s rise in the unemployment rate to 6.4 per cent is a taste of things to come in the jobs market.  As detailed below, this is still my greatest worry.

The major driver of the recovery in business conditions since mid-2013, however, is the upturn in the housing sector - along with its myriad multiplier effects.  The upturn in new home building is clearly evident in strength in the construction sector, but the NAB survey also reveals a lift in conditions in the financial and business service sectors, no doubt reflecting all the new home loans that banks and brokers are making, and the lift in property turnover enjoyed by realtors.  

And even business conditions in the long disparaged manufacturing sector have improved since mid-2013, likely reflecting some lift in demand for building construction products. 

To my mind, the somewhat surprising NAB survey results are a reminder that we should not underestimate the important cyclical role that the housing sector can play, even though home building per se only on average accounts for around 5 to 6 per cent of real national output.  

When the housing sector moves, it can move rapidly, producing not only a decent direction contribution to economic growth but indirect downstream effects through other sectors - not to mention its affect consumer spending through the movement in house prices. 

But while the housing sector is playing it part, it’s the still vulnerable consumer-labour market dynamic that most worries me about the economy right now.  

The great hope this year is that consumer spending – which accounts for a far larger 50 per cent of national output – will be bolstered by the wealth effects produced by rising house prices.  Yet this could be offset were employment growth to remain weak and the unemployment rate continue to edge higher.  I’m less convinced than many that last week’s jump in the unemployment rate was a “rogue result”, as history suggest such large jumps tend to be sustained in the months ahead. 

In fact, that’s perhaps not surprising given the shift in mining activity from relatively labour-intensive investment in new capacity to less labour intensive export shipments – which should boost reported labour productivity by keeping employment growth weak relative to economic growth.

Maybe the rebound in the housing sector – Australia’s new major growth engine – can fill the gap, which is why I’m watching the range of hiring indicators very carefully.  The good news is that’s also been some tentative lift in hiring intentions, but even as the Reserve Bank conceded last week that remains relatively “subdued”.   

Adding to the mix, it is also somewhat discomforting to find that retail prices pressures remain firm, despite the weakness in labour costs and still high Australian dollar. Two out of the last three consumer price index results were higher than expected, and even this week’s NAB survey revealed a further sharp lift in retail prices in July.  This will remains a modest source of discomfort to the RBA, but probably not enough to stop a further rate cut is the unemployment rate does indeed push beyond 6.5 per cent or so.  

But the RBA would still likely prefer to see a weaker $A than lower interest rates, and less destabilising shenanigans in Canberra.