Weakening Demand To Eventually Weigh On Wages And AUD

BMI View: Australia's manufacturing sector contracted in November after posting two months of expansion. The sector continues to face narrowing profit margins, which suggests that the recent stabilisation in the Australian job market is unlikely to persist. Apart from the government's efforts to reduce the bargaining power of labour groups, the Reserve Bank of Australia (RBA) has also indicated that it may employ policy measures to help induce depreciatory forces on the expensive Australian dollar (AUD). Ultimately, we believe that market forces, spurred by weakening domestic and external, will be the major force driving down wages and the AUD.

The post-election honeymoon period for the Australian manufacturing sector seems to have ended as soon as it began, with the sector's performance reading in November pointing to a dip back into contraction, coming in at 47.7, after posting activity expansion for the two preceding months. Given that the month's weak performance was due to declines in new orders, production and supplier deliveries, the sector's near-term outlook is quickly turning bleaker. The lack of production activity further suggests that the uptick in employment sub-index is unlikely to persist, in line with our expectations for Australia's overall unemployment rate to edge higher by the end of 2013, despite the decline recorded in September.

Eventual Wage Reductions To Relieve Margin Pressures

Margins Narrowing Rapidly...
Australia - Input & Selling Prices Sub-Indices For Manufacturing Sector

BMI View: Australia's manufacturing sector contracted in November after posting two months of expansion. The sector continues to face narrowing profit margins, which suggests that the recent stabilisation in the Australian job market is unlikely to persist. Apart from the government's efforts to reduce the bargaining power of labour groups, the Reserve Bank of Australia (RBA) has also indicated that it may employ policy measures to help induce depreciatory forces on the expensive Australian dollar (AUD). Ultimately, we believe that market forces, spurred by weakening domestic and external, will be the major force driving down wages and the AUD.

The post-election honeymoon period for the Australian manufacturing sector seems to have ended as soon as it began, with the sector's performance reading in November pointing to a dip back into contraction, coming in at 47.7, after posting activity expansion for the two preceding months. Given that the month's weak performance was due to declines in new orders, production and supplier deliveries, the sector's near-term outlook is quickly turning bleaker. The lack of production activity further suggests that the uptick in employment sub-index is unlikely to persist, in line with our expectations for Australia's overall unemployment rate to edge higher by the end of 2013, despite the decline recorded in September.

Margins Narrowing Rapidly...
Australia - Input & Selling Prices Sub-Indices For Manufacturing Sector

Eventual Wage Reductions To Relieve Margin Pressures

Dynamics of input and output prices suggests that the sector continues to face margin pressures, which bodes poorly for the long-term outlook for the manufacturing sector in Australia. Indeed, the divergence between the two price sub-indices is at present closing in on highs recorded in 2010 and 2011. As such, without corresponding declines in input prices like wages, the manufacturing sector is likely to continue to face declining profits, which will push more industries to consider exiting production in Australia, following the steps of a number of firms in the auto industry. Although the coalition government has pursued various means to reduce the bargaining power of labour groups since coming into power (such as tougher regulation on these bodies), there remains a lot more room for wages to fall before they reach levels similar to those of its global competitors. While we expect the government to continue its efforts to reduce rigidities in the job market, we believe that market forces are likely to be ultimately responsible for most of the declines in labour costs.

A Weaker AUD Will Certainly Help...
Australia - Manufacturing Sector Export Sub-Index & Exchange Rate (AUD/US$, RHS)

Australian Dollar Still A Concern

On top of the high wage and input costs that manufacturers face in Australia, sheer physical distance and an expensive Australian dollar (AUD) further weigh on the sector's outlook, as the currency further diminishes firms' ability to export. Given the high fixed costs in the manufacturing sector, the lack of ability to export reduces the volume demanded which, in turn, limits the firms' ability to expand production and reap economies of scale. Indeed, the Reserve Bank of Australia (RBA) has been eager to do its part to influence greater depreciatory forces on the currency, considering ways such as direct intervention in the market and interest rate cuts. While we expect the impact from the central bank's efforts to be transient and limited at best, we believe that the declining external and domestic demand will ultimately weigh on the currency. Material exposure to industrial commodities (iron ore and coal) and the Chinese economy, both of which we forecast to experience a difficult time in 2014, suggest that Australia's exports will falter. Moreover, we believe domestic demand is unlikely to provide much reprieve as Australian households remain highly indebted (household debt remains at 92.9% of GDP), and the declining profitability of the manufacturing sector suggesting that the job market is likely to soften once again. As such, we believe that worsening demand outlook is likely to reduce the attractiveness of Australian assets to foreign investors and, in turn, help bring the AUD to lower levels.

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This article is tagged to:
Sector: Country Risk
Geography: Australia
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