Australian business conditions weaken as sector gap widens

Australian business conditions weakened slightly in October, according to CreditorWatch Chief Economist Ivan Colhoun's analysis of the latest NAB business survey, which showed increasingly uneven performance across sectors.

The survey's net balance for business conditions slipped to -2 from -1. Forward orders and profitability also weakened, pointing to a slower period ahead for many firms.

Colhoun said the deterioration was modest rather than severe, but identified higher oil prices between July and October as a key driver of the recent shift. Because the survey was conducted before the Reserve Bank of Australia's November rate rise, it does not capture that impact, leaving open the prospect of further pressure in coming months.

"Australian businesses reported slightly weaker business conditions in October, but not extremely weak conditions. Higher oil prices between July and October have been an important factor in the recent deterioration in conditions. Weak forward orders and deteriorating profitability are signalling further slowing ahead, though the decline in forward orders looks suspiciously large this month. Input costs and labour costs remain very elevated. The trends by sector are consistent with increasingly divergent performance. Mining is the standout, but parts of construction, defence, energy, utilities, technology and services to these sectors are likely benefiting from the unusual mix of economic forces currently in play. Faring less well are interest sensitive and discretionary sectors - Real Estate and Residential Construction, Retail, Recreation and Personal Services. The survey was taken before the November interest rate rise, suggesting a further drag from interest rates in coming months, but oil prices have recently moved in the other direction. The RBA in any case is likely to remain on hold for an extended period now to assess developments in the economy and inflation," said Ivan Colhoun, Chief Economist, CreditorWatch.

Orders and margins

The survey detail pointed to broad weakness in new orders. Colhoun said the fall was especially pronounced in construction, manufacturing, and transport and utilities, with mining the only industry still reporting growth in new orders on a net basis.

Construction and retail appeared to be among the weakest parts of the economy in the latest reading. Colhoun said the softness in construction was notable given ongoing data-centre-related work, and suggested residential building may be starting to reflect the impact of higher interest rates, house prices and weaker turnover.

Cost pressures, meanwhile, remained high. Measures of purchase cost and labour cost growth were still elevated, even as retail prices showed only a 0.2% quarterly rate in the survey. That combination suggests a squeeze on margins for businesses with limited ability to pass on higher costs to customers.

Colhoun also noted that NAB has reduced the sample size of its monthly survey, making the results more volatile and less reliable, particularly at the industry and state level. He said that may help explain the scale of the latest fall in forward orders, which he described as unusually large.

Sector divide

The survey adds to evidence that higher borrowing costs are affecting sectors differently. Areas linked to discretionary spending and housing are under more strain, while mining and parts of the economy tied to investment in energy, utilities and technology appear to be holding up better.

Colhoun said this divergence reflected the combined effect of interest rates, energy prices and demand linked to investment themes such as artificial intelligence. In his view, this mix of forces is supporting some business activity while undermining areas more exposed to household spending or property markets.

Retail was singled out as particularly weak, alongside recreation and personal services and manufacturing. By contrast, mining remained the strongest performer in the survey.

State picture

Performance also varied across the states. Western Australia continued to post the strongest business conditions overall, although conditions there weakened in the latest month. New South Wales deteriorated further, while Victoria and Queensland improved.

Colhoun linked the weaker New South Wales result to the state's housing market and household debt profile. Consumers there tend to carry larger mortgages because of higher house prices, making them more sensitive to changes in interest rates.

Rates outlook

On monetary policy, Colhoun said the survey did not support the view that the economy was operating under severe capacity constraints. While capacity utilisation eased slightly again, he argued the move was not yet enough to confirm the recent rise in unemployment.

"I remain unconvinced by the RBA's capacity constrained narrative of the Australian economy. While aggregate capacity utilisation eased again a little this month, the sector data reveals a deterioration in five sectors was likely largely offset by an improvement in the large Recreation and Personal Services component. The NAB capacity utilisation measure is very closely correlated with both the unemployment rate and trends in the official cash rate. This reflects the fact that this measure of capacity utilisation includes an assessment of labour utilisation as well as plant and equipment. Cap use has eased a little in recent times, though the drop for me doesn't confirm the recent rise in unemployment as yet," said Colhoun.