RBA slams brakes on the brakes

Australia enters new cash rate cycle as inflation rises

Anneke Thompson Chief Economist CreditorWatch

High inflation is currently a global phenomenon, with various structural elements combining to create a perfect inflationary storm. High fuel costs as a result of the war in Ukraine is one major factor, impacting everything from shipping, trucking, air freight to food and manufacturing. Ongoing supply chain disruptions and production and staffing issues associated with COVID-19 are causing short term havoc. And global labour mobility has been severely impacted by the pandemic, with countries that typically import a lot of labour reporting severe productivity constraints as they make do without these employees.

Compared to other OECD nations, Australia’s inflationary curve was relatively modest, until the March 2022 quarter data was released. The USA and UK are recording inflation between 5.5 and eight per cent. Combined, the OECD

“Inflation is now well outside the RBA’s target band of two to three per cent: bringing in under control will involve a measure of short-term pain (for borrowers) for long term gain as price increases are brought under control.”

nations reached an average inflation rate of almost eight per cent by Q1 2022. The Reserve Bank of Australia (RBA) appears to be particularly concerned about the steepness of the inflation curve, and moved to increase the cash rate on 3 May ahead of any official data indicating wages are starting to increase. Inflation is now well outside the RBA’s target band of two to three per cent: bringing in under control will involve a measure of short-term pain (for borrowers) for long term gain as price increases are brought under control.

Reflecting their rising risk profile due to Australia’s higher inflationary environment, the Food and Beverage Services, Arts and Recreation Services and Transport, Postal and Warehousing Industries have all recorded an increase in their Probability of Default this year. As inflation works through the economy, it is expected that consumers will reduce spending on discretionary items.

Combined with home loans becoming ever more expensive for borrowers, we will start seeing spending patterns change, and reduce in many areas. Indeed, this is partly the aim of the RBA when they increase the cash rate. Cafés, restaurants and the arts and entertainment sectors are all typically areas where consumers choose to spend less as their discretionary income declines.

Annualised Inflation

Source: OECD

What does rising inflation mean for consumer confidence?

In the world’s major economies, rising prices and further interest rate rises are weighing on consumers’ minds more than they did when COVID-19 first went global in early 2020. In 2020, consumer confidence plummeted as the shock of the pandemic set in. However, massive amounts of government stimulus quickly reversed the trend, and, like it or not, most consumers settled into a life of online shopping, home renovations and lots of cooking! In Australia and the OECD, consumer confidence peaked around mid 2021, before the Delta wave arrived, and we realised that COVID-19 was not going away any time soon. Since then, the trajectory has been progressively worsening, as rising prices, COVID-related supply chain disruptions and the war in Ukraine all add up. Importantly, most consumers have now come to expect that their home and personal loans are going to get progressively more expensive, and this will curtail discretionary spending going forward.

Consumer confidence in Australia is sitting above the USA, UK and OECD average, however, we are not as far into our inflationary cycle. So, expect that this indicator will continue to worsen. Incredibly, consumers feel worse now than when they did when COVID-19 began. This is likely because both consumers and borrowers

Consumer Confidence Index

Source: OECD

now know that government stimulus has dried up, and central banks are going to need to wind back two years’ worth of extra liquidity injections.

Most developed economies were flooded with cash during the pandemic, which alleviated short term economic pain and certainly kept workers who were unable to work financially afloat, however, the cash is now showing up as higher prices across the board as the world normalises again. Australia’s money supply rose by about 22 per cent throughout COVID-19, far less than some other countries, so the good news is we may have a smaller problem to work through than some larger economies, namely the US.

What does this mean for the credit outlook for Australia’s industry sectors?

CreditorWatch’s February 2022 industry data recorded a significant rise in the probability of default for the Food and Beverage Services sectors, which rose from 5.7 per cent to 6.7 per cent over the month. This was the highest probability we had calculated in some time, and once again, probability of default for this sector has risen, now sitting at 7.1 per cent as at April 2022.

This figure sits well above all other industries, with the Arts and Recreation sector being the next most vulnerable at 4.8 per cent. The Food

and Beverage Services sector is facing numerous headwinds, even though turnover will be well up after years of COVID disruption. Labour, food, utilities and borrowing costs are all rising for this sector, while at the same time consumers are easily able to substitute eating a meal out at a restaurant for eating at home. This means that demand is likely to wane, particularly after further cash rate increases. In a similar vein, the Arts and Recreation sector will feel the burden of consumers reducing their discretionary spending as we move through 2022. The April 2022 Business Risk Index shows that the three industries with the highest probability of payment default over the next 12 months are:

At the other end of the spectrum, Health Care and Social Assistance maintained the lowest probability of default, at 3.3%. Agriculture, Forestry and Fishing remains the sector with the second lowest probability of default, at 3.5%. The challenges of moving goods around the globe means that the local manufacturing sector now comes in as the sector with the 3rd lowest probability of default (3.6%), overtaking Wholesale Trade.

“Most developed economies were flooded with cash during the pandemic, which alleviated short term economic pain and certainly kept workers who were unable to work financially afloat, however, the cash is now showing up as higher prices across the board...”

1. Food and Beverage

Services:

2. Arts and Recreation

Services:

3. Transport, Postal and

Warehousing: 7.1% (down from 7.2%)

4.8% (down from 4.9%)

4.7% (down from 4.8%)

The April 2022 Business Risk Index shows that the three industries with the lowest probability of payment default over the next 12 months are:

1. Health Care and

Social Assistance:

2. Agriculture, Forestry and Fishing:

3. Manufacturing: 3.3% (steady at 3.3%)

3.5% (down from 3.6%)

3.6% (down from 3.7%) Payment arrears is still a particular problem for the construction industry, with 11.7 per cent of the sector in 60 days or more arrears. This proportion is by far and away above any other sector, and partially represents almost the normalisation of late payment in the industry. As such, even though arrears are a problem in the construction sector, the probability of default rate is still a relatively low 3.8 per cent.

Anneke Thompson

Chief Economist CreditorWatch T: 1300 501 312 www.creditorwatch.com.au

Average Probability of Default by Industry

Food and Beverage Services Services Recreation and Arts Warehousing and Postal Transport, Training and Education Financial and Insurance Services and Media Information, Telecommunications Services Estate Real and Hiring Rental Administrative and Support Services Mining Other Services Accommodation Technical and Scientific Professional, Services Trade Retail Waste and Water Gas, Electricity, Services Construction Trade Wholesale Manufacturing Fishing and Forestry Agriculture, Assistance Social and Care Health

Source: CreditorWatch BRI April 2022