Should we worry about a global oil shock?

In the absence of a single, big domestic data drop this week, attention has been on potential economic fallout from worsening conflict in the Middle East in general and the risk of a significant oil price shock in particular. The region accounts for about one-third of global oil production. After all, history tells us that regional conflicts in this part of the world can sometimes lead to substantial disruptions to the supply and therefore price of oil and possibly of other commodities such as natural gas (which would in turn have implications for the price of fertilisers and therefore food), and that these price effects can in turn have destabilising consequences for the global economy, including higher inflation and lower activity. 

Key regional disruptions to the oil market in the past include the 1956-57 Suez Crisis, the 1973-74 Arab oil embargo in response to the Yom Kippur War, the 1978-79 Iranian Revolution, the 1980-88 Iran-Iraq war and the 1990 Iraq invasion of Kuwait. More recent disruptions include the 2011 Libyan civil war, the 2019 attacks on Saudi oil facilities and the levying of sanctions on Iran.

But analysis of this same historical record also tells us there is no simple, mechanical relationship between an oil price shock and global economic developments. Rather, the economic magnitude of any oil shock will depend not just on the size and duration of the disruption to regional supply, but also on a broader mix of supply and demand considerations. On the supply side, these will include the availability of alternative supply sources and the presence of (and willingness to deploy) strategic reserves. On the demand side, the prevailing level of the global economy’s reliance on oil will be important, which will partly reflect the current oil intensity of production. (This is the amount of oil required to produce one unit of GDP, which fell from 0.12 tonnes of oil equivalent (toe) in 1970 to 0.05 toe by 2022). It will also reflect the prevailing cyclical strength of world economic growth and consequent global oil demand. So, for example, while the two big 1970s oil shocks have been widely seen as triggering the onset of global stagflation, there have been similarly-sized price moves since then that have resulted in considerably less international economic disruption.

That complex set of interactions has been visible in the muted response of global oil prices to the conflict to date, in part because markets have been grappling with the hard-to-gauge probability of future supply disruptions, rather than an immediate shortfall. So, for example, the price of benchmark crude did jump to over US$90/barrel following the October 2023 Hamas attack on Israel. In the following months, however, prices retreated quite considerably from this high. Indeed, earlier last month the price of benchmark Brent crude had fallen to below US$70/barrel for the first time in three years after prices slumped by about US$10/barrel over August and early September 2024. In its September 2024 Oil Market Report, the IEA highlighted a rapid decline in global demand growth as driving this sell-off. Part of the story here was soft activity in China, which had seen oil consumption declining year-on-year for four consecutive months to July 2024. But the IEA also pointed to surging Chinese EV sales as signalling lower demand for road fuel on a more sustained basis.

More recently, in the aftermath of the recent Iranian missile attack on Israel, there was indeed a jump in the oil price, with the price of benchmark Brent crude rising to US$76/barrel, before falling back to around US$74/barrel, indicating that markets remain alert to the possibility of a future supply disruption. Yet just a few days later, the WSJ was quoting the Saudi oil minister as warning that oil prices could fall to as low as US$50/barrel if OPEC+ members failed to stick to their current pledged production limits.

None of this is to argue for complacency about the potential risk of an oil shock or other economic and financial disruptions, should the current conflict in the Middle East expand further. But hopefully it does provide some helpful context for making those risk assessments.

As already noted, there was no single key Australian data release this week. Rather, we received several updates cutting across a few economic themes. A stronger-than-expected August retail turnover result could be interpreted as evidence that an anticipated H2:2024 recovery in household consumption is getting underway. But the ABS also cautioned there are some one-off drivers behind the month’s spending rebound. The regular monthly download on home values from CoreLogic showed that while national home prices kept rising in September, the momentum of that price growth has continued to ease. Meanwhile, a decline in the rate of net overseas migration appears to be feeding into a slowdown in the rate of rental growth. On the other hand, with the trend in monthly building approvals running at around 14,000 and hence well below the kind of numbers needed to make the government’s target of 1.2 million new homes by 2029 look realistic, supply constraints remain significant. Also, this week, the Treasurer was able to confirm that the Australian economy had managed to run back-to-back budget surpluses for the first time since 2007-08. In fact, the final surplus came in larger than had been predicted at the time of the Budget and the burden of net debt as a share of GDP similarly came in below expectations. Which means that – despite some significant medium-term structural fiscal challenges – Australia continues to enjoy a debt and deficit position that will be the envy of many of its advanced economy peers.

There is a more detailed review of the week’s Australian data releases below, along with our regular linkage roundup that this time includes the latest IMF assessment of the Australian economy, a new Productivity Bulletin and an updated set of export forecasts in the latest Resources and Energy Quarterly. Finally, reminders that you can hear more about recent developments on the Dismal Science podcast and that my upcoming economics webinar on Australia and the New Economics of Industrial Policy, will be held on Thursday 17 October from 12 to 1pm. You can register for that webinar here.

Retail sales growth bounces back in August

The ABS said retail sales rose 0.7 per cent over the month (seasonally adjusted) in August 2024 to be up 3.1 per cent over the year. The pace of monthly growth was notably stronger than the meagre 0.1 per cent increase reported in July and was also above June’s 0.5 per cent expansion, as well bettering the market median forecast for a 0.4 per cent increase.

As readers will be aware, the future path of household consumption is one key uncertainty for the economic outlook. The RBA’s latest forecasts anticipate that spending will strengthen through the second half of this year as lower inflation, budgetary cost-of-living relief and tax cuts all work to lift disposable income. But weak levels of household sentiment suggest there is also some risk that households will choose to save, not spend, any income gains.

So, one view of the August increase in retail spending might be that it is consistent with the RBA’s base case (although note in this context that retail trade now only covers about one-third of household consumption as the pattern of spending has shifted towards services). Alternatively, the increase in the monthly growth rate may just reflect temporary factors that tell us little about underlying trends. For example, the Bureau said spending during the month was boosted by warmer-than-usual weather, with August 2024 the warmest August on record since 1910. The result was seen in increased spending on items that the ABS reckons are usually purchased in Spring, including summer clothing, liquor, outdoor dining, hardware, gardening items, camping goods and outdoor equipment. According to the Bureau, turnover in August also received a further boost from increased discretionary spending in response to Father’s Day-related sales events (Father’s Day this year fell on 1 September).

Australian housing market update

This week also brought new data on Australian house price and building approvals (with numbers on lending to owner-occupiers and investors due out on Friday).

Starting with house prices, CoreLogic reported that its national Home Value Index (HVI) rose by 0.4 per cent in September 2024 to stand 6.7 per cent higher over the year. The rate of monthly increase was little changed from the 0.3 per cent monthly growth rates reported in July and August and CoreLogic noted that with national home values only rising by one per cent over the September quarter, this represented the softest quarterly growth rate since March 2023.

The combined capitals index rose 0.5 per cent over the month and 6.7 per cent over the year, with the span of monthly price changes ranging from a 1.6 per cent increase in Perth and a 1.3 per cent gain in Adelaide to a 0.4 per cent fall in Hobart and a 0.3 per cent decline in Canberra.

CoreLogic’s assessment of the latest numbers is that the immediate outlook for housing markets is for continued overall growth in values, albeit accompanied by a further decline in momentum and an increase in diversity in price performance across the cities and regions. The current slowdown in market momentum looks to reflect an increase in supply as new listings are currently running almost nine per cent higher than the previous five-year average, with the flow of advertised housing stock the highest since 2021. There has also been some sign of a moderation in demand, with auction clearance rates falling by to four percentage points below their 10-year average. At the same time, house prices are underpinned by a still-robust labour market, expectations of a future RBA rate cut, budgetary support to household balance sheets from tax cuts and energy rebates and ongoing supply constraints limiting new housing supply.

Meanwhile, the national rental index increased by just 0.1 per cent over the September quarter, making the smallest change over a rolling three-month period in four years, with Sydney (down 0.5 per cent), Brisbane (down 0.2 per cent) and Canberra (down 0.8 per cent) all experiencing a decline in rents over the quarter. CoreLogic pointed to a slowdown in net overseas migration (down 19 per cent in Q1:2024 from the record highs set in Q1:2023) and affordability pressures as behind the ongoing moderation in the pace of rental growth.

Turning to building approvals, the ABS reported that total dwellings approved in August 2024 fell 6.1 per cent over the month to 13,991 (seasonally adjusted). That number was up 3.6 per cent relative to August last year. Approvals for private sector houses were up 0.5 per cent over the month and 8.4 per cent over the year to 9,338, while approvals for private sector dwellings excluding houses fell 16.5 per cent over the month and dropped 6.1 per cent over the year to 4,418. The decline in unit approvals followed a big jump in approvals for multi-unit dwellings in July this year and reflects the monthly volatility in apartment approvals.

Likewise, the value of total buildings approved fell by 0.2 per cent (to $13.25 billion) in August, following a 6.9 per cent rise in July.

On a trend basis, approval numbers have now risen from a little below 13,000 in January this year to almost 14,000 in August. This leaves them running well below a rate that would be consistent with the government's pledge to build 1.2 million new homes by 2029, which would imply an average annual construction rate of around 240,000 or a monthly rate of 20,000.

The 2023-24 final fiscal outcome

The Treasurer announced that the Final Budget Outcome for 2023-24 was an underlying cash surplus of $15.8 billion or 0.6 per cent of GDP. That follows a $22.1 billion (0.9 per cent of GDP) surplus in 2022-23 and means the government has delivered Australia’s first back-to-back budget surpluses since the global financial crisis. The budget position has now improved by $172.3 billion over the past two years, allowing the Treasurer to boast the largest nominal improvement in the budget position in any Parliamentary term. The final 2023-24 outcome also beat the fiscal forecast presented earlier this year in Budget 2024-25 by $6.4 billion or 0.2 per cent of GDP. The Budget projections had assumed a smaller surplus of $9.3 billion or around 0.3 per cent of GDP.

The fiscal improvement was driven by government payments coming in $10.2 billion below expectations. This was due to a mix of lower demand for some programs (including a $4.2 billion undershoot across several National Partnership agreements after delays in project delivery, plus lower payments due to lower unemployment rates) as well as delays in other payments. That in turn was more than enough to offset a $5.3 billion shortfall in tax payments, which was the product of lower personal and company income tax receipts.

As a share of GDP, government payments were 25.2 per cent, down slightly on Budget projections of 25.4 per cent. Budget receipts were 25.8 per cent of GDP, unchanged from the Budget projections, and at their highest level as a share of GDP since 2000-01.

By the end of 2023-24, gross government debt was $906.9 billion or 34 per cent of GDP. That was slightly higher than the Budget estimate of $904 billion or 33.7 per cent of GDP. On the other hand, net debt was $491.5 billion or 18.4 per cent of GDP, which was lower than the Budget estimate of $499.9 billion or 18.6 per cent of GDP. The net debt outcome was driven by a fall in the market value of Australian Government Securities alongside higher-than-estimated cash reserves and advances paid. As a share of the economy, net debt has now fallen back to its lowest level since 2016-17.

What else happened on the Australian data front this week?

The ANZ-Roy Morgan Consumer Confidence Index fell 2.9 points to a reading of 82 for the week ending 29 September, (extending the run of weeks that the index has been below the 85 mark) to a new record of 87. All five subindices fell over the week, with the largest decline coming in ‘current financial conditions’ which dropped 6.7 points in its largest weekly fall in more than a year. The decline in confidence followed the RBA’s decision last week to leave the cash rate target unchanged. In the aftermath of last week’s sub-three per cent monthly inflation reading, the survey measure of weekly inflation expectations fell 0.3 percentage points to 4.6 per cent – the joint lowest result since September 2021.

The ABS said the seasonally adjusted balance on Australia’s goods trade increased by just $8 million to leave the monthly surplus largely unchanged at $5.6 billion in August 2024. Goods exports fell $66 million (down 0.2 per cent) while goods imports fell $75 million (also down 0.2 per cent).

Other things to note . . .

• The Staff Concluding Statement from the IMF’s 2024 Article IV Mission to Australia says ‘near-term policies should continue to focus on reducing inflation while nurturing economic growth’. The fund reckons the RBA’s current restrictive monetary policy stance is ‘appropriate’ and says it expects a gradual economic recovery. Growth is forecast to start picking up through the second half of this year, and underlying inflation to return sustainably to target by the end of next year. But the IMF also warns that risks to this outlook are tilted to the downside, highlighting an uncertain external environment, along with concerns that disinflation could stall or that growth could prove weaker than forecast. If the disinflation process did stall, the Fund’s recommendation is for tighter fiscal and monetary policies – an unwelcome combination for an incumbent government with an election looming. In the medium-term, the IMF offers its support for the proposed new Monetary Policy Board for the RBA; for tax reforms that reduce reliance on direct taxes, alongside the phasing out of tax breaks including the capital gains tax discount and superannuation concessions; for reforms to capital and labour markets to lift productivity growth; and for the pursuit of a ’balanced mix of mitigation and adaption, combined with transition policies’ to deliver an ‘orderly transition to a low-carbon economy.’
• The Productivity Commission’s September 2024 Quarterly Productivity Bulletin warns that a year on from the bursting of the ‘COVID-19 productivity bubble’, Australian productivity growth appears to have reverted to a similar stagnant pattern to that observed in the five years leading up to the pandemic. This similar productivity growth is occurring within a quite different economic environment, however, one marked by near-record high labour force participation, low unemployment, and high interest rates.
• The September 2024 edition of Resources and Energy Quarterly (REQ) reckons the near-term outlook for Australian resource and energy commodity exports has worsened since the June 2024 REQ. Tight monetary policy settings continue to constrain growth in the major Western economies, while China’s economic performance suffers from the country’s weak property sector. In the September quarter of this year, for example, spot iron ore prices fell to two-year lows because of falling steel production in China and weakness in overall global steel demand and the REQ says lower prices are expected to reduce Australia’s iron ore export earnings by about $30 billion this year. According to the REQ, a rising AUD/USD plus lower commodity prices mean the total value of our resource and energy exports will fall from $415 billion in 2023-24 to $372 billion in 2024-25, before dropping again to $354 billion in 2025-26.
• New research from the e61 Institute looks at supermarket competition in Australia and argues policymakers need to consider not just supply-side issues (such as barriers to entry or anti-competitive mergers and acquisitions) but also demand-side factors (such as consumer inertia).
• The Grattan Institute runs its eye over the case for reform of negative gearing, arguing it should be seen not so much about housing policy as about good tax reform. (Their modelling of the Institute’s proposed changes to both negative gearing and the capital gains tax discount suggests this would raise about $2 billion and $5 billion a year in revenue, respectively, but perhaps take just two per cent off house prices – which have risen by about 50 per cent over the past five years).
• Via FT Alphaville, J P Morgan Asset Management’s comparison of Trump vs Harris policies.
• Related, the Peterson Institute explains what populists don’t understand about tariffs but economists do.
• The BIS Deputy General Manager gave a speech to the LSE on monetary policy in an era of supply headwinds, warning the future is likely to bring more volatile inflation and that this will require central banks to be more cautious about adopting their traditional approach of ‘looking through’ supply shocks.
• The OECD’s Tax Policy Reforms 2024.
• Related, the Economist magazine says if governments must raise revenues then they should try increasing taxes on consumption (such as the GST or another form of value added tax).
• The WSJ on the relationship between migration and government budgets. The piece draws on US Congressional Budget Office research on fiscal and economic implications of the recent surge in immigrants into the United States and a study from earlier this month by the UK Office for Budget Responsibility which includes a look at the fiscal implications for different compositions of migration in terms of age, earnings and length of stay.
• Also from the WSJ, how China’s housing glut is colliding with a shrinking population. (Neat accompanying images).
• A new IMF Staff Discussion Note looks at Green jobs and the future of work for men and women.
• On the end of development economics and measuring economic losses caused by climate change.
• Two interesting Big Reads from the FT. The first looks at China’s accelerating green transition, juxtaposing the rapid expansion in green energy with the country’s longstanding addiction to coal. The second argues that one critical way to boost India’s economic performance is by lifting the status of women, including by making them safer.
• This podcast from the Grattan Institute asks, should Australia invest in nuclear power?
• The Odd Lots podcast discusses how industrial policy can go bad.
• A bit different and YMMV, but after reading a bunch of his stuff way back when, I enjoyed this podcast discussion of Philip K Dick’s Do Androids Dream of Electric Sheep.