Bulletin

22 March 2012

The WestpacACCI Survey of Industrial Trends Q1 2012

Conditions lacklustre, labour market weakening
The WestpacACCI Actual Composite edged lower in
the March quarter to 47.4, from 48.2. This is the fourth straight sub-50 quarter.
70 60 50 40 30 20 Mar-75
Actual Expected
Sources: ACCI, Westpac

Westpac-ACCI composite indexes

Actual & expected, sa
index index 70 60 50 40 30 20 Mar-83 Mar-91 Mar-99 Mar-07

The Expected Composite rose to 51.6 in the March

quarter, from 50.2. In the past six months, the Expected Composite has retraced a third of the decline experienced over the six months to September 2011.

The 'outlook for general business conditions' net balance

improved for a second consecutive quarter, but at 11%, it still remains well below the decade average of 2%.

Although it improved marginally in the quarter, the level

of the Labour Market Composite remains consistent with annual employment growth of less than 1.0% over the next six months.

Further, news on the availability of labour compared to

three months ago also pointed to labour remaining 'easier to get' in early 2012.
10 8 6 4 2 0 -2 -4

Manufacturing & the business cycle

Westpac-ACCI composite index & domestic demand
% ann index
Sources: ACCI, Westpac

75 65 55 45 35 25

Consistent with the softer labour market conditions, more

manufacturers are now expecting the wage outlook to be subdued.

Despite the Actual Composite remaining in 'contractionary

territory', there was a modest improvement in the investment outlook.

Profit expectations deteriorated in mid 2011 after a strong

post-GFC recovery and have been weak since, although they have improved a little of late.

domestic demand (lhs)

actual composite (rhs)

Unit cost pressures were reported to have increased

further in the March quarter and they are expected to rise again in the June quarter, albeit not to the same extent.

-6 15 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12

Manufacturers' pricing power remains extremely limited:

on balance, average selling prices were reported to have declined in the quarter and are expected to remain broadly unchanged in the coming quarter.
80 60 40 20 0 -20 -40 -60 -80

General business situation

Next six months
% net % net 80 60 40 20 0 -20 -40 -60 -80
Sources: ACCI, Westpac

Actual export conditions deteriorated further in the March

quarter, likely owing to the continued strength of the Australian dollar and softer global growth. Respondents expect export conditions to improve in the June quarter, but only marginally so.

-100 -100 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12

Westpac Institutional Bank is a division of Westpac Banking Corporation ABN 33 007 457 141. Information current as at date above. This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs. Westpacs financial services guide can be obtained by calling 132 032, visiting www.westpac.com.au or visiting any Westpac Branch. The information may contain material provided directly by third parties, and while such material is published with permission, Westpac accepts no responsibility for the accuracy or completeness of any such material. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice and Westpac is under no obligation to update the information or correct any inaccuracy which may become apparent at a later date. Westpac Banking Corporation is registered in England as a branch (branch number BR000106) and is authorised and regulated by The Financial Services Authority. Westpac Europe Limited is a company registered in England (number 05660023) and is authorised and regulated by The Financial Services Authority. Westpac operates in the United States of America as a federally chartered branch, regulated by the Office of the Controller of the Currency and is not affiliated with either: (i) a broker dealer registered with the US Securities Exchange Commission; or (ii) a Futures Commission Merchant registered with the US Commodity Futures Trading Commission. If you wish to be removed from our e-mail, fax or mailing list please send an e-mail to economics@westpac.com.au or fax us on +61 2 8254 6934 or write to Westpac Economics at Level 2, 275 Kent Street, Sydney NSW 2000. Please state your full name, telephone/fax number and company details on all correspondence. 2012 Westpac Banking Corporation. Past performance is not a reliable indicator of future performance. The forecasts given in this document are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts.

22 March 2012
The WestpacACCI Actual Composite has a solid track record of predicting near-term final demand growth, including identifying turning points in the cycle. The components of the Composite Index are output, new orders, backlog of work, employment and overtime, with weights equivalent to the US ISM (nee NAPM) manufacturing survey. In the March quarter, the WestpacACCI Actual Composite edged lower to 47.4. The index has now been in the sub-50 contractionary zone for a year, averaging 48.1 during that time. That is well below the year to March 2011 average of 54.3, but is still well above the low levels seen in the midst of the GFC (the 2009 average of 42.9 and the cycle low of 34.1, seen in March 2009). The sub-50 readings for the Actual Composite over the past year have pointed towards weak conditions in the sector and, more broadly, a deceleration in domestic demand growth a trend that has also been evident in the national accounts data. Domestic demand growth was weak in Q4 2012, rising by only 0.2% the slowest pace of growth since Q2 2009. Annual growth also eased back to 4.4%yr, from 4.9%yr. While the pace of growth seen over 2011 is still a strong outcome, it must be remembered that this growth has been concentrated in the mining sector and that investment in this sector is relatively job-light and has a significant import component. Taking a broader perspective, although Australian growth outcomes have been better than most other advanced nations, Australian growth has still been stuck at a sub-trend pace for four years. Given the persistent weakness in the Actual Composite, it is not surprising that the net capacity utilisation indicator remained well below 'normal' at 21% in Q1 2012. Indeed, this indicator suggests that the manufacturing sector has been working below its 'normal' level of capacity utilisation for almost four years. In contrast to the Actual Composite, the Expected Composite rose in the March quarter to 51.6, a level consistent with expectations of modest expansion. In the past six months, the Expected Composite has retraced a third of the 15 point decline that occurred over the six months to September 2011. Despite improving in the quarter, manufacturers remain pessimistic about the future: a net 11% of respondents expect the general business situation to deteriorate in the next six months; that is well below the average level of the two years to March 2011 (the previous peak) of 19%, the decade average of 2% and the full-history average of 2%. Looking at the overall economy, mining investment is expected to continue to provide strong support for growth in 2012 and beyond, but the non-mining sector is weak and in need of further stimulus. We expect economic growth to maintain a sub-trend pace over the first half of 2012 before easier monetary conditions provide a boost to conditions. Labour market conditions will be key to the outlook for the economy and the RBA's policy stance. On the employment front, the Labour Market Composite improved a little in the March quarter, rising from 8.5% to 7.0%. The level of this index is consistent with annual employment growth of less than 1.0% over the next six months. Also, the proportion of respondents reporting labour as "harder to get" in net terms was unchanged in Q1 2012 at 4%. Both of these metrics are consistent with our expectation that the labour market will remain weak, resulting in an increase in the unemployment rate to around 5.7% in the next 36 months. Consistent with the soft labour market conditions, net wage growth expectations edged down in Q1 2012: 5% of respondents

Capacity utilisation
40 20 0 -20 -40 -60
Sources: ACCI, Westpac

% net

% net

40 20 0 -20 -40 -60

-80 -80 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12

Jobs growth has weakened

30 20 10 0 -10 -20 -30 -40 -50
Sources: ACCI, Westpac, ABS

% net

% ann

6 4 2 0

Westpac labour market composite - adv 2 qtrs (lhs) employment growth (rhs)

-2 -4

-60 -6 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12

Difficulty of finding labour

-80 -60 -40 -20 0 20 40 60
difficulty of finding labour - inverted (lhs) unemployment rate (rhs)
RBA hikes

%
Sources: Westpac, ACCI, RBA, ABS

12 10 8 6 4 2 0

80 Mar-84

Mar-89

Mar-94

Mar-99

Mar-04

Mar-09

Manufacturing wage growth pressures

40 30 20 10 0 -10 -20
Manufacturing Wage Price Index (rhs) wage rises greater than previous bargaining agreement* (lhs)

% net
*leading 2 quarters

% ann
Sources: ACCI, Westpac, ABS

5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0

-30 Mar-05

Mar-07

Mar-09

Mar-11

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

22 March 2012
now expect their firm's next wage deal will produce a smaller annual wage rise than the previous deal. The last three net balance prints for this measure are a stark contrast to the outcomes of the prior 18 months which averaged +10%. The WestpacACCI measure is pointing to a material softening in the ABS' Wage Price Index in the next 6 months. Profit expectations again firmed modestly in Q1 2012, with a net 4% of respondents now expecting their firm's profitability to improve over the coming year. It is apparent that firms have been less optimistic about their profitability over the past year than has historically been the case. Arguably this is a function of the strong Australian dollar and healthy wage growth. It is interesting to note that as manufacturers' wage expectations have softened in the past six months, profitability expectations have improved. However, it is clear that manufacturers face additional cost pressures. In Q1 2012, the average unit costs net balance remained elevated at 20% in Q1 2012. Manufacturers expect unit cost pressures to persist in Q2 2012, with a net 8% of respondents expecting their input costs to rise. Manufacturers are facing additional pressures owing to a lack of pricing power. On balance, average selling prices were reported to have declined further in Q1 2012 by 4% of respondents. Average selling prices are expected to gain a reprieve in Q2, with a net 1% of respondents expecting an increase in prices. This expectation is principally a function of less respondents expecting further declines in selling prices (10% vs 18%). All told, the current environment is not one that is conducive to a robust improvement in manufacturers' profitability, even though wage pressures seem to be abating. Turning to investment, manufacturers' plans for plant & equipment investment in the next 12 months were little changed in Q1 2012, with a net 6% of respondents planning to reduce their spending on equipment. Spending plans for buildings firmed modestly, but remained negative: a net 10% of respondents expect to reduce building investment in the year ahead. This is the fourth consecutive negative net balance for buildings and the third for equipment, highlighting an entrenched unwillingness amongst manufacturers to expand their operations. The Actual Composite has also had a good fit with economywide plant & equipment investment. In this cycle, the recovery in business equipment investment lagged the Actual Composite; but the deterioration in the index over the past year has not been followed by a deceleration in equipment investment growth. This is not that surprising when one recognises that it is the mining sector that is driving the current surge in equipment investment, and business investment more broadly. The 2011 CAPEX data highlights the importance of the mining sector: in Q4, mining CAPEX spending was up 78% over the year; in contrast, nonmining CAPEX was up 3.3%yr. In sum, this survey has again emphasised the weak state of the non-mining economy. Indeed, whereas international measures of manufacturing activity (e.g. the manufacturing ISM) picked up in Q1 2012, our WestpacACCI Actual Composite deteriorated further. Clearly the strong Australian Dollar is having a material impact on Australian manufacturers and, more broadly, the non-mining economy. With activity lacklustre and the labour market weakening, there is a very real need for looser financial conditions. We expect the RBA will respond by easing policy, beginning in May or June 2012. Elliot Clarke, Economist +61 (2) 8253 8476
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

Profit expectations
Next twelve months
80 60 40 20 0 -20 -40
Sources: ACCI, Westpac

% net

% net

80 60 40 20 0 -20 -40

-60 -60 Mar-91 Mar-94 Mar-97 Mar-00 Mar-03 Mar-06 Mar-09 Mar-12

Investment intentions
Next twelve months
40 20 0 -20 -40
Sources: ACCI, Westpac

% net

% net

40 20 0 -20

plant & equipment building

-40

-60 -60 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12

Activity & capital investment

Westpac-ACCI composite & equipment investment
30 20 10 0 -10
P&E investment - 3qtr MA (lhs) Westpac-ACCI composite (rhs)

% ann

index
Sources: ACCI, Westpac, ABS

70 65 60 55 50 45 40 35 30 25

-20 20 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12

Australian & US manufacturing surveys

Westpac-ACCI & ISM composite indexes
70 60 50 40 30 20 Mar-82
Westpac-ACCI (lhs) ISM (rhs)

index

index
Sources: ACCI, Westpac, Factset

70 60 50 40 30

Mar-88

Mar-94

Mar-00

Mar-06

20 Mar-12