Credit trends confirm dormant animal spirits

In light of recent comments from the RBA Governor, Glenn Stevens, that animal spirits remain dormant, the market will look for signs of a revival of entrepreneurial risk taking to gauge when the central bank might start to lift the overnight cash rate.  After what had been surprisingly strong growth in business credit in June, the estimate for July - released this morning - suggests that the corporate sector continues to defer capital expenditures and remains reluctant to raise gearing significantly.  Business credit rose by 0.3% in July and remains slightly below its peak in November 2008.  This weakness is consistent with the anecdotal evidence from the current reporting season, where restructuring and cost cutting are recurring themes among the 150 companies in the ASX200 that have reported their full year result.

Animal spirits in the housing sector remain buoyant, with housing credit have posted 0.5% growth in July.  Investors remain the key driver, having grown at an annualised rate of 7% over the past five years.  Despite concerns that investors continue to crowd out first home buyers, the fact that Australia has added over 2 million people to its population in the past eight years suggests that there is considerable pent up demand for housing, particularly in the major capital cities.  Talk of bubbles in residential property markets is premature considering that rental yields remain well supported and are in line or slightly higher than historical norms.

The softer than expected trading updates from discretionary retailers over the past quarter is consistent with still anaemic growth in personal credit, which remains 8% below its 2008 peak.  The weakness is all the more striking considering the population boom during this time, cited above. 

The RBA continues to under-estimate the power of monetary policy to revive animal spirits in the corporate sector, particularly in the non-mining sectors.  It clearly retains a watchful eye on the strength in investor housing.  Moreover, its submissions to the Murray Inquiry suggest that it remains wary of the major banks' capital ratios and the growing share of mortgages on their loan books, which is the highest in the industrialised world at over 60%.

The persistent weakness in business credit is a clear sign that animal spirits in the corporate sector remain dormant, and companies will continue to trim costs aggressively to combat subdued revenue conditions.  The market implications are straightforward: the RBA's timid approach to monetary policy means that growth in nominal GDP and company revenues will remain weak, interest rates will be lower for longer, and defensive stocks with high yields should continue to produce higher returns than the broader market, despite trading at already stretched valuations.