Australia cost pressures test business margins as growth slows

The composite reading's slip to 52.5 from 53.2 still points to a third straight month of private sector expansion, keeping the growth narrative intact even as the pace moderates. The more telling signal for policymakers is the reacceleration in input price inflation, the first pickup after three months of easing, concentrated more heavily in manufacturing where fuel, freight and raw material costs rose. That firms responded by slowing their own charge inflation rather than passing costs through in full suggests margin compression is building, a dynamic that could show up in corporate earnings before it shows up in headline inflation data. The six month high in business confidence and the pickup in new export orders offer some offsetting signal that demand conditions are improving, which may embolden firms to test pricing power again if cost pressures persist.

The expansion remained concentrated in services, where business activity continued to grow even as the rate of expansion slowed compared with July. Manufacturing output slipped into contraction, with goods producers pointing to staffing disruptions, longer supplier wait times and rising costs as the main drags on production. New orders told a more encouraging story, rising for a second straight month and supported by gains at both manufacturers and service providers, with manufacturers leading the pickup. August also brought the first improvement in export performance since March, driven by a rebound in international demand for Australian manufactured goods.

Cost pressures were the standout concern in the release. Input price inflation accelerated in August, breaking a three month trend of slowing increases, with the pickup more pronounced in manufacturing than in services. Panellists frequently cited rising fuel, freight, commodity and raw material costs, along with higher supplier price lists and, in some cases, the impact of tariffs. Despite the sharper rise in costs, businesses were less aggressive in raising their own prices, with charge inflation easing to its slowest pace since the start of the year and running below the series average, leaving firms to absorb a larger share of the cost increase themselves.

Eleanor Dennison, economist at S&P Global Market Intelligence, said the Australian private sector continued to signal expansion despite the more challenging backdrop, supported by a further improvement in order books, with business sentiment among firms rising to its strongest level in six months. She said manufacturing had recorded its strongest injection of new work since the start of the year, even as supply chain disruption and cost pressures led to a modest drop in output, while services maintained their growth path with activity and new business expanding at a slightly slower rate than in July. On costs, she said the trend of softening input price inflation seen since April's peak had come to an end, with businesses continuing to absorb much of the increase and margin pressure expected to persist.

Employment continued to rise, marking the 19th increase in the past 20 months, though the pace of hiring was the softest in three months and modest across both broad sectors. Backlogs of work at service providers rose slightly for a second straight month, while goods producers saw their strongest drawdown of backlogs in just over a year. Looking ahead, firms' 12 month outlook for activity improved to its brightest level since February, with expansion plans, stronger commercial activity and hopes for improved customer confidence cited as reasons for the more upbeat mood, even as confidence remained subdued by historical standards.