Australian Q2 GDP growth 0.5%; 1.4%Y/Y

Momentum continues to slow in the Australian economy as real GDP growth on a seasonally adjusted basis printed in line the consensus forecast at 0.5% in the June quarter, which resulted in the annual pace slowing from 1.8% to 1.4%, as expected, to its weakest since Q3 2009. Output growth at 1.4% year-on-year was well below the Reserve Bank of Australia's (RBA) forecast for 1.7% and is roughly half the nation's trend or potential growth rate. 

Activity expanded by an annualised pace of around 1.0% over the first half of 2019 in which uncertainty was a major headwind, not only from offshore due to rising US-China trade tensions, geopolitical factors and financial market volatility but also at home in the lead up to May's federal election given the potential for changes to government policy. The RBA anticipates activity to strength over the second half, due mainly to the stimulatory boost from its cash rate cuts in June and July and the federal government's tax relief for low-and middle-income earners, though there are clear downside risks for its forecast for growth of 2.4% by year's end.       

The key dynamic in the Australian economy is that there continues to be a stark divide between private and public sector demand. Private sector demand contracted by 0.1% in the quarter to be -0.3% over the year -- its weakest pace in nearly a decade. In the public sector, underlying growth in demand lifted by a solid 1.4% in Q2 to be tracking at a 5.5% pace through the year, with support from healthcare spending and infrastructure investment.  

Weakness in private sector demand can be attributed to slowing growth in household consumption, the downturn in residential construction and weakness in business investment. The chart, below, highlights that activity in Q2 was driven mostly by public demand and net exports.   

Household consumption growth was 0.4% in Q2, a slight improvement from Q1's outturn of 0.3%, though the annual pace slowed from 1.8% to 1.4%, which is a 6-year low. Household disposable income in real terms declined by 0.3% this quarter to be just 0.5% higher over the year. The RBA has clearly articulated the headwinds to income growth from spare capacity in the labour market, though there are also challenging structural factors at play due to weakness in productivity. The squeeze from low income growth remains evident with the household saving ratio falling by 0.7ppt to 2.3% -- its lowest since Q4 2007. Household consumption continues to be driven by essential goods and services at 1.9% over the year, which compares to just a 0.6% pace for discretionary spending -- its lowest since Q1 2013. 

The downturn in the residential construction cycle gathered pace in Q2, with private sector activity on aggregate falling by 4.4% in the quarter to be down by 9.1% across the year. The details showed new home building contracting by 5.9% in the quarter (-10.9%Y/Y) and alterations -1.4% (-5.6%Y/Y).   

Business investment was weak on net falling by 0.4% in Q2 and by -1.6% over the year. However, this was weighed entirely by a 4.8% fall in non-dwelling construction in the quarter, with equipment spending (+3.2%q/q), intellectual property products (+2.9%q/q) and cultivated biological resources (+4.1%q/q) all rising. The ABS's recent Capital Expenditure survey was broadly constructive for investment plans in the 2019/20 financial year, though the headwinds from global and domestic economic conditions warrant caution. 

Public demand contributed notably to output growth in the quarter, driven by government spending on healthcare initiatives such as the NDIS and PBS. Investment declined in the quarter, however there is a robust pipeline of infrastructure projects to work through and this will support activity over the medium to long term.   

Net exports added a sizeable 0.6ppt to activity in Q2 -- its strongest contribution since Q1 2018. Export volumes lifted by 1.4% in the quarter with broad-based support from the resources sector, while imports contracted by a sharp 1.3% underscoring the weakness in private sector demand and a lower Australian dollar. Meanwhile, inventories subtracted 0.5ppt from GDP growth in the quarter.

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