The two main factors behind that analysis were slowing growth in households' spending on goods and services and activity in residential construction turning over. Household consumption, which accounts for a little above 50% of the domestic economy, was soft in Q4 lifting by 0.4% and by 2.0% through the year — its slowest annual rate in 5½ years. Slowing consumption growth indicates that households are being constrained by weak income growth with saving having declined over recent years to a very low level, notwithstanding an uptick in Q4. Added to the mix were concerns around wealth effects from declining property prices and volatile equity markets during the quarter. Residential construction showed signs of weakness in Q3 that deepened towards the end of the year. Activity looks to be past the peak with new construction (-3.6%) and alterations (-3.1%) declining sharply in Q4 and fits broadly with the deterioration in building approvals that occurred over the second half of 2018.
While 2018 was a year of two halves for the domestic economy, it was also a year of two sides with growth in private and public sector demand diverging, as shown in our chart of the week, below. Public demand lifted sharply in 2018 driven by healthcare spending and infrastructure investment and was the leading contributor to economic growth over the year. In contrast, private demand slowed in response to broad-based softness from households, residential construction, and business investment.
Chart of the week
The soft growth outcome resulted in financial markets firming expectations for the Reserve Bank of Australia (RBA) to cut the cash rate. Markets are now fully priced for a 0.25% rate cut in September — in the hours before the GDP data was released the expectation was for a cut in February 2020 — and place the chance of a follow-up cut in early 2020 as a 50/50 prospect. Meanwhile, market economists' expectations are shifting towards 2 rate cuts this year as consensus.
In other events in Australia this week, the RBA remained upbeat at its monthly policy meeting (reviewed here) and the following day Governor Philip Lowe delivered a very timely speech on the state of the housing market and its impacts on the broader economy (read here). In short, Governor Lowe outlined his view that it is the expectation for weak income growth, in line with the experience from recent years, that is weighing on household consumption with a negative wealth impact from falling property prices only a marginal influence.
On the data front, there was a range of updates out for January. Building approvals lifted by more than expected in the month (analysis here), retail sales made a soft start to 2019 (see here) and Australia posted a near-record monthly trade surplus (covered here).
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From a global perspective, the major development this week was the European Central Bank's (ECB) shift to an ultra-dovish policy stance. In a move that surprised the markets, the ECB's Governing Council shifted its forward guidance on key interest rates — it now anticipates to remain on hold through to at least the end of 2019 where it had previously nominated the northern summer of this year — and announced a new round of target long-term refinancing operations — named 'TLTRO-III' — which will provide the euro area banking sector with access to a source of funding at cheaper and more favouable terms than in financial markets and incentivises lending to households and businesses.
Both the change in forward guidance and TLTRO-III had been foreshadowed by the Governing Council in their minutes from their January meeting. However, the timing of the announcement was somewhat earlier than the markets had been expecting, with the ECB looking to signal a proactive stance amid a period of slowing economic growth and to ward off a potential tightening in financial conditions due to more than €700 billion in funding obtained through earlier rounds of TLTRO due to be repaid by the banks in 2020 and 2021. TLTRO-III will start in September this year and end in March 2021, though full details are yet to be announced.
At the accompanying press conference, ECB President Mario Draghi outlined that the change in policy was necessitated by a "definite worsening in the projections", with the Bank lowering its forecasts for GDP growth in 2019 from 1.7% to 1.1% and in 2020 from 1.7% to 1.6%. Just hours before the announcement, GDP growth in Q4 posted a softer-than-expected outturn at 0.2% for the quarter and 1.1% over the year (see here). The factors mentioned by President Draghi as weighing on the outlook were; slowing global trade activity, particularly in China, a potential slowdown in the US, vulnerabilities in emerging markets and a general loss of confidence due to political tensions in "trade discussions" as well as issues pertaining specifically to the euro area — namely lower output in Germany's auto sector and political uncertainty in Italy.
Previously, the ECB was taking a wait-and-see approach to these uncertainties unsure if they would be temporary or signs of something longer lasting. The change in forecasts and policy changes point to the latter, with the ECB looking to underpin growth against uncertainties that are mostly external to the euro area while still assessing the risks to the outlook as "tilted to the downside".
