In review: Australian Q1 GDP; first contraction in 9 years on COVID-19 and bushfires

The emergence of the COVID-19 pandemic after the summer bushfires had a sharp impact on the Australian economy as it recorded its first quarterly contraction on GDP in 9 years falling by 0.3% in the March quarter, coming in slightly ahead of consensus (-0.4%) and below our forecast (-0.2%). On this result, annual growth slowed from 2.1% to 1.4% to match its low point from the GFC more than a decade ago. A much more significant contraction will be recorded in the June quarter where GDP may fall in the order of 7 or 8% to reflect the full scale of the disruption on economic activity and the labour market due to the pandemic.

The nation recorded its first confirmed cases of COVID-19 in late January, though it was not until late in the quarter that the infection curve began to ramp up, which led to the implementation of social distancing measures and the closure of non-essential services, while travel restrictions that had earlier been placed on arrivals from a few countries was broadened to a ban on overseas travel by Australians. The policy response from the nation's monetary and fiscal authorities to these developments has been without precedent. On March 19 the RBA lowered the cash rate to its effective lower bound of 0.25% and shifted its policy focus to a range of unconventional measures including yield curve control and a facility to ensure the banking sector will have access to ample and cheap liquidity over the next 3 years. Coordination with Treasury has been an important factor through this period and fiscal support measures announced by the Federal government have to date totalled around $190bn (around 10% of GDP) with more very likely to follow. 

These monetary and fiscal supports, when combined with the relative success the authorities were able to achieve in limiting the severity of the COVID-19 spread, will assist in the recovery, though the crisis will leave a lasting impact on the domestic economy that will require a careful and considered policy approach. The labour market is going through a very painful and disruptive period and the risk is that the pandemic leaves a legacy of a higher unemployment rate over the next few years. Consumption spending has been upended by social distancing measures but the production side of the economy has also been significantly affected at the same time and faces structural change going forward. Adding to the uncertainty of the recovery is how business and consumer confidence will evolve after collapsing over Q1, while visibility over the global economic outlook is extremely limited with the reopening of economies occurring on varying timelines from country to country. 

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GDP — Q1 | Expenditure: GDP (E) -0.2%q/q, 1.4%Y/Y

Household consumption (-1.1%q/q, -0.2%Y/Y) — The COVID-19 pandemic and summer bushfires had a severe impact on household consumption, which collapsed by 1.1% in Q1 — its sharpest fall in a single quarter in 34 years — swinging the annual pace into contraction at -0.2% to its weakest since the GFC from 1.3% in the previous quarter. 

The profile reveals that discretionary consumption was shunned (-3.9%qtr, -3.6%yr) as the implementation of social distancing measures and travel restrictions hit, while precautionary behaviour in general in relation to the risk of COVID-19 and the earlier effect of smoke haze from the bushfires also appears to have been a factor. Significant declines in Q1 were recorded across transport (includes air travel) (-12.0%), hotels, cafes and restaurants (-9.2%) and clothing and footwear (-8.9%), though furnishings and household equipment (1.3%) and communications (2.3%) advanced on preparations for work from home arrangements through the lockdown. Non-discretionary consumption lifted by 0.7% in Q1 (2.0%yr) with food demand soaring by 5.7%, which was by a considerable distance its strongest rise in a single quarter on record, in response to stockpiling by households at the supermarkets over the month of March. 

Turning to incomes, growth in real household disposable income lifted by 0.9% in the quarter to be up by 2.0% over the year and was little changed from Q4 at 1.7%Y/Y. However, this is with the full shock to the labour market from COVID-19 disruptions yet to come. The household saving ratio advanced by 2.0ppts to 5.5% to its highest level in 3½ years, though this was more likely to be due to the effect of social distancing measures and the closure of restaurants and cafes and venues for other types of recreational activity as well as travel restrictions reducing spending rather than a conscious effort to save. Consumer confidence will be key in driving the trajectory of household saving from here onwards. 

Dwelling investment (-1.7%q/q, -9.7%Y/Y) — The nation's residential construction cycle is mired in its deepest downturn in 7 years with overall activity pulling back by a further 1.7% in the March quarter to be down by 9.7% through the year. New home building has tracked the substantial unwind in dwelling approvals that occurred between mid-2018 through 2019 and is now at its weakest level in more than 5 years after falling by another 2.9% in Q1 (-15.5%yr). Alteration work was holding up, posting a broadly flat result on the quarter (0.4%) and was modestly higher over the year (1.8%). Meanwhile, ownership transfer costs (excluded from the dwelling investment figures, relating to fees associated with real estate transactions) were coming off a 10.6% surge in Q4 but flatlined in the March quarter on seasonal effects and the disruptions to sales activity from social distancing measures with open house inspections and public auctions prohibited.  

Business investment (-0.8%q/q, -2.6%Y/Y) — Severe headwinds associated with weak domestic demand conditions, plunging confidence and trading conditions and uncertainty over the economic outlook are weighing on business investment and forward-looking capital expenditure plans. The 0.8% fall in Q1 was its third straight quarterly contraction and centred on the non-mining sector of the economy (-1.7%qtr, -6.6%yr), though the upside is that mining investment has finally turned the corner (3.6%qtr, 10.3%yr) and is set to advance further over the next financial year based on the ABS's recent capital expenditure data. Details on the quarter were broadly weak as equipment investment pulled back by 1.9% (-3.3%yr) and non-dwelling construction softened by 0.3% (-5.4%yr) on a decline in new building activity, though some offset came through from an uptick in engineering work that looks to be linked to the mining sector. 

Public demand (1.5%q/q, 5.4%Y/Y) — Another robust rise in public demand occurred in the March quarter as the annual pace advanced from 5.1% to 5.4%. This has directly added 1.2ppts to activity over the period and has bolstered the economy at a time of weak private demand. Public consumption lifted by 1.8% in Q1 and was supported by health-related spending as the Federal government built up the national stockpile of medical supplies and expanded front-line services in response to the COVID-19 pandemic and bushfires. Meanwhile, investment was little changed in Q1 (0.2%) but was up by 1.9% over the year.  

  

Net exports (0.5ppt in Q1, 1.2ppts yr) — A 0.5ppt contribution to activity came through from net exports in the March quarter, though this obscures the narrative. Both the export and import sectors have been severely disrupted by the emergence of the COVID-19 crisis. Tourism has been shuttered by travel restrictions, while a now weak and highly uncertain global and domestic economic outlook will continue to hit demand for imports as businesses delay investment plans. Export volumes fell by 3.5% in Q1, with signs that Tropical Cyclone Damien in Western Australia had weighed on iron ore shipments, though this was much lower than the 6.2% collapse on imports and this drove the 0.5ppt addition to GDP.  

Inventories (-0.2ppt in Q1, -0.3ppts yr) — Inventories were run down sharply in Q1 and subtracted 0.2ppt from overall economic activity as firms' supply chains were stretched to the limit to keep up with the surge in demand for essential goods through March ahead of lockdowns across Australia in April to limit the spread of COVID-19. Public inventories lifted sharply by around $1.0bn reflecting the boost to the National Medical Stockpile in the fight against the pandemic.  

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GDP — Q1 | Incomes: GDP (I) -0.4%q/q, 1.4%Y/Y

The estimate of real GDP income contracted by 0.4% in the March quarter, slowing the annual pace from 2.1% to 1.4% — its weakest since the GFC. 

Australian nominal GDP growth lifted by 0.8% in Q1 — a vastly improved outcome on the 0.2% fall in the previous quarter — however, the pace in annual terms moderated from 3.9% to 3.1% due to a base effect.

Driving the improvement was a 2.9% rise in the nation's terms of trade over the March quarter (following Q4's contraction of 5.2%) as key commodity prices advanced, though it was still a little softer over the year (-0.9%).

Private sector company profits (excluding financial corporations) increased by 0.7% in the quarter after coming off a 2.2% fall in Q4, while the annual pace decelerated from 6.4% to 3.9% to their weakest in 3½ years. Profits by financial corporations were stronger in the March quarter rising by 1.5% to be only a touch softer over the year at 3.9%. 

Wages and salaries according to the compensation of employees measure slowed to growth of 0.5% in Q1 after rising by 1.0% in the previous quarter. As a result, the pace through the year pulled back from 5.1% to 4.2%. This was impacted by a sharp decline in hours worked over the quarter due to the disruptions from COVID-19 and possibly by the bushfires as well. 

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GDP — Q1 | Production: GDP (P) -0.3%q/q, 1.3%Y/Y

The production estimate for GDP in Q1 was -0.3% coming in between the expenditure and income estimates as the pace over the year slowed from 2.3% to 1.3% to its lowest in the post-GFC period. 

A total of 11 of 19 measured industries saw output levels contract in the March quarter, with accomodation and food services (-7.5%) seeing the worst of it as a result of the impact from social distancing measures, travel restrictions and the bushfires. A decline of 4.9% was also recorded by transport, postal and warehousing, with this including the hit to air travel both offshore and domestically due to travel bans and border closures. Output in the health care sector (-0.1%) was impacted by the postponement of elective surgical procedures by private providers as well as a reduced volume of face to face appointments in response to the pandemic. 

Output in the retail sector advanced by 1.7% in Q1 due to the surge in demand for essential supplies of food and pharmaceuticals, with wholesalers seeing a 1.5% increase off the back of this together with preparations made by households to work from home. The full breakdown across the industries is provided in the chart, below.  

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GDP — Q1 | Prices

Economy-wide inflation measured by the GDP deflator more than reversed its 0.8% fall in the December quarter as it lifted by 1.1% in Q1. This left the annual pace little changed at 1.7% from 1.8% in the previous quarter. The key factor in driving that turnaround was the 2.9% quarterly rise on the terms of trade. The Gross National Expenditure deflator adjusts for the terms of trade impact and on that basis prices lifted by 0.5% in Q1 to firm the pace over the year a touch to 2.0%. 

The household consumption deflator, which is the closest proxy in the national accounts to the Consumer Price Index (CPI) but accounts for dynamic changes in spending patterns, posted a 0.5% rise in Q1 as the annual pace ticked up from 1.8% to 1.9%. For comparative purposes, the CPI measure lifted from 1.8% to 2.2% over the year to the March quarter.  

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GDP — Q1 | Productivity

Total hours worked in the March quarter collapsed by 0.9% in response to the disruption from COVID-19, resulting in the annual pace falling away to 0.0% from 1.8%. The quarterly outcome on hours worked (-0.9%) was much sharper than the contraction on output growth (-0.3%) and this produced a lift on the GDP per hour worked measure advancing from 0.4% to 1.4% over the year. Hours worked in the market sector saw an even sharper contraction of 1.5% in Q1, with GDP per hour worked rising from 0.2% to 1.4%. While these outcomes would usually point to an increase in productivity, this was in contrast to a 0.7% contraction on GDP per capita in Q1 as the annual pace flatlined from 0.7% in Q4.   

Nominal non-farm unit labour costs were broadly flat in Q1 (0.1%), with the annual pace easing very slightly from 2.8% to 2.7%. Adjusting for inflation, real non-farm unit labour costs fell by 0.9% on the quarter, though a base effect saw the annual pace lift a touch to 0.9%. 

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GDP — Q1 | States

New South Wales saw the sharpest contraction in demand of all states falling by 1.5% in the March quarter. This was that state's largest quarterly decline since Q2 2000 and this swung the annual pace from 1.6% to -0.7% to an 18½-year low. The state was heavily affected by the summer bushfires and now the COVID-19 crisis and in response household consumption contracted by a sharp 1.6% in Q1. The downturn in residential construction activity remains a headwind falling by a further 4.5% in the March quarter, while there was also notable weakness across commercial construction (-11.4%qtr) and infrastructure work (-12.0%qtr). Public demand has been a key support for the state over the past year rising by 6.5%.  

       

State demand in Victoria saw a minor 0.1% contraction in Q1 after a 0.2% decline in Q4, while annual growth softened from 1.1% to 0.9%. As was the case in New South Wales, the emergence of COVID-19 after the bushfires was extremely disruptive to consumption spending, which fell by 1.2% in the quarter. Residential construction remained soft falling by 1.2% in Q1, while weakness in equipment spending (-4.8%qtr) continued to weigh on business investment. After a softer outcome last quarter, public demand saw renewed strength rising by 3.3% to be up by 7.1% over the year. 

In the other states it was a mixed quarter with state demand contracting in Queensland and South Australia but rising in Western Australia and Tasmania. In Queensland, Q1's 0.3% contraction slowed annual growth from 1.4% to 0.6% and was driven by a 0.5% decline in household consumption and a 4.4% fall from non-residential construction. South Australia saw state demand decline by 1.0% in Q1 — its sharpest quarterly fall in 7½ years — to be down by 1.0% over the year as consumption spending (-1.5%qtr) was significantly affected by the pandemic and bushfires. Demand in Western Australia advanced by 0.9% in the quarter driving annual growth to its strongest in more than 7 years at 3.4% reflecting the benefit of the turn in the mining investment cycle after several years of decline. In Tasmania, demand lifted by 0.6% leaving annual growth a touch softer at 1.2%. This was led by a spike in business investment, though travel restrictions will hit tourism in the state significantly.