Macro (Re)view (4/9) | Historic fall in Q2 Australian GDP

In the events of the past week, the full scale of the disruption that occurred in the Australian economy through the national shutdown was revealed. Real GDP contracted by its most on record falling by 7.0% in the June quarter (see chart of the week, below) to be down by 6.3% year on year, while hours worked across the economy were down by 9.8% in Q2 (full review here). Overall, activity in the domestic economy declined by 7.2% over the first half of the year, an extremely severe shock but relatively modest for this pandemic episode compared to what has been endured in other advanced economies (UK -22.1%, euro area -15.2% and the US -10.2%), reflecting differences in the scale of the initial virus outbreak and the severity and duration of containment measures. 

Chart of the week

The nature of the shutdown in Australia centred on the closure of non-essential services, travel bans, and restrictions on general mobility. As such, the economic contraction in the June quarter was overwhelmingly driven by household consumption, which collapsed by 12.1% (-12.7%Y/Y), accounting for 96% of the decline in the level of GDP. This came as the largest component of the economy in services-based consumption, including areas such as travel, hospitality and recreation, was the hardest hit by the restrictions falling in the order of 18%. In response to a severe dislocation in the labour market, fiscal support from the Federal Government was a key theme in the quarter, with the ABS reporting that the JobKeeper (wage subsidy) policy, enhanced social assistance payments, cash flow assistance for businesses, together with allowing the early access to superannuation accounts and loan and rent deferrals added around $67bn to household income. With the shutdown occurring and with confidence having deteriorated very sharply, the household saving ratio surged up to its highest level since the mid-1970s at 19.8% from 6.0%. This has significantly bolstered household balance sheets and will help support the economic recovery, with other areas such as business investment (-3.5% in Q2, -5.5%Y/Y) and residential construction (-6.8% in Q2, -11.2%Y/Y) likely to remain weak for some time weighed by uncertainty over the economic outlook. This underscores the importance of fiscal support ahead of the upcoming Federal Budget in October. A key aspect of the economic response to the pandemic in Australia has been the coordination between fiscal and monetary authorities and this continued this week with the RBA announcing changes to its Term Funding Facility, increasing its maximum size to around $200bn from around $152bn currently. Meanwhile, Governor Lowe in his decision statement at the conclusion of the September meeting noted the Board would "consider how further monetary measures could support the recovery" (see here).

The near-term outlook faces headwinds generated by the re-escalation of virus cases in Victoria that led to the reversal of the reopening in that state, a labour market that is still a long way from being repaired, and ongoing restrictions constraining the capacity of the economy. A range of indicators this week provided some insights into these dynamics, including the ABS Household Impacts of COVID-19 survey for August that highlighted effects on confidence not only in Victoria but also in the other states (see here). National retail sales growth in July was moderated to a 3.2% rise as spending in Victoria declined in response to the early impacts of the reinstatement of restrictions in Melbourne (see here), while house prices in the capital showed an outsized fall in August of 1.2% compared to the Sydney market (-0.5%) and combined capitals (-0.5%) according to CoreLogic's latest data. Also on the housing theme, the reopening of the economy appeared to be the key factor behind a 12.0% lift in dwelling approvals in July, with strength coming through from the detached (8.0%) and unit (20.1%) segments (see here). Likely also reflecting the reopening was a rebound in import spending in July (6.9%mth) as firms rebuilt inventory levels, while a decline in export earnings (-4.4%mth) on commdities weakness led to the trade surplus narrowing to its lowest level in 5 months at $4.6bn (see here).   

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Moving offshore, the latest employment report in the US continued to support the narrative of improving economic conditions, even if at a moderating pace, as non-farm payrolls in August advanced by 1.371mn in a slight upside result on the consensus estimate of 1.35mn. This extended total job gains since the reopening out to 10.6mn, representing the recovery of around 48% of the jobs that were lost over March and April as the pandemic emerged. Alongside August's job gains was an uptick in workforce participation to 61.7% from 61.4% as more Americans reconnected with the labour market. Rounding out the report, the unemployment rate declined sharply from 10.2% to 8.4%, coming in well ahead of the median estimate situated at 9.8%, while spare capacity more broadly reflected in the underemployment rate fell from 16.5% to 14.2%, down from a peak of 22.8% in April. The latest readings on business activity in the US were also broadly positive this week. The ISM manufacturing index for August lifted to 56.0 from 54.2 (readings > 50 signal expansion), notching a 4th consecutive month of expansion. This was led by a 6.1% surge in the new orders component, with 15 of the 16 measured industries reporting increases in their order books over the past month. In the services sector, the ISM services index softened slightly to 56.9 from 58.1, but this still brought up a third straight month of expansion in activity. This moderation was driven by a notable slowing in new orders (-10.9%), albeit from a very elevated level (67.7) in July, though export orders rebounded by 6.5% in August. Meanwhile, following the recent shift in the Federal Reserve's policy regime to average inflation targeting, several officials from the central bank spoke publically this week. Of note, were the comments from FOMC member Lael Brainard that she anticipated policy would be set "to accommodate rather than offset inflationary pressures moderately above 2 percent, in a process of opportunistic reflation", while Vice Chair of the Fed Richard Clarida indicated that forward guidance and enhanced asset purchases remain the Committee's preferred policy tools at this stage, ahead of yield curve control and negative rates.    

Across the Atlantic, the scene is set for what will be an interesting meeting next week for the Governing Council of the European Central Bank following the recent appreciation of the single currency in both US dollar and trade-weighted terms. A  Financial Times article quoting a few ECB officials gave the impression that the exchange rate, while not yet of significant concern, has the potential to cause headaches should the appreciation be extended. Underscoring these potential concerns, the ECB's Chief Economist Philip Lane was quoted by Bloomberg saying "the euro-dollar rate does matter" as it is a factor that influences its economic outlook and policy settings. On the other hand, Governing Council member Isabel Schnabel in a Reuters report provided another perspective, outlining that the euro appreciation reflected more positive developments from the continent, such as the recent agreement of the €750bn EU recovery fund and improved global confidence that is supportive of trade and growth prospects, in turn, benefiting the outlook domestically. For the moment, the data this week emphasised that the risks are clearly on the downside. Momentum in the pace of the economic recovery slowed in August, but still pointed to an expansion of activity in the month, as the IHS Markit Composite PMI reading moderated to 51.9 from 54.9 (readings > 50 signal expansion). The key influence was a slowdown in the service sector to 50.5 from 54.7 in July, reflecting contractions in output in Italy and Spain in response to the effects of the ongoing restrictions constraining capacity and renewed virus concerns. Meanwhile, the manufacturing sector remained resilient with the pace of expansion in August effectively unchanged on the month prior. The initial rebound from the consumer coming out of the shutdown is also fading as retail sales volumes declined by 1.3% in July (0.4%yr), coming against expectations for a 1.0% rise. Of more concern, particularly at the ECB, will be the weaker-than-expected outcome from the flash estimate of the Consumer Price Index for August, which turned negative to -0.2%Y/Y from 0.4%, while core inflation weakened to its slowest pace on record at 0.4%Y/Y from 1.2%.