Macro (Re)view (23/12) | Stumps in 2022

A very challenging 2022 draws to a close, a year in which markets had to contend with a range of macroeconomic and geopolitical headwinds. Rapid rate hiking cycles from global central banks in response to surging inflation, the accentuation of supply pressures in goods and energy markets following the war in Ukraine, ongoing disruptions from Covid (particularly in China) and elevated volatility are just some of the key themes that influenced markets. Economies have been remarkably resilient but will be tested in 2023 as the effects of rate hikes flow through. Improving signs on the inflation front have come through recently and if that continues, markets (if not already) appear likely to switch their focus to growth factors in 2023.     

BoJ lifts the anchor  

The anchor point in global bond markets from Japan was lifted this week at the Bank of Japan's policy meeting. The BoJ announced the band for Yield Curve Control (YCC) would widen to allow the 10-year bond rate to rise to 0.5% from 0.25% previously. In the post-meeting press conference, Governor Kuroda said the move did not constitute a rate hike and was made to support market functioning. Indeed, the meeting minutes noted that it was necessary to continue with policy easing to ensure the inflation target is met in a "sustainable and stable manner" backed by wage increases. However, markets have taken the decision as being the first step towards ending YCC and a broader normalisation of monetary policy in Japan.     

US inflation continues to slow 

Monthly US inflation prints continue to show sequential improvement. Underlying inflation on the core PCE deflator was 0.2% in November, down from 0.3% in the prior month and 0.6% at the highs in the middle of the year. The annual pace eased to 4.7% (from 5%), though the pace is softer on both a 3-month (3.6%) and 6-month annualised basis (4.3%), indicating there could be downside risk to the Fed's 2023 projection (3.5% year-on-year). 

Pause enters RBA radar 

The December RBA meeting minutes showed that while the Board considered rate hikes of 25 and 50bps (and ultimately decided on the former), the option of pausing entered the Board's discussions for the first time in the tightening cycle. Further tightening looks likely in 2023, but a pause may not be too far away as I discuss in a more detailed note here.  

ECB's hawkish tones continue   

Communication from the ECB remains strongly hawkish following last week's policy meeting. ECB Vice President de Guindos underscored this point in an interview published on the ECB website where he noted that 50bps rate hikes "may become the new norm" and that rates were still short of reaching the restrictive levels needed to return inflation to target. 

UK economy contracts in Q3 as households cut consumption 

September quarter UK GDP figures were revised to show a slightly larger contraction of 0.3% amid expectations the economy is already likely in recession. Growth expanded modestly through the first half of the year (0.7%), but households hit the brakes on consumption in Q3 (-1.1%) in response to falling real incomes caused by high inflation, with BoE rate hikes an additional headwind. 

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Thanks for reading and for all the discussions throughout the year. Merry Christmas and best wishes for 2023. 

Pause enters the RBA radar

For the first time in the RBA's hiking cycle, the Board considered the option to pause tightening at the December meeting. More tightening is likely in front of the RBA in 2023, but maybe not much more depending on the inflation outlook.  

A recap of 2022...

2022 was an extraordinary year for the RBA. Many of the pandemic monetary policy settings remained in place at the start of the year, with rates sitting on the historic low of 0.1% and QE still running. The QE program was wound up in February, but it wasn't until May that the first rate hike came, a 25bps increase. Hiking was then frontloaded in 50bps increments for the four meetings from June to September. The downshift to 25bps hikes came in October (ahead of many other central banks) and was followed up with hikes in November and December. All told, rates were hiked by 300bps since May, taking the cash rate to 3.1%. 

The path ahead... 

All indications are that the RBA hasn't finished tightening yet. The Board's guidance that it "...expects to increase interest rates further over the period ahead" was retained in December and has essentially been unchanged over recent months. The one caveat to this is that it added back into the December decision statement the qualifier that rates are "...not on a pre-set course". A similar qualifier was used by the RBA earlier in the hiking cycle ahead of the October downshift. On this occasion, it may reflect the optionality the RBA wants to retain going into 2023. The December meeting minutes showed the Board considered 3 different options for policy earlier this month: hiking by 25 or 50bps, or for the first time since the hiking cycle commenced, going on pause.    

The notion of pausing has bouyed local markets, coming on the back of last week's moves by the Fed, ECB and BoE to slow their respective hiking cycles (though all 3 remain hawkish) and in response to softer US inflation data. After initially drawing a firmly hawkish interpretation from the December meeting, markets have scaled back pricing for a 25bps RBA rate hike in February to a 50/50 proposition. Pricing for the terminal rate has remained well below 4%. 

Source: ASX 

In addition to the rate hikes, the RBA's balance sheet will be playing a more active role in tightening monetary policy next year. The quantitative tightening (QT) process started in May alongside the first hike, with maturing bonds being allowed to roll off the balance sheet. But the profile of the RBA's bond holdings has meant the effect on the size of the balance sheet has been minimal so far, reducing only modestly from the pandemic peak to around $630bn currently.  

The next couple of years will see the balance sheet reducing in size significantly. The main driver will be repayments of the cheap liquidity banks were able to access from the Term Funding Facility, with maturing bonds (acquired in support of the 3-year yield target and in the QE program) doing the rest. Because of this, the RBA has maintained the view bond sales are not required as part of QT. The chart below is from a speech by the RBA's Christopher Kent earlier in the year and shows the scale of the unwind that is ahead. Like most of its central bank peers, rates are the primary tool for the RBA, but the key point is that the balance sheet will contribute to a tighter monetary policy stance from next year.   

Source: RBA 

Inflation outlook holds the key... 

The question going into 2023 then is when will the RBA press pause. While it appears likely that rates will be hiked when the RBA returns in February, that might just about see things out. Consistently the Board has referred to the delayed effects of rate hikes on the economy, and as discussed above the balance sheet will be a factor next year. It has also been mindful of the risks of overtightening, noting that it is attempting to return inflation to target "over time" while keeping the economy "on an even keel".     

Before a pause can come, the Board will likely need to see the inflation outlook coming back into the 2-3% target band. Currently, the RBA sees inflation remaining above 3% out to 2024 despite expectations for a growth slowdown over the next couple of years. The RBA is cautious that upside risk to inflation could come from the labour market; however, wages growth only recently cleared 3%, a pace it has described as "not inconsistent" with the inflation target. 

Source: RBA 

The RBA will update these forecasts in February. Deevlopments offshore over the summer could provide an indication of what to expect. A plausible scenario is that there is a further softening in the inflationary pulse and the effects of aggressive rate hikes start to weigh more on growth. If Australia follows suit, lower forecasts for inflation and growth could open the door to the RBA pausing its hiking cycle in March.

Macro (Re)view (16/12) | Hawkish tones prevail

Despite improving signs on the inflation front and weaker growth outlooks going into 2023, central banks continue to assert that they have more work in front of them. That was the key message from the Federal Reserve, European Central Bank, and the Bank of England this week even as all 3 slowed the pace of their respective tightening cycles.  

Australian labour market strengthens further... 

Conditions in the Australian labour market have continued to strengthen, leaving the RBA's guidance for rates to continue to rise in 2023 on track. Employment came in at 64k in November, strongly above consensus for the second month in succession (October was revised up to 43.1k), confirming a reacceleration in employment after a slowdown in Q3 (full review here). Rising employment has been met with a lift in the participation rate back to record highs (66.8%). The unemployment rate held at 3.4%, its lowest rate since 1974, though broader measures of spare capacity declined further such that total underutilisation in the labour force established a new 41-year low (9.3%).

... but sentiment is weak going into 2023 

Consumer sentiment on the Westpac-Melbourne Institute Index bounced by 2.9% in December but is still at deeply pessimistic levels (80.3), reflecting cost-of-living pressures on households. There were indications in the report that households sense the end of the RBA's hiking cycle is nearing, but the effects of the earlier hikes have yet to fully flow through. In anticipation of a material slowdown in household spending, business confidence in the NAB Survey turned outright negative in November (at -4 index points), belying the robust conditions (+20 points) currently reported.   

Fed remains on the press despite easing US inflation 

After 4 successive 75bps rate hikes, the Federal Reserve's FOMC made its well-telegraphed downshift to a 50bps hike this week. The policy rate now stands in the 4.25 to 4.5% range, up by a rapid 425bps since the start of the year. And all indications are that the FOMC is not done yet. The decision statement noted that "ongoing increases" in rates were anticipated and in the post-meeting press conference Chair Jerome Powell said policy had not yet reached the "sufficiently restrictive" levels needed for inflation to return to target. On top of this, the updated set of economic projections raised the median forecast for the peak in the fed funds to 5.1% from 4.6% previously, against market pricing for rate cuts in the back half of 2023.

Indeed, Chair Powell confirmed it was still the FOMC's view that rates will need to remain at restrictive levels for a "sustained period" and that backing away prematurely posed more risk to the economy than overtightening in the first place. Clearly, FOMC members are yet to be convinced that the inflation impulse is waning despite markets taking encouragement from the past two CPI reports (more below). That was underscored by FOMC members' median projections for both headline and core PCE inflation being adjusted higher through to the end of 2024. The upward revisions to inflation in 2023 (3.1% from 2.8% on headline and 3.5% from 3.1% on the core rate) are notable as they come alongside the growth outlook for next year being cut sharply to 0.5% from 1.2%. 

This week's CPI data for November was softer than expected on the back of a downside surprise in October. Headline CPI was 0.1% month-on-month (vs 0.3% expected), slowing annual growth to 7.1% from 7.7%, while the core rate was in at 0.2%m/m (vs 0.3%) and 6.0%yr (down from 6.3%). The two main drivers of the softening in inflation over the past couple of months have been a disinflationary pulse coming through from goods, consistent with improved supply chain pressures and reduced demand (due to spending rotating back to services), and falls in energy prices from their peaks earlier in the year. However, services inflation is still elevated on the back of surges in rents and housing costs. 

Hawkish turn from the ECB 

Although the European Central Bank hiked rates by 50bps (to 2.0% on the depo rate), dialling down the pace from 75bps at the past two meetings, this was far from a step closer to the end of the tightening cycle. In fact, according to a Bloomberg article, there was a "sizeable push" within the Governing Council for the pace to remain at 75bps at this week's meeting. However, the main message was in the decision statement and then in President Christine Lagarde's post-meeting press conference that rates needed to "rise significantly at a steady pace" to reach levels that are "sufficiently restrictive" to bring inflation back down to target. The Governing Council also gave the green light to start quantitative tightening in March, with the plan to initially reduce the reinvestment of maturing bonds in the Asset Purchase Programme by an average of €15bn per month (representing around 50% of redemptions) through to the end of June.   

 

This vastly more aggressive tone from the ECB comes in response to a "substantial upward revision to the inflation outlook". December's ECB staff projections have been revised to show inflation falling back at a slower pace in 2023 (6.3% from 5.5%) and 2024 (3.4% from 2.3%) and to still remain above target at the end of the projection horizon in 2025 (2.3%). Notably, falls in food and energy prices drive the forecast decline in the inflation rate, with price pressures in the core components expected to remain sticky. Reflecting the economic headwinds the euro area is confronting from tighter monetary policy, high energy prices and slowing global growth, a "short-lived and shallow recession" is now factored into the ECB's baseline outlook, resulting in weaker but still positive growth in 2023 (0.5% from 0.9%). A rebound is then projected in 2024, with forecast growth left unchanged at 1.9%.  

ECB chart 

Bank of England downshifts

The Bank of England reverted back to a 50bps rate hike this week lifting the policy rate to 3.5%, downshifting from November's outsized hike (75bps). The less aggressive stance follows the recent Autumn Statement, giving the BoE greater clarity over the direction of fiscal policy under the new leadership of the government, and the BoE's special bond-buying operations that settled the gilt market soon after the mini-Budget was tabled. But even though calmer waters have prevailed, the 9-member MPC split this week's vote 3 ways: 6 opting for 50bps, 2 (Tenreyro, Dhingra) voting for no change, and 1 (Mann) calling for another 75bps hike.

November's inflation data showed a slight cooling in price pressures as headline CPI softened from 11.1% to 10.7%yr and from 6.5% to 6.3%yr on the core rate, but with data on the labour market remaining strong and pay growth pushing up to a 6.1% annual pace, the MPC retained the policy guidance that further rate hikes  "...may be required", reaffirming also that it is prepared to "act forcefully" again if needed. However, the MPC removed its explicit pushback to a peak rate above 5%, reflecting the reduction in market pricing over recent weeks to 4.75% currently.

Crucially, the implications for BoE policy from the government's fiscal plans appear limited. According to the MPC's assessment, the measures in the Autumn Statement modestly lower the inflation outlook (-0.75ppt in Q2) and add to growth in 2023 (0.4ppt). The fiscal impulse to growth is then expected to be neutral in 2024 before turning slightly contractionary in 2025 (-0.5ppt). 

Australian employment 64k in November; unemployment rate 3.4%

Australian employment increased by 64k in November coming in strongly to the upside of expectations for the second month running. A reacceleration in employment from a slowdown in Q3 has drawn a supply response, with the participation rate back at record highs. The national unemployment rate remained at its half-century low of 3.4% and broader measures of spare capacity were reduced further. The report is consistent with the RBA raising rates in 2023. 

Labour Force Survey — November | By the numbers

• Employment increased by 64k in November, well above the consensus estimate (19k). Upward revisions were made to prior months, including an elevation in October's outcome to 43.1k from 32.2k initially reported.

• The unemployment rate was unchanged at 3.4%, remaining at its lowest level since 1974. The underemployment rate fell from 5.9% to 5.8%, driving the broader underutilisation rate down from 9.4% to 9.3%, its lowest since 1982. 
• The participation rate returned to record highs lifting from 66.6% to 66.8%.

• Hours worked were a touch softer in November (-0.4%) coming off a 2.4% surge in October that reflected a significant easing in Covid-related absences. 

Labour Force Survey — November | The details

Employment posted its strongest increase in 5 months rising by 64k in November, with gains coming through in both the full-time (34.2k) and part-time segments (29.8k). This morning's preview provided the correct steer for Macro View readers identifying that the reacceleration in employment in October was likely to carry on into November. Hiring temporarily slowed over Q3 but has reaccelerated sharply to rise by 107.1k over October-November.   

The labour market remains dynamic, with the reacceleration in employment being met with a supply-side response. The participation rate lifted to 66.8% to be in line with its record high, up 0.6ppt since the start of the year and 1ppt above its pre-pandemic level. Growth in the working-age population has lifted since earlier in the year supported by the full reopening of the international border (chart below). The share of the working-age population in work is also at a record high (64.5%) after rising by 0.2ppt in November.  

November's strength in employment was sufficient to maintain the national unemployment rate at 3.4%, equal to its lowest level since September 1974. The underemployment rate came in 0.1ppt to 5.8%, a low to August 2008. The broadest measure of spare capacity in the labour market has come down further, reduced to 9.3% in November to be at its lowest level since March 1982.  

The one aspect of today's report that did not improve from October was hours worked (-0.4%m/m). However, that was coming after a very strong rise in October (2.4%), which was driven by a reduction in Covid-related absences to their lowest level of the year.

In November, the number of people working fewer hours due to illness increased again but was still well down from the peak in August. Meanwhile, new lows continue to be seen in the number of Australians on reduced hours due to economic reasons (such as insufficient work or layoffs etc), consistent with the very low level of spare capacity in the labour market.   

Labour Force Survey — November | Insights

The Australian labour market remains very robust. Employment has reaccelerated following a slowdown in Q3 and forward-looking indicators remain consistent with this strength continuing well into 2023. Spare capacity is at historical lows and the participation rate is up at record highs. Wages growth in this labour market has picked up but only to a 3.1% pace, far from the levels that would concern the RBA that high inflation is driving up wage settings. But the RBA remains cautious and indicated at last week's meeting that rates are expected to rise again in February. Thereafter, I see the case for the tightening cycle to go on pause will build and be on the table in March. 

Preview: Labour Force Survey — November

Australia's Labour Force Survey for November is due for release from the ABS at 11:30am (AEDT) today. Going into today's report, the national unemployment rate is on the lows for the cycle at levels not seen in almost 5o years after employment reaccelerated in October. There looks to be scope for that momentum to continue in November as labour demand remains very strong.  

As it stands | Labour Force Survey

Employment increased by 32.2k in October, well above consensus (15k) and more than rebounding from a fall in September (-3.8k). The full-time segment added 47.1k to employment but was moderated by a 14.9k fall in part-time employment. Over the past year, employment has surged by 5.9% (762k) as the effects of the pandemic and the associated restrictions have eased. 

The unemployment rate established a new low for the cycle falling from 3.5% to 3.4%, its lowest level overall since September 1974. The broader underemployment rate declined from 6.0% to 5.9%, reducing the total underutilisation rate in the labour force to 9.3%, a 41-year low. These outcomes came alongside the participation rate remaining just off record highs at 66.6%. 

Hours worked increased by 2.3% in the month, its sharpest rise in 8 months following a significant reduction in Covid-related absences to their lowest level since December 2021. This drove hours worked to 7.4% above their pre-Covid level. 

Market expectations | Labour Force Survey

The consensus expectation is for employment to rise by 17k in the month, though the range of estimates is once again wide, from zero to 45k. The latest reading from the ABS's high-frequency payrolls series is consistent with rising employment in November. No change is anticipated in the unemployment rate (3.4%) from October (range: 3.3% to 3.5%), with the participation rate also expected to remain steady (66.6%).  

What to watch | Labour Force Survey

After employment surprised strongly to the upside in October, I see scope for a similar outcome in today's report. While vacancy data and job ads have come off their highs, they are still at very elevated levels that make the consensus estimate for employment look modest in comparison. 

Employment is coming off a patchy Q3 where a slight decline was recorded (-4k). The national accounts last week showed that although GDP expanded by 0.6% in Q3, hours worked were largely flat (0.1%) pointing to the effects of seasonal factors and Covid-related disruptions. 

Employment may therefore be playing catch up over Q4, with the October outcome potentially being the first sign of that. Leaving aside the lockdown-affected 2020 and 2021, employment in prior years has shown a fairly consistent pattern of strength over the final quarter, boosted in part by seasonal hiring. The difference this time is that spare capacity in the labour market is at historical lows, so the pace of hiring is likely to be slower. Nevertheless, there is reason to be optimistic on prospects for another upside surprise for employment.

Macro (Re)view (9/12) | Australian economy remains resilient

The rally in US equities from the October low relented as the main indices saw their steepest declines in 5 weeks. In contrast, China moving away from its Covid zero approach boosted some markets in Asia. There are increasing signs that central banks may be past peak hawkishness. In Australia, the RBA hiked by 25bps and will now break for the summer. The Bank of Canada hiked by 50bps but is now "...considering whether the policy interest rate needs to rise further" observing that inflation pressures may be "losing momentum". It is likely that the Federal Reserve, European Central Bank and the Bank of England will all slow the pace of their respective tightening cycles next week.  

Resilient households continue to anchor Australian economic growth... 

The Australian economy expanded by 0.6% in the September quarter as household spending remained resilient to falling real incomes and interest rate hikes. Real GDP growth increased by 5.9% through the year, driven by a consumption-led recovery on the reopening of the services sector from the pandemic. My In review series has in-depth analysis and key charts from the Q3 national accounts here. 

In the quarter, household consumption growth slowed but was still solid at 1.1% (11.8%Y/Y), supported by the ongoing rebound in services spending, notably in travel and hospitality services. Consumption continues to rise against a backdrop of high inflation, weak sentiment, and, more recently, RBA rate hikes. Real incomes have now fallen in 3 of the past 4 quarters (-0.4% in Q3), seeing their largest annual decline (-2.7%) in three decades. But households have been willing to keep spending as the very strong labour market is bolstering income, backed also by a very elevated stock of excess saving accumulated over the pandemic, estimated to be well over $200bn. The early effects of the RBA's tightening cycle have emerged with interest payments on mortgage repayments surging by 36% in the quarter.  

 ... as the RBA indicates rates will rise further 

At this week's meeting, the RBA Board hiked its main policy rate by another 25bps to 3.1%, now up 300bps from the first hike in May (see here). Governor Philip Lowe's decision statement left intact the guidance that the Board "...expects to increase interest rates further", though he reinserted the qualifier that rates are "not on a pre-set course"; similar to a phrase used earlier in the tightening cycle preceding the downshift from 50bps to 25bps rate hikes.

The RBA expects a growth slowdown to 1.5% in 2023 and 2024, but given the scale of the hit to real incomes in the national accounts - coming ahead of the full effects of the tightening in monetary policy - the risks look to the downside. That may make the Board's sensitivity to the growth outlook in its policy deliberations more elevated, continuing to note this week that it is aiming to keep the economy "on an even keel" while returning inflation to target. If the RBA's next set of forecasts in February downgrade the growth outlook and show inflation falling back within the target band by the end of the projection period, a pause in the tightening cycle could be a genuine possibility at the March meeting. 

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Data on Australian international trade confirmed a deterioration in the underlying dynamics following a retracement in commodity prices from the elevated levels reached in the early phase of the Ukraine war. The terms of trade declined by 6.7% and the current account swung into deficit for the first time since 2019 (see here). The monthly trade surplus was still elevated in October at $12.2bn, broadly unchanged from September (see here). 

Fed to hike by 50bps; softer US inflation expected  

A heavy-duty week awaits in the US headlined by the Federal Reserve's policy meeting and the November CPI report. Markets have long anticipated the pace of Fed tightening will slow to a 50bps hike. Much of the focus therefore will be on the new set of projections for the economic outlook and the policy rate. October saw a cooling in US inflation and that is expected to have continued into November, with the key core rate forecast to slow to 6.1%yr from 6.3%. 

The FOMC's projections for the fed funds rate will be effectively marked to market, raising the estimate for the terminal rate from 4.6% to around 5%. Markets will also be looking out for insights around how long the FOMC anticipates rates will need to remain at their peak level in order to lower inflation back to target. Recession risks rise the longer the period of restrictive monetary policy. Throughout the tightening cycle, Fed officials have said the risks of overtightening were less severe to the economy than not tightening enough. However, last week, Chair Jerome Powell was more nuanced on this point, so how the FOMC sees this balance of risks evolving will also be of interest.  

Downshift on the cards for the ECB and BoE next week  

Ahead of next week's ECB meeting, Chief Economist Philip Lane said both the inflation outlook and the quantum of tightening already delivered will factor into the Governing Council's deliberations on rates. Markets have been reluctant to price out another 75bps hike following a recent speech by Executive Board member Isabel Schnabel, but a downshift to a 50bps move may come if the more dovish section of the Governing Council get their way. The updated set of economic and inflation forecasts to be published alongside the meeting are likely to hold the key. A more severe growth slowdown in 2023 (currently 0.9%) and inflation coming back below the 2% target over the projection period would tip the scales to a 50bps hike.  

The Bank of England will also meet next week. Here, markets are more convinced that rates will be hiked by 50bps, with November's larger 75bps hike seen as a one-off move. Since the November meeting, the UK government's Autumn Statement presented what was seen by markets as a credible path for fiscal policy, albeit with much of the tightening delayed until 2024/25. That should give the BoE more comfort over the inflation outlook, allowing it to revert back to a 50bps hike.   

Australian trade surplus $12.2bn in October

Australia's trade surplus remained elevated in October at $12.2bn, little changed from the month prior. Exports were softer but remain close to record highs while imports declined on the back of an easing in fuel prices. 

International Trade — October | By the numbers

• Australia's trade surplus came in at $12.2bn, broadly as expected ($12bn) and little changed from September ($12.4bn). 

• Exports were 0.9% lower to sit at $60.1bn, just below June's record high and up 38.4% over the year. 
• Imports declined for the first time in 4 months, off 0.7% in October to $47.9bn. Import spending is up 43.8% on a year earlier.

International Trade — October | The details

The trade surplus was near unchanged in October from the month prior with only modest movements in exports (-0.9%) and imports (-0.7%). The balance on goods trade was $0.2bn lower but in surplus to the order of $14.7bn; the services balance was flat at -$2.5bn and has been in deficit for the past year as Covid restrictions on travel have eased. 

Export earnings declined due mainly to the volatile non-monetary gold component (-20.5%m/m). Non-rural goods were also a driver of the overall weakness (-0.5%) as exports of metal ores and minerals (iron ore) declined by 2% on a combination of lower prices and shipment volumes. Monthly iron ore exports have been running at an average of $14.1bn in 2022, broadly in line with the October result ($14.2bn). Rural goods advanced by 1.7% in the month and have surged by 45% over the year. Favourable weather conditions have supported production in the sector while strong demand amid supply global constraints due to the war in Ukraine have elevated the prices for many of these goods.   

Services exports moderated to growth of 0.4% in October (45.1%yr), with the sector still in recovery mode from the pandemic. Earnings from transport services (including passenger travel) are still down by more than 20% on their level at the end of 2019.  

Import spending declined on the back of falls in capital (-1.7%) and intermediate goods (-0.8%). The decline in intermediate goods was notable as it was driven by a sharp fall in fuel imports (-7.1%) reflecting lower oil prices on global markets. However, the earlier acceleration in prices following the Ukraine war sees the value of fuel imports up by almost 90% over the year. In October, consumption goods lifted (1.2%) as vehicle imports rebounded (16.9%). 

Services imports increased by 0.6% to be up 86.5% over the year. Overseas tourism has been rebounding rapidly as travel restrictions have eased, though spending in the category is still around 35% down on its pre-pandemic level.  

International Trade — October | Insights

Another elevated result for the monthly trade surplus in October. Yesterday's national accounts reported that Australia's international trade dynamics became less favourable during the September quarter as the terms of trade declined from a record high as commodity prices retraced. Data earlier in the week showed Australia's current account turned back into deficit for the first time since 2019.  

In review: Australian Q3 GDP: Households continue to spend

Household spending continued to drive growth in the Australian economy despite falling real incomes and surging interest payments. Real GDP expanded by 0.6% in the September quarter, slightly softer than expected (0.7%) but the momentum in growth from the first half of the year (1.3%) was broadly maintained. Output is now 6.5% higher than its pre-pandemic level at the end of 2019, with growth rebounding by very a strong 5.9% from the Delta wave lockdowns a year earlier. 

In the September quarter, household consumption contributed the bulk of the increase in activity (0.6ppt) as services spending (0.5ppt) continued to rebound from the pandemic. The recovery in overseas travel was boosting imports, leading to a negative contribution from net exports to GDP (-0.2ppt). Rising imports also reflected an easing of pressure in global supply chains; the production of vehicles has picked up supporting a rise in inventories (0.2ppt). Fewer disruptions caused by wet weather and an improvement in capacity constraints for materials and labour saw home building activity (0.1ppt) and non-residential construction (0.2ppt) adding to quarterly growth.  

Headwinds from the global economy intensified in the quarter. Growth in advanced economies moderated as cost-of-living pressures squeezed real incomes and slowed household spending. US household demand was proving to be more resilient than in the euro area and the UK. Global supply chain constraints had shown further signs of easing but were likely to still be holding back activity. Some of that improvement followed the easing of Covid lockdowns in China, supporting a rebound in quarterly growth there.    

Global inflation pressures remained elevated. Headline inflation appeared to be around its peak as energy prices retraced from the highs reached following the Russian invasion of Ukraine. However, high underlying inflation was persisting and monetary policy continued to be tightened aggressively in response, most notably in the US.     

Supply pressures in global energy and goods markets have contributed to rising inflation in Australia. Domestic inflation pressures have also risen in response to strong demand and supply disruptions caused by floods down the east coast during an extended La Niña system. The domestic demand deflator rose above 6% in year-ended terms, its fastest pace since 1990.

Adding to the cost-of-living pressures were rising interest rates in Australia. The RBA raised rates by 150bps over the September quarter, and although their full effect had yet to be felt, interest payments on mortgages had risen to their highest in 10 years. 

Households have continued to increase their spending as the effects of the pandemic have dissipated, particularly in the services sector in areas including travel, events and dining out. That spending has been supported by a very strong labour market where the unemployment rate has declined to a half-century low of 3.4% and broader measures of spare capacity are at multi-decade lows. 

Robust demand and rising prices has meant that households have increasingly been spending more of their disposable income. The household saving ratio has declined back to its levels on the eve of the pandemic. However, based on an extrapolation of pre-pandemic trends, the household sector on aggregate is estimated to have built up well over $200bn in excess savings over the Covid period, which might now be drawn down and keep the momentum in spending rolling for a time. 

The RBA has continued to raise rates, announcing 25bps increases at the last two meetings. At 3.1%, the main policy rate has risen by 300bps since May. Slower domestic growth is projected by the RBA to 1.5% in 2023 and 2024 as the rebound in household spending from the pandemic runs its course and in response to tighter monetary policy. The risks look to be to the downside given the falls in real income reported in the Q3 national accounts, though the large amount of accumulated savings could offset that headwind to some degree depending on the willingness of households to draw down those funds. The Board's guidance indicates rates are likely to rise in 2023 when it next meets in February. The rapid rise in rates gives rise to the risk of overtightening, with the Board noting it is aiming to keep the economy "on an even keel" as it returns inflation to target "over time". A 25bps hike could be on table in February ahead of a pause in the tightening cycle in March.    

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National Accounts — Q3 | Expenditure: GDP (E) 0.6%q/q, 5.8%Y/Y

Household consumption (1.1%q/q, 11.8%Y/Y) — Real household consumption growth was solid in Q3 at 1.1% but the pace moderated from Q2 (2.1%). Consumption has risen by 11.8% through the year, with more than three-quarters of that growth coming through in services as spending patterns were rebalancing after the lockdowns and the reopening of the borders. 

Services consumption advanced by 1.7% to be 4% higher than its pre-pandemic level, with hotels, cafes and restaurants (5.5%) and travel services (13.9%) driving growth in Q3. A modest rise in goods consumption was posted in Q3 of 0.3% to remain at very elevated levels, up 8.9% on a pre-Covid comparison. Vehicle purchases increased sharply (10.1%) as disruptions hampering global production eased allowing backlogged orders to be delivered. Household furnishings and equipment (-1.5%) declined for the second quarter running, which is likely to be linked to the cooling property market on a weaker volume of transactions. 

The rebound in household consumption over the past year has come alongside the largest hit to real disposable incomes (-2.7%Y/Y) since the early 1990s as inflation pressures have surged coming out of the pandemic. While this has weighed heavily on household sentiment, consumption has remained resilient. 

Key factors behind this resilience have been pent-up demand, the very strong labour market and accumulated savings. In nominal terms, disposable income lifted strongly in Q3 by 1.6% (up 3.3% over the year) as labour income (3%q/q, 9.5%Y/Y) has been supported by the decline in the national unemployment rate to 50-year lows. Increases to the national minimum wage and the superannuation guarantee added a further boost in the quarter. The strength in labour income was more than sufficient to offset an acceleration in interest payments as the RBA continued to raise rates aggressively. 

The effects of rising cost-of-living pressures and RBA rate hikes show in the decline in the household saving ratio from 12.9% at the start of the year to 6.9% in Q3, now broadly back in line with pre-pandemic levels. Over the period, in nominal terms, household consumption has lifted by 10.5% reflecting the combination of underlying demand and high inflation. This far exceeds the lift in disposable income (3.7%) leading to the reduction in saving.

Dwelling investment (1.0%q/q, -3.9%Y/Y) — Residential construction activity posted its first quarterly rise (1.0%) in a year as supply constraints in materials and labour and wet weather delays eased from recent quarters. 

Pandemic stimulus measures including construction subsidies and RBA rate cuts led to a substantial pipeline of new homes, but the supply and weather-related disruptions have hampered activity in the sector significantly over the past year (-3.9%). Despite a sharp rebound in new home building in Q3 (3.4%) activity in the segment is still down 2.8% through the year. Alteration work is unwinding (-2.2%q/q, -5.3%Y/Y) as more of the renovations started in response to the HomeBuilder scheme are being completed.   

Conditions in housing markets across the nation are cooling in response to the RBA's tightening cycle. Housing prices are down by around 7% on a national basis from their recent peak in April according to CoreLogic. A reduction in transaction volumes continues to weigh on ownership transfer costs — fees associated with real estate transactions — down 11.2% in Q3 to be 16.2% lower through the year. 

Business investment (0.7%q/q, 3.7%Y/Y) — The expansion in business investment extended to a fourth quarter in succession, rising to 8.1% above its pre-pandemic level. The strength in domestic demand, accommodative financing conditions and tax incentives have been key to this expansion. 

In Q3, non-residential construction (4.3%) was the main driver as both building (3.8%) and engineering activity (4.8%) picked up pace as supply and weather-related disruptions eased. This more than offset a pullback in equipment investment (-3%) from an elevated level, up 14.4% over the Covid period since the end of 2019.  

In the recent ABS capital expenditure survey, forward-looking investment plans for 2022/23 were upgraded and remain upbeat despite official forecasts anticipating a slowdown in global and domestic growth over the next couple of years.    

Public demand (0.2%q/q, 3.2%Y/Y) — Growth in public demand has consolidated over the past couple of quarters, slowing year-ended growth to 3.2% from its peak of 8.2% in Q1. Government expenditure was driven to a very high level in response to the pandemic and recent flooding events along the east coast but was broadly flat in Q3 (0.1%). Underlying investment slowed to growth of 0.5% in Q3, contributing only modestly to year-ended growth despite an expansive pipeline of public infrastructure projects.  

Inventories (0.2ppt in Q3, 1.1ppts yr) — Pressures in global supply chains caused by product shortages and lengthy delivery times have improved, driving a rebuilding of inventories that has added 1.1ppts to GDP growth over the past year. In Q3, better weather conditions allowed production in the mining sector to rebound. Meanwhile, retail inventories increased sharply reflecting the improvements to supply chains that have hampered vehicle production. 

Net exports (-0.2ppt in Q3, -1.9ppts yr) — Net exports weighed modestly on quarterly GDP. Imports increased by 3.9% driven by services (16.2%) as the recovery in offshore travel continued, rising overall to 7.9% above their pre-pandemic level. Goods imports advanced by 1.5% and by 11.1% over the year as constraints in global supply chains affecting vehicles (22.5%) and capital goods (9%) production have eased. Export volumes expanded by 2.7% but were still 6.5% below their pre-pandemic level. Services exports surged (10.6%) as the recovery in inbound travel gained momentum following the full reopening of the international border earlier in the year. Resources exports softened (-0.4%) driving a moderation in goods export volumes to 1.4% in Q3 from the previous quarter (4%).

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National Accounts — Q3 | Incomes: GDP (I) 0.6%q/q, 5.9%Y/Y 

The real GDP income estimate printed at 0.6% in the September quarter, elevating growth through the year from 2.9% to 5.9%. In the quarter, the new development was commodity prices retracing from the elevated levels they hit in response to the war in Ukraine, weighed by concerns around the global economic outlook. This led to export prices falling by 2.8%q/q while import prices advanced 4.1% reflecting the high global inflationary environment. That set of outcomes saw the terms of trade pulling back from its record high, posting a 6.7% decline in the quarter, its largest quarterly contraction in more than a decade. Even with that decline though, the terms of trade are still 23.1% higher than their pre-pandemic level. 

The falls in commodity prices flowed through to weigh on private non-financial corporations gross operating surplus (-4.7%) driven by a fall in mining profits. Profits in the manufacturing industry were hit by margin pressures stemming from rising energy prices. Worsening margins are also likely to have been a factor in the 1.7% decline in gross mixed income (small business profits). Attenuating those falls, financial corporations gross operating surplus lifted by 4.9%, its strongest quarterly rise in 14 years boosted by rising interest rates. 

Although quarterly growth in hours worked was modest (0.1%) and employment growth consolidated, compensation of employees increased strongly by 3.2% (and 10% in year-ended terms) reflecting the tightening in the labour market as the economy has come through the pandemic. The quarterly increase was boosted by the national minimum wage rise and the lift in the superannuation guarantee. Measures of labour costs on an hourly basis softened to around 3% year-on-year, a similar pace to aggregate wages growth.  

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National Accounts — Q3 | Production: GDP (P) 0.7%q/q, 5.9%Y/Y

The GDP production estimate was 0.7% in the quarter as year-ended growth lifted from 3.3% to 5.9%. Industries in goods distribution led the way in the September quarter, with gross value added (GVA) on aggregate rising by 1.9% to be 6.3% above its pre-pandemic level. The main driver was the transport industry (3.5%) reflecting the ongoing rebound in overseas travel. Meanwhile, the wholesale industry also advanced (1.3%) as vehicle imports improved following earlier supply-related impacts. 

GVA in goods production saw its strongest increase in 2022 (0.9%) to move firmly into its post-pandemic expansion phase. Fewer weather-related disruptions and an easing in capacity constraints saw the construction industry rise by 2.3%. The mining industry posted a 1.2% increase as iron ore production rebounded due to improved weather conditions. 

Business services industries contributed a 1.1% increase in GVA in the quarter to be 11% above its pre-pandemic level. The strong labour market and robust domestic demand conditions supported broad-based growth in administration (3.3%), professional and IT services (1.1%). However, the rental, hiring and real estate industry weakened (-0.6%) as activity in the housing market declined.  

Reopening dynamics supported a modest rise in household services GVA (0.3%), lifting to an 8.1% expansion on a pre-pandemic comparison. Accommodation and food services were the driving factor, accelerating by 3.4% on the back of the strength in demand for dining out and domestic tourism. There was a moderation in arts and recreation services (-0.2%) following a strong rebound (5.7% above end 2019 levels) as demand for gambling activities and performances consolidated. 

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National Accounts — Q3 | Prices

Domestic inflation pressures lifted in the September quarter. Robust demand conditions and rising input costs saw the domestic demand deflator rising by 1.8%, its strongest quarterly rise since the introduction of the GST in 2000 to be running at a 6.2%Y/Y pace. Consumer prices measured by the household consumption deflator rose by 2%q/q and by 6.0% over the year. That is a softer pace than the CPI (7.3%Y/Y) reflecting substitution in the consumption basket of households to cheaper alternatives. Growth in nominal GDP slowed to a 0.8% rise for Q3 (its weakest outcome in a year) as the terms of trade declined (-6.7%). That was the key factor in the economy-wide GDP deflator slowing to just a 0.2%q/q rise, with year-ended growth moderating to 6.9%. 

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National Accounts — Q3 | States 

A wide variation in state demand outcomes was reported in Q3. Tasmania came in on the topside at 1.6%q/q (its strongest rise in a year) while South Australia (0.1%) and Victoria (0.0%) were in at the low end. South Australia was consolidating as state demand rose to 11.7% above its pre-pandemic level. 

Demand in Victoria slowed as a 1.3% rise in household consumption was offset by falls in residential construction (-1.1%), business investment (-1.6%) and public demand (-0.8%). In New South Wales, state demand was up 0.7% and looks to have recovered to its pre-Delta wave trajectory when lockdowns hit the state hard, with demand now 4.9% above its pre-pandemic level. Consumption growth slowed in Q3 but was still solid (0.9%). 

State demand rose at a similar pace in Q3 in Queensland (0.7%) and Western Australia (0.6%). Both states have seen a similar post-pandemic expansion in demand, up 12.2% in Western Australia and 10.6% in Queensland. This has been driven by household consumption as restrictions affecting both states' large tourism sectors have eased.