Macro (Re)view (30/6) | Equities close out strong first half

A panel of the world's major central bank chiefs at the ECB's Sintra forum made clear that the focus remains on hiking rates to more restrictive levels given the risk of prolonged high inflation. The inflation dynamics in the US, euro area, and UK each have their own characteristics but the commonality is that underlying inflation rates are high and progress in returning it to central banks' targets has been slow. There has been little change in this narrative in 2023. While this has led to more inverted yield curves as recessionary risks have increased there has been a sustained rise in equities, coming through headwinds that include the banking turmoil in the US and Switzerland and a fading reopening in China. At the halfway point of the year (see below) US markets are up around 15-30%, European majors are 15% higher; Asia has been more mixed but the Japanese market has been a standout globally rising 27% through the first half.  

Australian inflation slows; RBA still likely to hike 

Markets were encouraged by a notable deceleration in Australia's headline inflation rate from 6.8% to 5.6% in May, assessing that this increases the chance of an RBA pause at next week's meeting. Slowing inflation was driven mainly by falling fuel and holiday travel prices, both considered to be volatile items in the CPI basket. Looking ahead to next week, a hawkish RBA that has been highlighting upside risks to the inflation outlook seems likely to give more weight to the elevated underlying inflation measures in the May report. The trimmed mean gauge came in at 6.1%, down from 6.7% in April but still far too high for the Board, while the CPI ex-volatile items and holiday travel measure printed at 6.4% from 6.5% previously. 

Household spending and the labour market - two other key areas of focus for the RBA - showed ongoing resilience in the data to hand through the week, pointing to a 25bps rate hike on Tuesday. Retail sales accelerated by 0.7% in May, the strongest outturn since the start of the year. The rise was driven by discretionary-related spending (sales ex-food lifted 0.9%) supported by dining out and end-of-financial-year sales (see here). Despite numerous headwinds including from higher interest rates and cost-of-living pressure, spending is holding up better than may have been expected, with the labour market a key support. Job vacancies declined by 2% for the 3 months to May to be 10% below their peak a year earlier; however, labour demand still remains very strong. Total vacancies in Australia came in a 431.6k, equivalent to a historically elevated share of the labour force at around 3%. 

US inflation easing but still elevated 

The disinflationary process in the US continued in May with the headline PCE deflator falling from 4.4% to 3.8%, a low going back to April 2021. Underlying inflation, which remains harder for the Fed to shake, ticked down from 4.7% to 4.6%. That said, markets were buoyed by the underlying measure that excludes housing costs (considered a more accurate guide of where inflation is headed) which softened from 4.4% to 3.9%. That particular measure is considered monitored by the Fed and if the trend lower remains in place, the need to hike rates further becomes a more nuanced discussion.    

That comes as household demand - while still resilient - appears to have lost much of its momentum. Real consumption lifted solidly by 1% in the first quarter, but this has been followed since by a 0.2% rise in April and a flat outcome in May. A softer impulse from consumption supports an outlook for easing inflation. 

ECB Sintra wrap-up  

Inflation and the response to it was (unsurprisingly) the theme of the ECB's Sinta Forum. In her opening remarks, ECB President Christine Lagarde said that the series of shocks that caused inflation to surge quickly risked taking longer to unwind. While headline inflation is coming down declining from 6.1% to 5.5% in June, the core rate has yet to decelerate and ticked up slightly from 5.3% to 5.4%, the latter the main focus of the ECB. 

The main risk the ECB sees to persistent inflation is from rising unit labour costs. While the ECB expected stronger wages growth in response to a tight labour market and as catch-up to past high inflation, it is concerned that this is occurring against the backdrop of weak productivity growth. To avert a more sustained period of wages following prices, President Lagarde maintained the message that rates would rise further. The key questions the Governing Council were now pondering are the appropriate level rates needed to reach and the length of time they would need to remain there. 

Australian retail sales rise 0.7% in May

Australian retail sales accelerated by 0.7% in May posting their strongest rise since the start of the year. Discretionary categories drove the rise in spending amid strong demand for dining out and discounting associated with end-of-financial-year sales. Despite numerous headwinds and weak sentiment, spending by Australian households is displaying resilience. 

Headline retail sales lifted by 0.7% in May, with discretionary sales (total sales ex-basic food) rising at a slightly stronger pace of 0.9%. These were the strongest outturns for both categories since January. The ABS identified an early start to end of financial year sales and events such as Mother's Day and Click Frenzy promotions as key factors behind the acceleration in spending in May.  

Across the categories, the strongest rises were in restaurants and cafes (1.4%) and other retailing (2.2%), the latter boosted by online sales and spending at florists and for cosmetics and pharmaceuticals. Household goods (0.6%) saw their first rise since January. Weakness in discretionary spending was evident in clothing and footwear (-0.6%) and department stores (-0.5%). Food sales lifted by 0.3%.   

As highlighted above, there were several factors supporting retail spending in May, this coming amid the backdrop of a very strong labour market and rapid population growth. Inflationary effects also remain a factor in boosting nominal sales; goods-related inflation in Australia is slowing but the process is taking longer than seen overseas. Overall, declines in sales volumes over the past two quarters (-0.3% in Q4 and -0.6% in Q1) show that retail demand has softened; however, household consumption in services has held up and is appearing resilient. 

Macro (Re)view (23/6) | Rally setback by renewed hawkishness

The upbeat sentiment that has fuelled equity markets of late dissipated this week amid renewed central bank hawkishness. Both the Bank of England and Norges Bank surprised markets with larger rate hikes than were expected, while the Swiss National Bank hiked by 25bps and signalled the prospect of more tightening ahead. These factors boosted the US dollar and led to more inverted yield curves.   

BoE accelerates tightening 

The BoE surprised markets with a larger rate hike than expected at this week's meeting. The Monetary Policy Committee (MPC) voted 7-2 to hike rates by 50bps to 5%, the pace of tightening accelerating from 25bps increases at the previous two meetings. As noted last week, renewed strength in wages growth meant a rate hike was assured, but it was a hot inflation report on the eve of the meeting that prompted the MPC to act more aggressively. Headline CPI inflation is in decline, though progress stalled in May printing at 8.7%yr (vs 8.4% exp); however, a rise in core inflation from 6.8% to 7.1%yr (vs 6.8% exp) marked a new high and clearly shocked the MPC. 

External shocks, namely Covid and the war in Ukraine, initially led to a surge in UK inflation, but increasingly the drivers are turning to domestic factors with businesses raising prices to protect margins and households receiving higher wages for the cost of living. The MPC is concerned that the changing nature of inflation risks prolonging elevated price increases. Services inflation, which is the key focus for the MPC, pushed up from 6.9% to 7.4% to be running at its highest since the early 1990s. The MPC retained its guidance that developments consistent with persistent inflation pressures would see rates hike further. Markets anticipate the MPC will hike rates to a peak of 6% by year-end. 

Fed remains on message... 

Federal Reserve Chair Jerome Powell told Congress that further rate hikes in the US are expected to be needed, consistent with the messaging at last week's FOMC meeting. Despite inflation having decelerated significantly, Chair Powell said there was still "a long way to go" on the path back to the 2% target. Last week's decision to leave rates on hold was taken to allow the FOMC to take on board more data, acknowledging that the full effects on the economy from 500bps of tightening remain in the pipeline. That approach also meant that there was now less emphasis on the pace at which rates were being hiked than earlier in the tightening cycle. 

... as does the ECB 

Coming out of last week's meeting, the ECB reiterated its determination to do more to return inflation to target. In a speech, ECB Executive Board member Isabel Schnabel said that given the risk of high inflation remaining persistent, it was prudent for monetary policy to "err on the side of doing too much rather than too little". Schnabel identified three sources of upside risk to the inflation outlook including: i) ongoing supply shocks, ii) lasting effects on productivity from these supply shocks, and iii) a greater resilience in demand conditions than anticipated.  

RBA adapting to inflation risks 

More insights into the RBA's latest rate hike came to hand in the June meeting minutes. The emergence of upside risks to the RBA's inflation outlook has meant that its hiking pause in April was short-lived. As was the case in May, the Board considered leaving rates on hold but ultimately elected to hike, a judgment it again said was "finely balanced". 

It was outlined that the risk of inflation staying higher for longer had increased. Specifically, the Board is wary that wage and price settings indexing to past inflation could become more widespread, while a more robust growth outlook, supported by rising housing prices in Australia and an improving global backdrop, could delay the process of returning inflation to the 2-3% target. 

The Board's other mandate, full employment, was discussed in a speech by RBA Deputy Governor Michele Bullock this week. Bullock's main argument was that full employment goes hand in hand with inflation at the target. While the RBA expects the labour market to soften on the back of higher rates, it remains of the view that there is a path to achieving a soft landing. 

Macro (Re)view (16/6) | More hawkish turns

Following the likes of the Reserve Bank of Australia and the Bank of Canada, the Federal Reserve and the European Central Bank increased the hawkish volume of their messaging on policy at their respective meeting this week. But this proved no match for the rally in global risk sentiment. The expectation is that further rate hikes will be required in the US and euro area as the risk of persistent inflation pressures remains present. Markets are unconvinced the Fed will hike again while they took the ECB's messaging in their stride. The Bank of Japan also met this week, leaving all settings unchanged. Attention shifts to the Bank of England's meeting next week, a 25bps hike considered a lock on the back of a strong labour market report and rising wages growth. Given the forward profile for UK rates is aggressive, with 4 additional hikes expected to a peak of 5.5%, it may be harder for the MPC to deliver a hawkish surprise.    

Fed hawkishness falls flat as inflation decelerates 

The Federal Reserve's FOMC delivered the 'skip' it had guided markets to expect at this week's meeting, the fed funds rate remaining steady in the 5-5.25% range. Cautioning against extrapolating this week's decision into a more extended pause, the FOMC raised its projection for the peak rate to 5.5-5.75%. However, markets are unconvinced an additional 50bps of rate hikes will be forthcoming given the disinflationary pulse working through the US economy. Headline CPI fell from 4.9% to 4% in May - its slowest since March-21 - and this was backed up by a continued easing in pipeline price pressures in producer (1.1%yr) and import prices (-5.9%yr). The core CPI softened to 5.3%yr but is still elevated and as Chair Jerome Powell highlighted in the post-meeting press conference, the FOMC has been frustrated by the slow pace of progress on this front. 

Speaking to this, FOMC members raised their outlook for the core PCE deflator - its preferred gauge of underlying inflation - from 3.6% to 3.9% this year; the projection for 2024 was left unchanged at 2.6%, with a return close to the target anticipated in 2025 at 2.2% (from 2.1%). Chair Powell also made the point that the FOMC continues to see that the balance of risks to its inflation outlook remain to the upside, justifying the expectation for a higher peak rate. This comes amid renewed confidence in the resilience of the economy; forecast GDP growth was upgraded from 0.4% to 1.0% in 2023, which lowered the outlook for the unemployment rate to 4.1% from 4.5% previously.

ECB recalibrates as inflation risks persist 

In addition to announcing a 25bps hike to its key rates this week, the ECB signalled rates were set to rise further in July, developments that were expected by markets. The depo rate now stands at 3.5%, up from -0.5% this time last year. Uncertainty remains over how close the ECB is to the peak rate. In the post-meeting press conference, ECB President Christine Lagarde said an outlook for higher inflation than previously expected meant that rates had yet to reach their destination, remaining short of a sufficiently restrictive level.   

ECB staff macroeconomic projections raised the inflation profile to 5.4% on a headline basis in 2023 (from 5.3%) and to 5.1% on the core rate (from 4.6%). Inflation is then anticipated to decline at a slower pace through the projection horizon, remaining firm to its 2% target come 2025: headline at 2.2% (from 2.1%) and core at 2.3% (from 2.2%). The drivers of inflation - previously caused by the shock to food and energy prices stemming from the war in Ukraine - are switching to labour cost pressures, which the ECB says carries upside risk to its outlook. That portends higher rates but at the cost of a more forceful headwind to the economy. Euro area growth has contracted slightly over the past couple of quarters, resulting in the ECB  lowering its growth outlook from 1% to 0.9% this year and to 1.5% from 1.6% in 2024. 

Source: European Central Bank, Eurosystem staff macroeconomic projections, June 2023 

Australian labour market rebounds strongly 

A strong rebound in the Australian labour market from the slowdown over the Easter holiday period has put a hawkish and data-dependent RBA back in focus. Pricing for a July rate hike has pushed up to 50% from 25% as employment surged above expectations rising by 75.9k in May - its strongest increase in 11 months - after declining by 4k in April (full review here). Attesting to the strength of labour demand, the unemployment rate fell back from 3.7% to be close to its lowest since 1974 at 3.6%. While this will keep the RBA alert to wage pressures, labour supply in Australia remains highly dynamic - as it was through the pandemic - with the participation rate rising to a new record high of 66.9%.

Surveys on households and businesses continued to report that confidence remains weak. For households, the Westpac-Melbourne Institute consumer sentiment index was broadly unchanged in June (-0.2%) but remains in deeply pessimistic territory, largely reflecting the impacts of cost-of-living pressures and rising interest rates. A weak confidence reading for businesses in the NAB survey (-4) appears driven by the expectation that conditions - while still above average for now despite softening in May (+8) - are set to weaken materially amid an outlook for economic growth to slow as consumers pull back.

Australian employment 75.9k in May; unemployment rate 3.6%

The Australian labour market regained its momentum from earlier in the year, rebounding strongly from a slowdown over the Easter holiday period. Employment posted its strongest increase in 11 months (75.9k), rising through 14 million for the first time. This drove a fall in the unemployment rate to 3.6%, remaining around cycle lows as the participation rate elevated to a new record high (66.9%). The report increases the chance of an RBA rate hike in July.        

    

Labour Force Survey — May | By the numbers

• Employment surged by 75.9k (on net) in April, blitzing expectations for a rise of 17.5k. This follows a 4k decline in April (revised from -4.3k). 

• National unemployment fell back to 3.6% (or 3.55%), reversing the increase to 3.7% in April. The broader underemployment rate was 0.3ppt higher at 6.4%, resulting in total underutilisation increasing from 9.8% to 10% (11-month high).  
• Labour force participation rate hit a record high in May at 66.9%, more than rebounding from April's decline to 66.7%. The employment to population ratio (share of working-aged Australians in work) is also back at record highs after rising to 64.5%.  

• Hours worked were 1.8% lower on the month following a 2.7% acceleration in April. Year to date, hours worked have risen by 2.8%. 

Labour Force Survey — May | The details

The Australian labour market has returned to the strong momentum seen in the first quarter of the year, confirming (as expected) the weak report in April was driven by seasonal effects around the Easter holiday period. Employment increased sharply by 75.9k in the month (full time 61.7k and part time 14.3k), its strongest rise in 11 months.  

Over the 3 months to May, employment averaged an increase of 47.6k per month, the pace annualising at a robust 4.2%. The momentum in employment softened into the end of last year, but it has since reaccelerated. Annual growth in employment is running at 3.4%, outpacing growth in the working-age population (2.7%).

Total employment in Australia rose through 14 million for the first time, an increase of more than one million from its level on the eve of the pandemic. The Australian economy has been a powerhouse for employment in its recovery and subsequent expansion from the Covid recession. Real GDP to the March quarter was 7.4% above its pre-pandemic level, an expansion that has generated a 7.9% increase in employment to May-23. 

Such was the strength of the employment outcome in May, the unemployment rate fell from 3.7% to 3.6% even as the participation rate lifted to a new record high at 66.9%. At this level, unemployment is around cycle lows and at its lowest levels since the mid 1970s. Meanwhile, rapid population growth post the pandemic has contributed to a larger labour force in Australia. The participation rate is 1.1ppts higher than in early 2020. 

Where there has been some easing in the labour market is in the underemployment rate (including unemployed people and employed people wanting additional hours), now 6.4% compared to the cycle low of 5.9% in late 2022. Alongside this, underutilisation has lifted to 10% from the low of 9.3% last October. But, overall, both measures remain low by historical standards. 

Hours worked pulled back in May (-1.8%) after the surprise increase in April (2.7%) when more than 5 million people were on annual leave over Easter. This month around 4 million people were back at work, but hours were reported to have fallen. Looking through the volatility, hours worked are up by 0.9% over the past two months.   

Total hours worked in May were up 2.8% since the start of the year and up 10% overall on the pre-pandemic level from March 2020. 

Labour Force Survey — May | Insights

There was good reason to be upbeat going into today's report given that the labour market had accelerated in the first quarter; the weak report in April came against the run of play and clearly looked to be related to the Easter holiday period. Given this and the RBA's recent hawkish turn, markets looked to be underpricing prospects for a July rate hike, assessed to be a 1 in 4 chance at yesterday's close. Expectations for a July hike will firm off the back of today's report. That said there are upcoming key events including a speech from RBA Deputy Governor Bullock (20/6) and the monthly CPI report for May (28/6) that will provide more of a guide.  

Preview: Labour Force Survey — May

Australia's Labour Force Survey for May is scheduled for release at 11:30am (AEST) today. Coming off a month of weakness in April, labour market activity is expected to have rebounded in May. The employment outcome could be stronger than markets have factored in, which could have implications for the next RBA meeting.     

As it stands | Labour Force Survey

A weak labour force report for April surprised markets that were anticipating a continuation of the strong momentum seen during the first quarter of the year. Seasonal effects associated with the Easter holiday period were the likely cause. Employment fell for the first time since December, down 4.3k in the month (vs 25k exp) driven by a decline in full time employment (-27.1k) as part time employment increased (22.8k). 

The fall in employment pushed the unemployment rate up to 3.7% from 3.5% in March, occurring alongside an easing in the participation rate from 66.8% to 66.7%. Despite the rise in unemployment, the broader underemployment measure (including employed people wanting additional hours) ticked down from 6.2% to 6.1%. These offsetting movements in unemployment and underemployment left total labour force underutilisation unchanged at 9.8%, around historic lows in Australia. 

Hours worked were reported to have surged by 2.6% in April, a surprising outturn given that 5.1 million people were taking annual leave during the reference weeks for the survey, which covered the full Easter holiday period. The timing of Easter in 2023 was similar to 2015; back then, 5.2 million people took annual leave, with no growth in hours worked in that particular month. 

Market expectations | Labour Force Survey

Employment is forecast to rebound by 15k in the month on the median estimate (Bloomberg survey) around a range from -10k to 45k. The high-frequency ABS payrolls index lifted by 0.5% for the month to mid-May, consistent with a rebound in employment coming out of the Easter holiday period. Prior to Easter, the momentum in employment had reaccelerated to rise by 116.6k through the first quarter of the year, the strongest quarterly increase since the middle of 2022. Given these factors, the risks look tilted to the upside of the consensus expectation for employment in May. 

An expected rebound in employment is seen holding the unemployment rate in check at 3.7%, with the participation likely to see an uplift after the holiday period amidst ongoing rapid population growth.   

What to watch | Labour Force Survey

Despite the weak report for April and genuine questions around seasonal effects during Easter, the RBA continued to hike interest rates last week. A data-dependent RBA retains a tightening bias and if today's report shows a strong rebound in the labour market in May, markets are likely to respond by pushing up pricing for a 25bps hike in July. 

Macro (Re)view (9/6) | Committed to the cause

Rate hikes from the Bank of Canada and Reserve Bank of Australia surprised markets this week. With both central banks walking back from earlier pauses, the message sent was that there is no room for complacency given the risk of inflationary pressures remaining more persistent. Australian bonds underperformed global peers as RBA rate expectations were revised higher, driving the Australian dollar to a sharp increase over the week. A pivotal week is ahead highlighted by meetings from the Federal Reserve, European Central Bank, and the Bank of Japan. Markets have been guided to expect the Fed to "skip" a rate hike next week - though inflation data prior to the meeting will be closely monitored - while a 25bps hike from the ECB is all but assured; in Japan, reporting indicates there will be no tweaks to yield curve control. 

RBA turns more hawkish...

The RBA underlined its commitment to bringing inflation down to its 2-3% target as the Board hiked rates (+25bps) against expectations for the second meeting in succession, the cash rate now standing at 4.1% (more here). The Board judges that recent developments in wages and prices - both domestically and offshore - have put its objective of returning inflation to target "within a reasonable timeframe" at an increased risk. The retention of the guidance that additional tightening "may be required" and a notably hawkish speech from Governor Lowe suggests the RBA's work is not done yet. As a result, market pricing for the peak cash rate has pushed up towards 4.6%, a rise of around 50bps over the week.  

... as the Australian economy slows further 

Increased RBA hawkishness makes the growth and inflation trade-off - keeping the economy "on an even keel" as the Board speaks of - more challenging to balance. The Australian economy has shifted into the slow lane as the National Accounts reported real GDP softened to 0.2% in the March quarter from 0.6% in the December quarter last year. Growth through the year is still solid at 2.3%, but that has been underpinned by reopening factors, including rapid post-pandemic population growth and the recovery in the services sector, notably tourism and education. Households - facing headwinds from falling real incomes and rising interest rates - have moderated consumption growth (0.2%qtr, 3.5%yr), with spending rotating to essentials (1%qtr) from discretionary areas (-1.1%qtr). The household saving ratio came down to a 15-year low (3.7%) in the quarter, though savings built up during the pandemic remain substantial. My feature-length review of the March quarter National Accounts with in-depth analysis and more than 30 charts is available here. 

In other local news this week, Australia posted another elevated current account surplus at 1.9% of GDP in the March quarter on the back of the second-highest trade surplus on record (see here); the monthly accounts, though, reported a narrowing of the surplus in April to $11.2bn (see here).

OECD forecasts improved global growth outlook 

After global growth slowed materially in 2022, the OECD in its June outlook projected 2023 to be a year of stabilisation. The group revised up its forecast for global GDP this year to 2.7% from 2.6%, with growth of 2.9% (no change) expected in 2024. Declining inflation, China's reopening, strong labour markets and resilient household finances support the growth outlook. But the OECD categorises the risks as being to the downside; persistent inflation could require a longer period of restrictive interest rates, which would weigh on growth and potentially lead to stresses in financial markets. 

Headwinds emerge in US services sector 

US services sector activity came close to stalling in May according to the ISM gauge, which slid by 1.6% over the month to a 50.3 reading. The services sector has underpinned the US economy, with activity in the manufacturing sector contracting since late last year. But there were signs of weakness emerging in the services sector: the employment index (49.2) fell below the 50 line (into the contractionary zone) - though this contrasts with the strong 339k rise in nonfarm payrolls in May - and new orders (52.9) slowed sharply. The positive was that the prices paid component fell back to mid-2020 levels (56.2) as inflationary pressures faced by firms continued to ease. 

ECB to continue tightening 

A 25bps rate hike from the ECB next week is considered a done deal, with markets then expecting one more hike to round out the tightening cycle. However, comments from the ECB's Executive Board member Isabel Schnabel suggest those expectations could be too light; Schnabel said the risk of persistent inflationary pressures setting in still had the balance tilted in favour of overtightening rather than undertightening. She also highlighted that the ECB needed to see "convincing evidence" that inflation was on the way down to the 2% target, something that as yet remains elusive. Meanwhile, momentum in the euro area economy has faltered as revisions showed growth has contracted slightly (-0.2%) over the past two quarters.  

      

Australian trade surplus narrows to $11.2bn in April

Australia's trade surplus narrowed to an 8-month low in April but remained elevated at just above $11bn. Weakness in export commodities and rising capital goods spending drove the narrowing. The value of services exports has now caught up with imports.    

International Trade — April | By the numbers

• Australia's trade surplus in April was $11.2bn, lower than expected ($13.7bn) and in from $14.8bn in March (revised from $15.8bn). 

• Exports declined by 5% to $56.2bn (3.2%yr) following a 4.1% rise in the previous month. 
• Imports were 1.6% higher in April at $45bn (prior: 3.7%m/m), up 8.5% over the year. 

International Trade — April | The details

The monthly trade balance narrowed sharply to a surplus of $11.2bn, an 8-month low. The surplus on goods trade fell from $15.2bn to $11.2bn as services trade moved into balance, with exports and imports netting each other off at $8.7bn in April. 

Export income was down 5% on the month to $56.2bn, its lowest since August-22. The value of goods exports declined by 7% on falls in rural (-9.3%) and non-rural goods (-6.1%); the volatile non-monetary gold component was another point of weakness (-19.7%). A mixture of lower commodity prices and reduced shipments weighed on export values for iron ore (-10.4%) and coal (-7.1%), driving the fall in non-rural goods. Coal exports retraced to a low going back to the start of 2022.  

Turning to rural goods, while most categories are down from the highs of last year (with prices retracing), the value of meat exports continues to rise at pace, up 19.2% over the year. 

Import spending remains elevated, with demand supported by lower prices due to the resolution of supply chain pressures. Yesterday's national accounts reported a 3.2% rebound in import volumes in the March quarter, with prices down 4% in the period. In April, imports were driven mostly by a 7.2% rise in capital goods spending. 

In services trade, exports continue to advance on reopened borders; however, imports have trended a little lower over the past 6 months or so. This has allowed exports to catch up with imports. 

International Trade — April | Insights

Despite narrowing sharply in April, the trade surplus remains elevated. This is also after the trade surplus widened in the first quarter of the year, driving another historically sizeable current account surplus of 1.9% of GDP. 

In review: Australian Q1 GDP: Growth shifts to slow lane

Australia's economy slowed further in early 2023. Real GDP growth softened to 0.2% in the March quarter, coming in below expectations (0.3%) and downshifting from growth of 0.6% in the final quarter of last year. Excluding the Covid period, this was the weakest quarterly growth rate since late 2018. The pace of economic growth moderated from 2.6% to 2.3% through the year, but activity is now more than 7% higher than its pre-pandemic level at the end of 2019.

Slowing growth in Australia reflects a weaker economic backdrop from offshore. Growth across OECD economies was 1.5% over the year to Q1, well down from a 4.5% pace a year ago. The fading of the pandemic rebound, high inflation and rising interest rates have been some of the key factors behind this slowdown. The US economy has proved to be more resilient to these headwinds. Global growth was also supported by the removal of Covid restrictions in China; however, more recent data indicates the reopening effort there has lost momentum. 

In Australia, the impulse to economic growth from household consumption, which was rising coming out of the pandemic, is now fading. This is the major driver of slower growth. Pressures on households from the cost of living, RBA rate hikes, earlier falls in housing prices and weak sentiment have contributed to the momentum in consumption turning lower. 

There have been two key factors that have underpinned growth in the Australian economy over the past year: an acceleration in population growth on reopened borders and the recovery in the services export sector. Population growth has surged by 2% over the year, its strongest pace since late last decade. Growth in GDP per capita (output adjusted for the population increase) was just 0.3% over the year. 

The reopening of the international border has also facilitated the recovery in the services sector, most notably in tourism and education. Services exports rebounded by around 50% through the year, contributing 2ppts to economic growth.  

Inflation in Australia eased slightly in Q1 but remained elevated. A disinflationary pulse from offshore led to falls in goods and petrol prices; inflation, however, generated by domestic sources was yet to peak.  

The focus of the RBA's tightening cycle has turned to respond to domestic inflationary pressures, including a 25bps hike at the June meeting that increased the cash rate to 4.1%. The strength in the labour market has led to rising wages growth, which the RBA notes has not been accompanied by a rise in productivity. In fact, measured productivity has fallen over the year (-4.5%), due to hours worked (7.1%) far outpacing economic growth (2.3%). 

The RBA highlights elevated unit labour costs (7.9%) - the underlying cost of labour for firms -  as posing a risk to returning inflation back to its 2-3% target "within a reasonable timeframe"; the RBA effectively argues that rising wages could become inflationary unless they are being driven (in part) by a sufficient increase in productivity (around 1%, the RBA estimates). 

Looking ahead, the headwinds faced by households are set to intensify through the remainder of the year. The effects of earlier rate hikes will continue to flow through to mortgage payments; many households will move to paying much higher variable rates as their fixed-rate periods locked in during the pandemic end. However, the economy will remain supported by population growth and the labour market, while households (in aggregate) continue to hold a large amount of accumulated savings. 

— — —

National Accounts — Q1 | Expenditure: GDP (E) 0.3%q/q, 2.6%Y/Y

Household consumption (0.2%q/q, 3.5%Y/Y) — The momentum in household spending slowed further amid the headwinds from cost-of-living pressures, rising interest rates, earlier declines in housing prices and weak sentiment. Household consumption growth was 0.2% in the March quarter from 0.3% in Q4, a sharp loss of momentum from the robust growth in the first half of 2022 (4.1%).

The consumption basket of households rotated to being driven by essentials (1.1%) as discretionary spending was cut back (-1.1%), indicating the post-pandemic rebound in spending effectively dried up in Q1. The decline in discretionary spending was driven by household goods (-2.4%) and new vehicle purchases (-2.2%); however, ongoing tourism demand kept transport services (4%) and hotels, cafes and restaurants (0.2%) supported. 

While strong labour market conditions are supporting incomes, this is being eroded by high inflation. Real incomes were down by 0.3% in Q1 and have contracted by more than 4% over the past year, a fall of historic magnitude. Adding to this squeeze is the effect of rising interest rates. Mortgage payments lifted to 6% share of (nominal) household disposable income in Q1, the highest level in nearly a decade. 

Excess savings accumulated over the pandemic - estimated to be well over $200bn in aggregate - have supported household spending. But the household saving ratio is now down to 3.7%, its lowest since 2008, and households may look to rebuild their savings buffers, particularly given very weak sentiment. 

Dwelling investment (-1.2%q/q, -4.4%Y/Y) — Residential construction activity contracted by 1.2% in the March quarter and has been a headwind to the economy over the past year (-4.4%). 

Capacity constraints in the availability of materials and labour, rising interest rates and an earlier downswing in housing prices are all weighing on new home building (-1.3%q/q, -1.6%Y/Y). Alterations (-0.9%, -8.2%Y/Y) continue to unwind from their peaks reached during the pandemic when they were supported by government construction subsidies.

The downturn in housing prices - a fall of around 10% from their pandemic peak - responding to the RBA's tightening cycle has seen ownership transfer costs — fees associated with real estate transactions — decline by 22% over the year, subtracting 0.4ppt from economic growth.    

Business investment (2.9%q/q, 6.6%Y/Y) — A 2.9% rise in the March quarter was the strongest lift in business investment in two years, the outturn resulting in year-ended growth working up from 4% to 6.6%. 

Non-dwelling construction (2.3%) picked up in the quarter and expanded strongly through the year (8.9%) as capacity constraints and adverse weather that caused earlier delays eased.  Machinery and equipment spending (4.9%q/q) has also accelerated over the past year (6.6%); eased pressures in global supply chains and the reopening of the borders to allow people with the relevant technical expertise to come into the country have helped facilitate investment. Intellectual property products lifted by 1% for the second quarter running. 

According to the recent ABS capital expenditure survey, forward-looking investment plans remain robust to an outlook for slower growth both domestically and offshore. 

Public demand (0.8%q/q, 0.7%Y/Y) — Public demand lifted 0.8% in Q1, its strongest rise in a year, remaining elevated as a share of GDP but down from the peaks during the pandemic crisis. Public investment (4.6%Y/Y) is gaining momentum as progress in rolling out infrastructure projects is picking up. Health-related policies have kept government spending at a high level over the past year.   

Inventories (0 ppt in Q1, -0.9ppt yr) — Inventories were neutral to growth in the March quarter. Although there was a large rise in wholesaler and retail inventories on the back of a rise in vehicle imports, this was offset by drawdowns in manufacturing and public authorities' inventories.   

Net exports (-0.2ppt in Q1, 1.3ppts yr) — Weighed modestly on activity in Q1 (-0.2ppt) but have added strongly to growth over the past year. The reopening of the borders continues to drive exports (1.8%q/q, 10.8%Y/Y), led by the services (49.7%Y/Y) on the back of the recovery in the tourism and education sectors. Imports rebounded in the quarter (3.2%) on eased supply chain pressures and falling prices.   

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National Accounts — Q1 | Incomes: GDP (I) 0.2%q/q, 2.1%Y/Y 

The income approach to real GDP posted growth at 0.2% in Q1 and 2.1% over the year. Higher incomes and prices are reflected in high nominal growth in Australia. Nominal GDP was up by a further 2.1% in the quarter - supported by a 2.8% rise in the terms of trade - to be up by more than 9% through the year. 

Continued strength in the Australian labour market is supporting a rising wages bill. The compensation of employees lifted 2.4% in Q1 and has risen by 10.8% over the year on a combination of an increase in hours worked, faster wages growth and the use of bonuses and other incentives as firms focused on retaining staff. 

Company profits (ex-financials) were 4% higher in the first quarter and are up 13.5% through the year. The manufacturing and hospitality sectors drove the rise in quarterly profits on the back of rising sales; meanwhile, wholesalers benefitted from improved margins as input prices fell. 

Financial corporations profits softened in the quarter (-0.2%) and are lagging in annual terms (8.3%) as the effects of rising interest rates weigh on loan demand. Gross mixed incomes - small business and farming profits - have been hit by margin pressures due to rising prices; lacking the pricing power of larger firms (or due to declines in rural commodity prices), profits are contracting (-3.8%q/q, -4%Y/Y). Lower output is also a factor in the agriculture sector - farm GDP is down almost 6% through the year after floods impacted the east coast in 2022. 

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National Accounts — Q1 | Production: GDP (P) 0.2%q/q, 2.1%Y/Y

The production estimate of GDP at 0.2%q/q was in line with the headline increase in quarterly GDP but softer in the annual growth rate at 2.1%. Gross Value Added (GVA) in Q1 increased at a similar pace for both the goods production (0.5%) and goods distribution sectors (0.3%), but there was a divergence between household (0.8%) and business services (-0.6%). 

In the goods production sector, output was driven by manufacturing (2.4%) on increased production of food and metals, and by the utilities industry (1.5%) as warm weather in late summer saw electricity consumption rise. The goods distribution expanded as a rebound in grain production after flooding in 2022 boosted wholesale trade (1.3%), with the associated freight logistics underpinning the transport industry (0.4%). These gains were partially offset by the retail industry (-0.5%) as households cut back discretionary spending. 

Household services advanced on rising demand for health care services (1.1%). Output in accommodation and food services (0.7%) was supported by major sporting events. Increased vehicle maintenance and repairs (part of other services) was another contributor to growth (1.2%). Business services weakened in Q1. The effect of rising interest rates weighed on real estate (-1.6%) and financial services (0%). Professional services (-1.2%) and administration (-1.4%) both contracted.  

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National Accounts — Q1 | States 

State demand has slowed sharply across the nation over the past year. Year-ended growth rates to the March quarter show state demand ranges from 1.9% at the low end (Victoria) to 2.8% at the top end (Western Australia). 

Household consumption in the two major states has lost momentum over recent quarters but is remaining resilient, New South Wales posted a 0.2% rise in Q1 while Victoria lifted by 0.3%. Consumption growth in the quarter was strongest in South Australia (0.8%) and weakest in Queensland (-0.1%). Residential construction activity contracted in all states through the year to Q1. In contrast, business investment has expanded at a 7-8% annual pace in most states. Public demand has moderated from the pandemic crisis, slowing to 0.4%Y/Y in New South Wales and declining in Victoria (-1.7%Y/Y).