Macro (Re)view (22/12) | Markets ride high to close 2023

Markets go into the holiday season riding high. It has been a stellar year for US and European equities while Japan has been the standout in Asia. Expectations for rate-cutting cycles are increasingly being backed up by the data - as seen in the latest inflation data in the US and UK this week. The 2-year US Treasury yield (4.32%) trades at lows going back to May while at the longer end the 10-year yield (3.89%) has retraced to 5-month lows having pressed 5% as recently as October. This backdrop has weakened the US dollar, the Australian dollar a notable beneficiary rallying by around 8% against the USD from its October lows.  

Cooling inflation in the US continues to underpin expectations for a sizeable Fed easing cycle in 2024. The headline PCE deflator eased from 2.9% to 2.6% at an annual rate to November and the core deflator softened from 3.4% to 3.2%, both in below expectations and at their lowest since early 2021. Notably, on a 6-month annualised basis, the core deflator at 1.9% is now inside the Fed's inflation target for the first time since September 2020. Should this momentum continue, there is an entirely plausible scenario where underlying inflation returns to the target by the middle of next year.   

Markets were left none the wiser on the timeline for policy normalisation following the Bank of Japan's meeting this week. All policy settings were left unchanged (-0.1% key rate and 0% 10-year yield target) and its forward guidance to step in with "additional monetary easing" if required has remained intact. The meeting statement conceded there are 'extremely high uncertainties' for the inflation and economic outlook in Japan, leaving policymakers reluctant to signal forthcoming policy changes. While inflation is expected to run above the 2% target through 2024, this is due mainly to the pass-through of higher imports prices and is judged as unlikely to be sustained. Underlying inflation is anticipated to 'increase gradually toward achieving the price stability target'; however, that relies upon growth picking up to an above-trend pace to underpin a rise in wages growth.   

The BoE's pushback to near-term rate cuts failed to gain traction after last week's meeting, and downside surprises in the UK's inflation report for November have only added to the extent of easing priced for 2024 (rising to around 130bps from 115bps). 12-month headline inflation fell from 4.6% to 3.9%, printing at a 26-month low and well below the 4.3% consensus figure. Inflation has declined substantially from its 11.1% peak 13 months ago driven largely by falling energy prices; however, there are increasing signs that the disinflationary process is broadening to other categories of the basket. This was reflected by a decline in the core rate from 5.7% to 5.1% (21-month low) against 5.6% expected. An easing in services inflation to 6.3% (from 6.6%) rounded out an encouraging report, but the BoE will want to see far more progress in this key component through the early months of 2024. 

The minutes of the RBA's December meeting get across the Board's tightening bias remains in place, but the message has been dated by recent events. Most notably, at the time of the meeting, the board members observed that 'market expectations for policy rates in other countries had eased significantly over the prior month, while being little changed for Australia'. Subsequently, those expectations have spilled over into Australia as the data have softened, with around 50bps of RBA cuts priced for 2024. The timing has meant the RBA goes into its summer break not having had the opportunity to push back on that pricing in the way the ECB (subsequently reiterated by Vice-President de Guindos) and BoE did last week. 

As to the December decision, the Board elected to leave rates on hold assigning greater option value on waiting for additional data than delivering a follow-up hike to the 25bps increase in November. It was noted there had been 'encouraging signs of progress towards the Board's objectives' while the 'pace of disinflation in some other countries... had accelerated' and that if this flowed through to prices in Australia it 'would be helpful in bringing inflation back to target'. The case to hike further rested on upside risks to the inflation outlook, driven by strength in domestic demand conditions. However, the sharp slowdown in GDP growth to 0.2% in the September quarter has made this a difficult narrative for the RBA to sustain going into next year.

A Merry Christmas to all and best wishes for 2024. A sincere thank you for reading. 

Macro (Re)view (15/12) | Fed turn adds to year-end rally

A Fed that surprised with a dovish turn by opening the door to rate cuts has added weight to the year-end rally in equities and fixed income, reducing a host of other top-tier events through the week to little more than glancing interest for markets. Equities advanced broadly (but underperformed in Europe and China), the USD came under renewed pressure and bond yields fell sharply. At this stage, the Fed stands in contrast to the pushback seen at the ECB and BoE to expectations for rate cuts despite presiding over much weaker economies. 

Although the Fed's FOMC held rates in the 5.25-5.5% range this week, the Committee is now openly discussing rate cuts - something Chair Jerome Powell had said would be premature only a couple of weeks ago. Markets were emboldened by this shift in messaging, bringing forward their timing for the first cut to March (from May) and pricing in more cuts next year (150bps from 125bps). 

In the post-meeting press conference, Chair Powell explained that with the Committee seeing what it had been wanting to see in the US economy: strong growth moderating, heat coming out of the labour market and inflation cooling, discussions were turning towards 'when it will become appropriate to begin dialing back the amount of policy restraint that's in place'. That framing is crucial and contrasts with a situation where the Fed is easing to head off a recession. Data this week showed retail sales outperformed expectations with a 0.3%m/m rise in November; meanwhile, headline inflation printed at 3.1%yr in November (from 3.2%) and the core rate was unchanged at 4%yr, both as expected. Notably, Chair Powell also said that rates could be cut before inflation was back at the 2% target to avoid leaving restrictive policy in place for too long.     

This discussion of policy easing was predicated on the FOMC's updated dot plot increasing the number of rate cuts implied for 2024 from 2 to 3, while it also needs to be remembered that the rate hike it had signalled for this meeting back in September has not eventuated. Broadly, the accumulation of FOMC members' forecasts points to an expected soft landing for the US economy in 2024, with growth cooling to 1.4% (revised from 1.5%) but unemployment rising only modestly from 3.8% to 4.1% (unchanged). These dynamics see the projections lowered for both headline (2.4% from 2.5%) and core inflation (2.4% from 2.6%) to be within reach of the 2% target by year-end in 2024.  

Source: Kathy Jones (Charles Schwab) via Twitter/X

By contrast to the Fed, policymakers at both the European Central Bank and the Bank of England continued to push back on prospects for rate cuts at their respective meetings this week. At the ECB, the Governing Council held its key rates unchanged (MRO 4.5%, MLF 4.75%, DF 4%) while reaffirming the need for these settings to be left in place "for a sufficiently long duration". It was also announced that reinvestments of maturing bonds in the PEPP portfolio would be tapered through the second half of 2024, reducing at a run-rate of €7.5bn per month and discontinued by year-end.

While markets price around 150bps of cuts next year, ECB President Christine Lagarde held firm in the post-meeting press conference saying it would not lower its guard. This came as the ECB's updated macroeconomic projections marked down an already weak growth outlook to 0.6% in 2023 (from 0.7%) and 0.8% in 2024 (from 1%) and sharply lowered its 2024 headline inflation forecast to 2.7% (from 3.2%), with the core rate also easing to 2.7% (from 2.9%). But inflation is still seen on a protracted path back to the 2% target in 2025/26 and President Lagarde said risks remained around domestic price and wage pressures. 

The BoE's Monetary Policy Committee (MPC) held a steady hand at 5.25% on Bank Rate. A 6-3 vote (the minority with siding with a 25bps hike) and a continuation of the line that restrictive policy would likely be required "for an extended period of time" gave the decision a clearly hawkish tilt. The meeting minutes conveyed that the core of the MPC remains alert to inflationary risks due to ongoing pressures in services prices and wages. There remains an expectation that these pressures will be slow to ease. 

In Australia, both the November Labour Force Survey and the mid-year update to the 2023/24 Federal Budget were neutral from an RBA perspective. Employment is accelerating into year-end rising by 61.5k in November, surprising strongly to the upside for the second month running following a 42.7k gain in October (full review here). Surging population growth is supporting employment and adding to labour supply, the participation rate resetting to a new record high (67.2%). This is rebalancing the labour market, resulting in the unemployment rate rising to 3.9%, still very low historically but now up 0.5ppt from cycle lows a year ago. Hours worked (0%m/m) showed further signs of being a margin of adjustment to slowing economic growth.

Significant upgrades to forecast revenue on the back of economic resilience, surging population growth and elevated commodity prices is estimated to deliver a windfall of around $67bn to the government over the next 4 years. In MYEFO (reviewed here), the Treasurer indicated 92% of the windfall would be used to offset future pressures on spending, lowering forecast deficits. New policy announcements add a modest $5.3bn of new stimulus through to 2026/27. In response, the AOFM announced its funding task for 2023/24 was expected to be $50bn (of which $23.6bn has already been completed), down from $75bn anticipated following the May Budget.  

Australian employment 61.5k in November; unemployment rate 3.9%

Australian employment surged to a 61.5k rise in November, coming in well above expectations for the second month in succession. Rapid post-pandemic population growth is supporting employment and has seen labour force participation reach a new record high (62.7%). However, the unemployment rate has lifted to 3.9%, its highest since May 2022, while hours worked were flat in the month. The labour market is rebalancing from peak tightness and validates the RBA's decision to hold rates unchanged over its summer break.    

November by the numbers...

• Employment increased by a net 61.5k in November, sharply above the expected 11.5k rise. A downward revision lowered October's increase to 42.7k from 55k reported initially.  
• Headline unemployment shifted from 3.8% (revised up from 3.7%) to 3.9% in November, a high since May last year. With the underemployment rate rising from 6.3% to 6.5%, total underutilisation moved from 10.1% to 10.4%, softening to a 21-month high.

• Labour force participation reset to a new record high at 67.2% from 67%, while the employment to population ratio also stands at a record level after rising to 64.6% from 64.5%. 

• Hours worked stalled in November coming off a 0.4%m/m lift in October, up 1.6% over the year. 

The details...

After coming through a patchy Q3, employment is accelerating into the back end of 2023. In November, employment increased (on net) by 61.5k, its strongest outcome since August that came as markets were expecting a post-referendum moderation in hiring (11.5k). This was driven by a resurgence in the full time segment (57k) over part time (4.5k), counter to the recent trend. Even allowing for the downward revision to employment in October to 42.7k (from 55k), employment is up by a net 104.2k over the past two months, already well above the increase seen in Q3 (76.1k). 

The main takeaway is that momentum in employment growth remains solid. The 3-month average increase to November was 37k, broadly in line with its average through the first half of the year (38.5k). On a 3-month annualised basis, employment growth is tracking at a 3.2% pace.

Regular readers of these reports would be aware that I have been of the view that strong population growth would keep employment supported even as momentum in the economy slows. This looks to be what is playing out currently. Simply put, the working-age population is surging (3%yr) on the back of net overseas migration (MYEFO yesterday put the rise at 510k in 2022/23). 

This has delivered additional workers into the country, reflected in record-high labour force participation (67.2%). The participation rate is up 1.4ppts on its pre-Covid level, with 0.4ppt of this rise coming through over the past year. Meanwhile, the share of working-age Australians employed has never been higher (64.4%). 

However, as this additional labour supply has arrived, the labour market has loosened. The unemployment rate lifted from 3.8% to 3.9% in November, up from the cycle lows of 3.4% seen a year earlier. Underemployment stands at 6.5% compared to its post-Covid low of 5.8%. Overall, underutilisation - the combination of the two - is now 10.4%, its highest since February 2022. But while the labour market has clearly receded from peak levels of tightness, it still remains robust. 

A broad range of indicators - including last week's Q3 National Accounts - are aligning to convey that the economic slowdown in Australia is currently playing out through a reduction in hours worked rather than employment. The various ABS measures report hours worked declined between 0.6-0.8% in Q3. The Labour Force Survey reported an encouraging 0.4% rebound in hours worked in October. I was hopeful this could extend; however, today's report showed hours worked came in flat month-on-month in November. 

In summary...  

A solid report today that was headlined by an acceleration in employment into year-end. Employment increasingly looks to be supported by strong population growth, and I remain upbeat that this can continue. But there is a rebalancing occurring in the labour market, reflected in the easing in conditions from peak levels of tightness and weakness in hours worked. Together with the slowdown in Q3 GDP growth, I think today's report will be read by the RBA as validating the decision last week to leave rates unchanged. 

Preview: Labour Force Survey — November

Australia's Labour Force Survey for November is due today at 11:30am (AEDT), the last major domestic data point left on the calendar for the year. After sharply outperforming expectations in October, employment is anticipated to moderate in November (11.5k), with the unemployment rate seen ticking up to 3.8%.       

A recap: Employment lifted strongly in October, but the unemployment rate increased 

Employment lifted by 55k in October, surprising strongly on the upside of expectations (24k). Full time employment saw a 17k rise; however, employment continued to be driven by the part-time segment (37.9k), potentially boosted by temporary hiring for the Voice Referendum. 

While employment increased strongly, it was outpaced by a rise in the participation rate, which increased from 66.8% to 67% to be back at record highs. As a result, the unemployment rate increased from 3.6% to 3.7%, returning to its level from July and August. With the underemployment rate remaining unchanged (6.3%), the uptick in unemployment saw the combined underutilisation rate rising from 9.9% to 10%.  

Hours worked saw their strongest rise in 6 months lifting by 0.5% in October. However, this was after a weak Q3, with the estimates across the various ABS measures suggesting hours worked declined in the order of 0.6-0.8% in the quarter. The recent weakness in hours worked is the clearest sign of an adjustment in the labour market to the slowdown in the economy.  

Employment is expected to moderate in November...   

Markets forecast a modest rise in employment of just 11.5k in November, with the band of estimates ranging between -30k to 30k. The moderation expected reflects the recent volatility in monthly employment outcomes. It also seems to be based on the view that the Voice Referendum boosted the October figure. The ABS's payrolls series fell slightly (-0.2%) for the month to mid-November, weighed by a sizeable decline in the index for public administration and safety industry (-6.7%) post the Referendum. Expectations are for the unemployment rate to lift from 3.7% to 3.8% (range: 3.6-3.9%). 

... with hours worked remaining in focus 

Given the recent volatility in employment outcomes is expected to continue, the hours worked figure should provide the cleanest read on conditions. Markets sense that the recent weakness in hours worked reflects a loosening in the labour market. But after a rebound was seen in October, the question is whether another rise can come through in November. 

Australia MYEFO 2023/24: Revenue upgrades drive lower deficits

The Australian government presented today its Mid-Year Economic and Fiscal Outlook (MYEFO) for 2023/24. Since the Treasurer handed down the 2023/24 Budget in May, revenue has come in well ahead of earlier estimates, delivering a windfall to the government that is anticipated to extend. The Treasurer in today's update indicated that 92% of the revenue upgrades will be used to lower future deficits, with the remainder directed at new spending in health and aged care and housing.  

MYEFO 2023/24 | Fiscal Position

Despite headwinds to the Australian economy from slowing growth domestically and offshore, MYEFO reports that the outlook for the nation's finances has improved markedly since the May Budget. Government revenue is now projected to be $67.4bn higher over the forward estimates out to 2026/27. This has been driven by the rapid post-pandemic increase in the population (510k in 2022/23 vs 400k estimated), still-elevated commodity prices and the robust labour market. This windfall is partially offset by a cumulative (or 4-year) increase in costs of $27.8bn, largely in the major 5 items of government spending (NDIS, health, aged care, defence and debt interest). However, this still leaves the government with a net boost to forecast revenue, which it is electing to use mainly as a buffer against future budget deficits. 

Accordingly, the budget is now forecast to be broadly in balance by the end of the 2023/24 financial year (-$1.1bn or 0% of GDP), an improvement from a deficit of $13.9bn (0.5% of GDP) projected back in May. The revenue windfall then allows the government to run smaller deficits through the out-years when pressure from the 'major 5' is set to intensify. The revised profile for the deficit is now: $18.8bn in 2024/25 (from $35.1bn previously), $35.1bn in 2025/26 (from $36.6bn), and $19.5bn in 2026/27 (from $28.5bn). All told, this has cut the size of the deficit projected through to 2026/27 to $74.6bn from $114.1bn anticipated in the May Budget. 

MYEFO 2023/24 | Overview 

The main theme in MYEFO is the sizeable upgrades expected in government revenue. As noted above, revenue upgrades total $67.4bn out to 2026/27. This almost exclusively reflects the boost from 'parameter changes' ($66.1bn), underpinned by a higher tax-take ($64.4bn). This windfall flows from a resilient economy and strong labour market (that is also larger due to population increase) that boosts the associated income tax receipts, while elevated commodity prices drive higher corporate taxes. Meanwhile, new policy decisions have added $1.2bn to the coffers, with over half of this coming via higher taxes levied on foreign investors in the housing market. 

On the other side of the ledger, government payments have been marked up by $27.8bn over the forward estimates. Of this, $21.3bn is attributed to 'parameter changes' - reflecting increased spending in the NDIS and Child Care Subsidy and from the impact of higher interest rates. New policy decisions taken since the May Budget come at a cost of $6.5bn. This is headlined by additional funding to the Pharmaceuticals Benefits Scheme ($3.5bn), new housing ($0.7bn), aged care reform ($0.5bn) and support for the NDIS ($0.5bn), but a 're-profiling' of infrastructure spending has clawed back $7.4bn for the government. Overall, Treasury estimates that these measures will inject a modest net stimulus to the economy of $5.3bn over the next 4 years.

As a result of the revenue upgrades and their effect on lowering the deficit, the profile for government net debt has improved relative to expectations in the May Budget. Lower budget deficits mean the government's funding requirement is reduced, while higher bond yields have led to a fall in the market value of Australian government bonds on issue. Net debt in 2023/24 is now forecast to come in at 18.4% of GDP ($491bn), down from 22.3% of GDP ($574.9bn) previously. Over the out-years, net debt increases but on a slower trajectory than in the May Budget - reaching 20.8% of GDP in 2026/27, well down from the previous projection of 24.1% of GDP. The profile for net interest payments was little changed in MYEFO.  

MYEFO 2023/24 | Economic Outlook

The baseline economic outlook from Treasury is broadly unchanged compared to the May Budget. As covered last week in the Q3 National Accounts, the Australian economy is slowing as headwinds domestically (cost-of-living pressures and higher interest rates and offshore (conflicts and uncertainty) are impacting. Still, Treasury continues to forecast a soft landing, in alignment with the RBA's outlook. 

Domestic growth is anticipated to be weak in 2023/24 (1.75%) and subdued in 2024/25 (2.25%). This helps to ease inflation over the period, but a return to the midpoint of the RBA's target band is not anticipated until 2025/26. The extended timeline reflects the outlook for the labour market to remain in robust shape: the unemployment rate is seen reaching a high of 4.5% through 2024/25 into 2025/26, still a historically low level in Australia through the decades. Both the RBA and Treasury see the current pace of wages growth (4%) as the peak for the cycle. 

The nominal side of the economy is supported by a deferral in the timing of the expected retracement in commodity prices (to US$60/t for iron ore; US$140 for metallurgical coal; and $US$70/t for thermal coal), by 6 months to the September quarter in 2024. This has resulted in a slower decline in the terms of trade, driving a substantial upgrade to the growth outlook in 2023/24 for nominal GDP to 4.25% from 1.25% previously.   

Macro (Re)view (8/12) | Easy does it

Markets remain buoyed by expectations for significant central bank easing cycles next year. With the Fed, ECB and BoE all meeting next week the question is around the extent of pushback there will be to policy easing. Solid US payrolls data saw some reduction of rate cut pricing in the US, putting the brakes on the declines in Treasury yields and supporting the US dollar. Speculation that the Bank of Japan could be preparing to tighten policy drove a sharply higher yen, with the local Nikkei index underperforming this week. 

Key US employment data beat expectations, bolstering conviction in the outlook that the Fed can deliver a soft landing for the economy. However, some of the rate cut pricing for 2024 was pared back (to around 110bps) and this may be subject to further revision at next week's Fed meeting. Nonfarm payrolls (NFPs) increased by 199k in November, above expectations (185k) but boosted by the return of 30k auto workers from strikes in the prior month. Net revisions subtracted 35k from payrolls over September and October; however, the 3-month average increase on NFPs lifted from 192k to 204k. The main surprise was the unemployment rate falling back to lows since July at 3.7% from 3.9% (underemployment also declined from 7.2% to 7%), which came alongside a rise in the participation rate to 62.8% (from 62.7%). Consistent with cooling inflationary pressures, growth in average hourly earnings eased to a 4%yr pace (slowest since June 2021). Meanwhile, a 5.2% productivity increase in Q3 saw unit labour costs fall by 1.2%q/q.  

A Reuters interview with the ECB's Isabel Schnabel was the catalyst for a deepening of rate cut pricing into next year's profile. Around 130bps of easing is now priced, with markets seeing the March meeting as a 50/50 bet for the first rate cut. But the more pressing matter is the ECB's meeting next week. Schnabel (seen as one of the more hawkish members on the Governing Council) said the fall in the euro area's headline inflation rate from 2.9% to 2.4%yr in October (a low to mid 2021) made further tightening "unlikely" and gave no explicit pushback to easing next year saying the data will dictate policy. Over in the UK, the BoE is looking at markets pricing 75bps of easing going into next week's MPC meeting. But at the press conference that followed the release of the BoE's Financial Stability Report, Governor Bailey said rates would likely need to remain at current levels "for an extended period" to be assured of bringing inflation back to the 2% target. 

Australia has joined the global shift in rates markets with RBA easing now expected in 2024, a major change from last week when additional tightening was assessed as a live possibility. That view was giving acknowledgment to the RBA's tightening bias that it could hike further if the data outperformed expectations. But the outlook changed after the September quarter National Accounts reported GDP growth slowed to 0.2% quarter-on-quarter, surprising materially on the downside of expectations (0.5%). The day before, the RBA signed off for 2023 holding rates unchanged (4.35%), leaving markets with the message that it is open to doing more if the data over the summer warrants it (see here). Governor Bullock's statement revisited the factors behind the decision to resume the tightening cycle in November while highlighting that a follow-up move wasn't required due to only "limited information" coming to hand since the last meeting. 

The slowdown in the Australian economy looks to be sharper than what the RBA (and most analysts) had expected. Growth through the year is now running at 2.1%, down from a 5.8% pace a year ago as households have been hit with headwinds from cost of living pressures, higher interest rates and rising taxes. In response, household consumption slowed to the point of stalling in Q3 and was near flat on a year ago (0.4%). More broadly, private demand is weak (0.2%q/q, 1.4%Y/Y), with growth being bolstered by the public sector (1.4%q/q, 4.2%Y/Y). If these dynamics continue, which appears likely, it would argue for an easing of domestic inflation pressures in 2024. Please see my feature review of the Q3 National Accounts for more here. Other local highlights this week included a sharp narrowing in the current account surplus to a broadly balanced position in Q3 (see here), an uplift in the trade balance to $7.1bn in October (see here), and a 5.4% rise in housing finance in October (see here). 

Australia's trade surplus rises to $7.1bn in October

Australia's goods trade surplus widened to $7.1bn in October from a downwardly revised $6.2bn in September. This was below the 3-month average ($7.7bn), which has retraced to lows since early 2021. Exports lifted modestly (0.4%m/m) but are down nearly 18% on their mid 2022 peak as commodity prices have unwound. Import spending remains around record highs despite declining by 1.9% in the month. 

After narrowing to a 2½-year low in September ($6.2bn), the goods trade surplus widened to $7.1bn in October. This is half the level it was a year ago ($14.2bn), with export income falling 11.9% over the period and imports rising 2.4%. On a 3-month average basis, the surplus was $7.7bn, back in line with early 2021 levels. 

In October, exports consolidated (0.4%) coming in at $45.5bn, which followed a 1.8% fall in the prior month. Rises in non-rural goods (0.4%) and the volatile non-monetary gold (5.3%) overcame a decline in rural goods (-1.8%). The non-rural goods category was boosted by a lift from iron ore (2.3%) to $16.3bn, the level up by 17.3% over the year in contrast to the large falls seen in coal (-37.4%) and LNG exports (-41.5%).

Spending on imports fell 1.9% in October to $38.4bn. This was after imports posted their sharpest rise in 19 months in September (8%). An 11.2% fall in capital goods was the main driver, a continuation of the pattern of volatile movements seen in recent months. 

Consumption goods were soft (-0.5%) on the back of falls in household goods and electrical items. These declines were partially offset by 1.4% rise in intermediate goods as the value of fuel imports saw a 10.3% rise, rebounding to $6.2bn to be up 39.5% on their recent low in July. 

In review: Australian Q3 GDP: Slowdown continues; Consumption stalls

The slowdown in the Australian economy continued in the September quarter. Real GDP was 0.2% quarter-on-quarter - the weakest outturn in a year - coming in below expectations (0.5%) after growth expanded by 1% through the first half of the year. Pressures on household finances are weighing heavily on consumption, driving the slowdown. Growth firmed from 2% to 2.1% through the year, down sharply from a 5.8% pace 12 months ago. Rapid post-pandemic population increase (2.4%) continues to imply weakness in per capita GDP (-0.3%Y/Y).  

The Australian experience is consistent with the slowdown in advanced economies offshore, with growth across the OECD averaging 1.7% through the year to Q3. US growth has been a notable exception, accelerating in the most recent quarter (1.3%) to 3%Y/Y. In China, growth has been patchy from quarter to quarter as it has continued to come out of the pandemic.

Domestic household consumption has slowed sharply over the past year, stalling in the September quarter (0%). Elevated inflation has caused a historic decline in real disposable incomes. At the same time, disposable income has been squeezed by the RBA's tightening cycle, while the strong labour market and rising wages have led to a rising tax burden. Combined, mortgage interest costs and income tax are taking up a very high (and still rising) share of gross income.

Consumption growth, though weak, is still positive but would almost certainly be declining without households having the sizeable stock of savings accumulated during the pandemic to spend from. The extent and duration of the savings draw-down remains to be seen, a key variable to the economic outlook. However, if Australian inflation follows global trends and decelerates at pace in 2024, an improved dynamic around real incomes could support consumption by more than many expect.     

Driven by the slowdown in household consumption, private demand has continued to weaken (0.2%q/q, 1.4%Y/Y). This also reflects an easing of momentum in investment in the quarter after tax incentives for new equipment purchases expired. Meanwhile, residential construction activity remains weak. An expansion in public demand (1.4%q/q, 4.2%Y/Y) has bolstered the Australian economy, holding an even sharper slowdown at bay.

Overall, the September quarter National Accounts confirm that demand conditions in Australia have cooled materially. Indications are that this will continue, which should help to ease domestic inflation through 2024. The cash rate (4.35%) looks unlikely to rise any higher, despite the RBA leaving its tightening bias in place at its final meeting for the year.   

— — —

National Accounts — Q3 | Expenditure: GDP (E) 0.2%q/q, 2.1%Y/Y

Household consumption (0%q/q, 0.4%Y/Y) — Pressures on household budgets from the cost of living, rising interest rates and taxes have intensified, causing household consumption to slow to the point of stalling in Q3 (0%). Growth came close to flatlining through the year (0.4%) and is down substantially from its pace 12 months ago (11.8%).

In nominal terms, household incomes are rising sharply (1.8%q/q, 7.5%Y/Y), supported by the strongest labour market conditions in decades and recent increases to award rates. But this is being offset by elevated inflation, higher interest rates and rising taxes. Reflecting all this, disposable income growth is weak (0.1%q/q, 1%Y/Y) - deeply negative in real terms (-1.3%q/q, -4.6%Y/Y) - and the household saving ratio fell to its lowest level since 2007 at 1.1% in Q3.

Although the RBA held rates steady through Q3, interest costs continued to rise (7.6%) as more fixed-rate periods on mortgages rolled onto higher variable rates. Meanwhile, income taxes surged (7.6%q/q) due to rising wages pushing people into higher tax brackets and with the Low and Middle Income Tax Offset ending. 

Despite these headwinds, discretionary-related consumption (0.7%) saw its first quarterly rise in a year, as the essential category contracted (-0.5%). That profile suggests households were spending out of the stock of savings built up during the pandemic, estimated widely to be in the order of $250bn. The rebound in discretionary consumption included a 13% surge in new vehicle purchases, a 3.9% lift in transport services (associated with overseas travel) and a 0.9% increase in hospitality services, boosted by the FIFA Women's World Cup. The weakness in essentials appears overstated given that it reflects the effect of government rebates reducing household spending on utilities and child care. 

 

Dwelling investment (0.2%q/q, -0.3%Y/Y) — Residential construction activity remains weak rising by just 0.2%q/q, with higher interest rates and capacity pressures weighing over the past year (-0.3%). New home building saw a modest fall (-0.3%), declining for the first time in 5 quarters. Alteration work has been unwinding from the surge this activity saw during the pandemic; however, it posted its first increase in 2 years with a 1% rise coming through in Q3. 

Business investment (0.6%q/q, 8%Y/Y) — Business investment has been resilient to the broader economic slowdown. Growth was particularly strong through the first half of 2023 (6.8%) but the momentum slowed in Q3 (0.6%). This came after machinery and equipment investment was frontloaded into the first half (9.1%) ahead of the expiry of pandemic-related tax incentives at the end of the 2022/23 financial year. This subsequently saw equipment investment consolidating in Q3 (0.2%). Non-dwelling construction - also strong in the first half (5.4%) - eased (0.6%) as building activity fell (-1.5%); however, a surge in mining sector investment (9.6%) supported engineering work (2.3%).  

Public demand (1.4%q/q, 4.2%Y/Y) — A major driver of growth in Q3, contributing 0.3ppt to real GDP. Strength in public demand over the past year (4.2%) has bolstered the economy from the slowdown in private demand (1.4%) as the pandemic recovery has cycled and cost-of-living pressures and higher rates have taken effect. Governments have attempted to moderate these headwinds through measures such as rebates on energy bills, child care payments and assistance for pharmaceuticals and aged care, underpinning a lift in public expenditure to 1.1%q/q (2.9%Y/Y). Meanwhile, progress in rolling out the large pipeline of public transport, energy and communication projects continued at pace in Q3 (2.8%q/q, 11.6%Y/Y).  

Inventories (0.4ppt in Q3, -1.1ppts yr) — A large rise in mining sector inventories - the outcome of exports falling by more than the decline in production - underpinned the headline 0.4ppt contribution to real GDP in Q3. Wholesaler inventories increased as the easing of global supply pressures facilitated the delivery of new vehicles. 

Net exports (-0.6ppt in Q3, 1.4ppts yr) — Subtracted 0.6ppt from quarterly activity, largely reversing its 0.8ppt contribution to growth in the previous quarter. Export volumes declined by 0.7%, backsliding to be 3.2% below pre-Covid levels at the end of 2019. Weakness in resources exports (-4.7%) were the main driver. There was some offset from the services sector (1.9%), supported by inbound travel for the FIFA Women's World Cup and by overseas students. Imports advanced by 2.1%, rising to be nearly 10% above pre-Covid levels. Services imports surged in Q3 (8.4%) on the back of strong demand for overseas travel. 

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National Accounts — Q3 | Incomes: GDP (I) 0.2%q/q, 2.0%Y/Y 

Australian national income was weighed by another decline in the terms of trade (-2.6%), its fourth decline from the past five quarters to be 14.1% below its record high in mid-2022. Export prices contracted by 1.4%, reflecting falls in major commodity prices amid slower global growth and elevated inventories, while import prices lifted by 1.2%.  

Although the terms of trade fell, nominal GDP growth was 1.2% in the quarter (4.5%Y/Y), rebounding from a fall in Q2 (-0.7%). This outcome came on the back of a 1% rise in economy-wide prices together with the 0.2% lift in output.

Wage incomes rose at an accelerated pace in Q3 (2.6%), its fastest rise in a year, to be up by 8.4% through the year. This quarterly rise was supported by the continued strength in the labour market, the Fair Work Commission's increases to award rates and the lifting of public sector wage caps. 

Due to hours worked in the economy contracting in Q3 (-0.6%), non-farm wages rose by an even sharper 3.1%q/q to 4.1% in year-ended terms. However, an increase in quarterly productivity of 0.8%q/q (as output rose and hours worked declined) meant that some of that uplift in wages was offset. Unit labour costs for firms - labour costs adjusted for productivity - lifted by 2.2% in Q3, with the year-ended pace easing from 6.9% to 6.4%. 

After falling by 7.6% in the previous quarter, company profits in the non-financial sector declined by a further 4.5% in Q3 to be down by 6% through the year. Weakness in commodity prices weighed on mining profits, while margin pressures crimped profits in professional services and in transport services. By contrast, financial company profits are advancing (2.1%q/q, 6.4%Y/Y) with net interest margins expanding due to higher interest rates. Small business and farming profits (gross mixed income) were broadly flat in Q3 (0.3%) but down 4% year-on-year.  

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National Accounts — Q3 | Production: GDP (P) 0.2%q/q, 2.1%Y/Y

The September quarter GDP production estimate was 0.2%, matching the headline growth outcome. Year-ended growth firmed modestly from 1.8% to 1.9%. Gross Value Added (GVA) in the services sectors advanced, led by household services (1.2%) from business services (0.4%). The goods sectors were broadly offsetting: goods production contracting (-0.5%) but goods distribution expanding (0.5%). 

Household services saw broad-based gains in output across the various industries. The FIFA Women's World Cup supported the hospitality (1.5%) and arts and recreation (2%) industries. Public health services underpinned the health care industry (1.8%). Business services moderated from Q2 (0.9%), driven by a pullback in labour hire and recruitment that weighed on administration and support (-1.7%). Media services drove the telecommunications industry (2.6%). Professional services picked up on the back of increased demand for engineering services. 

Goods distribution (0.5%) was driven by a pick-up in demand in the retail industry (0.6%) for household goods and clothing and as supply chain pressures for new vehicles eased. The transport industry remained robust supported by overseas travel demand. Goods production contracted (-0.5%), with utilities falling (-2.6%) as unseasonably warm weather reduced household demand for energy. Mining production also declined (-1%) amid outages for maintenance.