Preview: RBA September meeting

Having elected to retain its previously announced tapering timeline at the August meeting, the RBA Board will be revisiting that decision at today's September meeting (due at 2:30pm AEST), while all other settings are expected to remain unchanged. Total purchases in the Bank's QE program reached $200bn yesterday — the level at which the Board has said will see the pace of purchases tapered from $5bn to $4bn per week (chart below). That guidance was first announced back in July and then reaffirmed in August where the Board held the line against a deteriorating outlook due to the Sydney lockdown. RBA forecasts were factoring in a contraction of "at least 1%" in Q3 GDP; however, the tapering guidance was retained in recognition of the stronger-than-expected pace of the recovery and its strong outlook for 2022. 

In the August meeting minutes it was noted that the QE program would remain responsive to the "...economic conditions and the health situation" and that in the event of a "more significant setback" for the recovery, the Board would be "prepared to act". Since that meeting, things have worsened materially, with the spread of Delta sending around 60% of the population into lockdown across New South Wales, Victoria and the ACT. An accelerating vaccination program will encourage the RBA in assessing future prospects, but the authorities have made it clear that the attainment of the 70-80% vaccination rates targeted by the National Cabinet will determine when the current restrictions profile eases, and that is not likely to occur until well into Q4. Compared to the forecasts the Board was presented with in August, a much more severe economic contraction is now likely in Q3 as a result of the broader and longer lockdowns, with market forecasts and high-frequency indicators suggesting this will be in the order of -3%. 

Important to note is that with the second $100bn tranche of purchases completed, the RBA's operation of the QE program shifts from a quantity target to a more flexible approach, where the pace of purchases responds to changes in the underlying conditions and is reviewed periodically. In light of this, the deterioration on the economic and health fronts since the previous meeting argues for the RBA's policy guidance to be recalibrated to these developments by delaying the taper. As with other central banks, the RBA disassociates tapering from tightening and the August decision and subsequent communications have highlighted some skepticism around the effectiveness of delaying what is a modest tapering announcement. But as the situation currently stands, to be adding less support to the economy amid a material downgrade to the outlook and increase in uncertainty risks sending conflicting signals. 

Macro (Re)view (3/9) | Caution amid uncertainty

As a snapshot of conditions ahead of the emergence of the Delta variant and associated lockdowns, the Q2 national accounts reported that the Australian economy was performing strongly with the momentum from the reopening surge being sustained over the first half of the year. For the June quarter, real GDP increased by a stronger-than-expected 0.7% (vs 0.4% consensus), with the expansion in the economy rising to be 1.6% above pre-pandemic levels. Output was also 9.6% higher than at the depths of the pandemic recession, reflective of a recovery that had outperformed even the most optimistic set of forecasts. However, the trajectory has since shifted significantly with widespread lockdowns in place as caseloads continue to rise and what appears will be a period of elevated uncertainty through the transition to the national reopening plan. With the RBA Board to meet next Tuesday, it shapes as likely that it will push back the start of QE tapering, due to start next week with bond purchases dialing back to $4bn per week from $5bn. That was a move resisted by the Board at the August meeting, but with the economy now expected to contract much more sharply in Q3 than it previously anticipated and with the uncertainty associated with Q4, it is likely that it will now see the need to recalibrate policy to that outlook. 

Robust domestic demand continued to underpin the Australian economy in Q2 on the support of stimulus measures and the tailwinds from high commodity prices, with the terms of trade advancing to a record high in the period. Household consumption was rising at a solid pace (1.1%), with the rotation back towards the services (1.3%) and discretionary categories (1.6%) indicative of the high levels of optimism seen at the time and the willingness to spend out of high accumulated savings. However, the 2.7% fall in retail spending in July (see here) due to the lockdowns and the disruptions to services are an abrupt shift. Residential construction rose at a more modest pace in the quarter (1.7%), but the sector was still in its strongest upswing in many years from earlier stimulus measures. Supportive dynamics were continuing to drive business investment (2.3%), with firms lifting capital expenditure to meet rising demand. Another key factor was the robust growth in public demand, with infrastructure spending a key aspect to the stimulus response from governments. Overall, domestic demand at 1.7%q/q was considerably stronger than the 0.7%q/q GDP outcome, with the spread relating to a sizeable subtraction to activity from net exports, due to disruptions to resources shipments (see chart below). A full review of the Q2 national accounts with in-depth analysis and key charts is available here. 

Chart of the week

To the survey data through the week and the robust gains in house prices extended for another month, lifting by 1.5% nationally in August (18.4%yr) according to CoreLogic. Rising house prices and the tightening seen in rental markets in a few capital cities are fundamentals that continue to advance investor activity, with the segment keeping housing finance commitments at very elevated levels in July (see here). Meanwhile, dwelling approvals continued to retrace from record highs earlier in the year falling by 8.6% in July reflecting the end of the HomeBuilder scheme to new applicants (see here). Elevated commodity prices, notably iron ore, saw both the current account surplus for Q2 (see here) and the monthly trade surplus for July (see here) resetting to new record high levels.     

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The August US non-farm payrolls report was the major event of the week for markets offshore, though it did little to resolve uncertainty around the tapering timeline from the Federal Reserve. Employment on non-farm payrolls came in at 235k in August, substantially lower than the median estimate for a 733k rise — albeit with that figure being formed from a very wide range of forecasts going into report that was between 400k to 1,000k. However, this miss was to some extent offset by revisions from the past two months that added on a net 134k to payrolls. The details of the report point to the effects of the spread of Delta and rising caseloads, with employment in leisure and hospitality flat in August after surging by 415k in July and with retail seeing a larger fall this month (-29k) compared to last month (-8k). Despite the large miss on employment, both the unemployment rate (5.4% to 5.2%) and underemployment rate (9.2% to 8.8%) were lower, as more people found jobs than lost them in the month. But the more significant issue remains on the supply side of the US labour market, with the participation rate unchanged at 61.7%, still 1.6ppts below its pre-pandemic level. Labour shortages and difficulties in finding staff continued to be reported by firms in both the ISM manufacturing and services surveys this week. On the back of this, average hourly earnings strengthened further rising by 0.6%m/m to 4.3%yr. Stemming from the speech from Fed Chair Jerome Powell at last week's Jackson Hole symposium, expectations for tapering to start as early as September had been priced out, while the August payrolls could now mean that it is delayed a bit longer with more data needed to assess the impact of Delta on labour market conditions.  

An upside result on euro area inflation in August has provided an interesting lead-up to the ECB's policy meeting next week. The initial estimate for the headline CPI printed at 0.4%m/m as the year-over-year pace accelerated from 2.2% to 3.0% — a 10-year high and ahead of the 2.7% consensus forecast. The core rate also advanced from 0.7% to 1.6%Y/Y against 1.5% expected. A range of temporary factors were boosting inflation including higher energy prices, the unwinding of a cut in the value added tax in Germany and the later start for summer clothing sales from last year, delayed by lockdowns that had the shops closed. Meanwhile, survey data, including from this week's PMI readings, confirmed the continuation of supply chain constraints as another factor putting upward pressure on prices. Asset purchases under the ECB's PEPP program are currently running at an accelerated pace of around €80bn per month, with the high inflation readings leading to some speculation, particularly from the Governing Council's more hawkish voices, that tapering could soon be warranted. However, the core view of the ECB has been that high inflation will be transitory. Given the ECB's reformulated 2% inflation target, the more relevant factor for policy will be the inflation outlook in the updated economic forecasts that will be made available to the Governing Council at next week's meeting rather than the near-term volatility in the CPI.   

 

Australian retail sales fall 2.7% in July as lockdowns return

Australian retail sales fell sharply for a second consecutive month as lockdowns restricted spending opportunities and trading conditions. Turonver was down 2.3% in July driven by a heavy fall in New South Wales (-8.9%) as the lockdown tightened to see non-essential retailers closing. While there will be more weakness to come for in-store retail, there is some respite as online sales are surging having risen by 36% over the past two months. 

Retail Sales — July | By the numbers 

• National retail turnover fell by 2.7% for the month in July, in line with the preliminary estimate, coming in at $29.8bn. Retail spending had fallen by 1.8% in June. 
• Annual turnover growth went into the negative range, swinging to -3.1% from +2.9% on the July result. 

Retail Sales — July | The details  

Australian retail spending was hit significantly as concerns over the Delta variant emerged and lockdowns were reimposed. These effects have since intensified through August into September. For July, sales were down by 2.7% driven by an 8.9% fall in New South Wales — the largest decline seen in any state in almost a year — as non-essential retail in Sydney was shuttered by the lockdown. Spending in Queensland (-0.9%) and South Australia (-3.3%) declined with stay-at-home restrictions being in place for short periods in the month. Victoria was up overall (1.3%), with the boost from reopening enough to counter the headwinds from lockdown 5 that was in place over the second half of July. 

Coming after a 1.8% fall in June, Australian retail sales had declined by 4.4% over the past two months, equating to a loss in turnover for the sector of around $1.4bn. Retail sales were still elevated relative to their pre-pandemic trajectory, though this has been a sharp loss in momentum with more weakness to come. 

The category detail highlighted the effects of lockdowns on trade. Areas benefitting from stay-at-home restrictions lifted, with food up 2.3% supported by stocking up supermarkets (2.3%) and liquor stores (3.5%). Meanwhile, online sales are soaring as in-store retail closes, with a 19.3% rise coming through in July on the back of the very strong rise in the month prior (14.3%). This has predominantly been driven by non-food sales, which have surged by 40.2% over the past two months, indicating discretionary spending is strong amid the lockdowns. Online retail sales are a stunning 98.2% higher than their pre-COVID level, and they accounted for 12.6% of total turnover in July — their highest share on record. The closures affecting non-essential retail saw clothing, footwear and personal accessories down 15.4% for the month, department stores fell 11.4%, while restrictions on dining out saw cafes and restaurants plunging by 12.3%.

Retail Sales — July | Insights

Momentum in retail sales has fallen sharply as lockdowns have restricted the ability to go out and spend. This week's national accounts showed there was strong momentum in household consumption, with accumulated saving at high levels. Strong balance sheets, low interest rates and a strengthening labour market prior to the Delta outbreaks were also key supports. All this should leave households well placed for spending to rebound when lockdowns have run their course, albeit this time around the presence of COVID in the community is a risk and at this point is an unknown.  

Australian housing finance steadies in July

Australian housing finance commitments were broadly flat in July but remained at very elevated levels. Refinancing surged to record highs in the month with activity on the rise in both the owner-occupier and investor segments as borrowers move to lower interest rates on offer, reflecting the RBA's monetary policy support.  

Housing Finance — July | By the numbers

• Housing finance commitments ($ value, ex-refinancing) were steady in July (0.2%), coming in close to estimates for a -0.2% result (prior: -1.6%m/m). The level stayed elevated at $32.1bn to be up 68.2%yr. 
• Owner-occupier commitments eased by 0.4% to $22.8bn, with annual growth slowing to 58.3% from 75.9%. 
• Investor commitments increased by 1.8% to $9.4bn — a high going back to April 2015 — with growth over the year running at 98.7%. 
• Refinancing activity across both the owner-occupier (4.9%) and investor segments (8.3%) advanced, taking the total level to a record high at $17.2bn in July (59.9%yr). 

Housing Finance — July | The details 

Housing finance commitments may be starting to level out as July's broadly flat outcome of 0.2% followed the 1.6% fall in June. Commitments remained at a very elevated level just above $32bn but may have seen the highs for the cycle given the underlying developments and the current lockdown disruptions. Owner-occupier commitments were softer in the July month (-0.4%) at $22.7bn with upgraders (0.8%m/m) moderating the unwind in the construction-related segment (-5.2%m/m) on the closure of the HomeBuilder grants scheme and as increasing affordability constraints from rising housing prices weighs on the first home buyer segment (-7.6%m/m). 

In the investor segment, the momentum in its surge has eased off slightly with the gains moderating to a 1.8% rise in July after June's 0.7% lift. However, at $9.4bn, borrower-accepted commitments to investors were at their highest in more than 6 years. 

Meanwhile, refinancing activity had lifted to its highest level on record in July at $17.7bn with many borrowers switching to lower rates on offer for fixed rate loans. The RBA's yield target at the 3-year segment and the Term Funding Facility have been key supports to this. Refinancing to owner-occupiers was up 4.9% to $11.4bn and lifted 8.3% for investors to $5.9bn. 

Turning to the approvals data, we see the effects of the end of the HomeBuilder scheme continuing, with construction-related approvals falling by another 8.4% in the month. First Home Buyer approvals were retracing from their peak at the start of the year. Approvals to upgraders were elevated but eased off their high reached last month. 

Developments at the state level are summarised in the table below. Investors shifted up a gear in New South Wales and Queensland in July. It remains to be seen the effects of the ongoing lockdown on activity in the former, where the owner-occupier segment is also very robust. First home buyer activity was weaker across the nation in response to the strong growth in housing prices that was likely squeezing this segment.    

Housing Finance — July | Insights

It remains a mixed picture for housing finance ahead of the likely impacts associated with lockdowns. The owner-occupier segment is being driven by upgraders, though activity from first home buyers is rolling over and is unwinding in the construction-related area post HomeBuilder. Meanwhile, the investor segment retains very strong momentum on supportive fundamentals from rising housing prices and tightening rental markets. Reflecting the support from the RBA's accommodative monetary policy settings, refinancing activity is surging.  

Australia's trade surplus resets record high in July

Australia's trade surplus came in at $12.1bn in July, resetting its record high from the month prior. Elevated commodity prices drove exports to a record high, with iron ore accounting for 41.5% of the monthly total.  Imports were held up by intermediate goods as both consumption and capital goods weakened with lockdowns returning. 

International Trade — July | By the numbers

• Australia's monthly trade surplus advanced by $1.0bn to $12.1bn in July, well clear of the market consensus for $10.0bn.  The ABS revised the June surplus higher, from $10.5bn to $11.1bn. 

• Export earnings posted a 4.8% increase for the month to $45.95bn — its highest level on record — elevating growth over the year to 35.8% from 24%. The increase in exports in June was revised up from 3.6% to 4.1%. 
• Import spending lifted by 3.3%m/m following a 1.0% rise in the month prior (revised from 0.8%). This drove imports to $33.83bn to be 14.1% higher than a year earlier. 

International Trade — July | The details

Elevated commodity prices continued to advance the trade surplus from its previous record high in June; the monthly surplus for July went through $12bn to be up by around $1bn over the period. This widening reflected the acceleration in export earnings associated with commodities, while the underlying details for imports pointed to lockdown effects playing through. 

Exports lifted by 4.8% to drive monthly earnings to a record high level at just below $46bn. Non-rural goods were the key contributor, rising by 7.1%m/m to $34.2bn. Within the category, iron ore climbed by 3.5% to $19.1bn for the month to be up by a stunning 66% over the year. 

Rural goods lifted by 5.7% supported by meat (8%m/m), wool (11.9%m/m) and 'other' rural products (8.1%m/m). Non-monetary gold was a modest influence, down 2.8% in July. Services exports fell 7.8%m/m as tourism-related earnings plunged (-17.4%), pointing to the impact of the closure of the New Zealand travel bubble arrangement. 

For imports, spending was higher overall rising by 3.3% in July to $33.8bn to be in line with pre-pandemic levels. However, the underlying detail reflected shifting spending patterns associated with the return to widespread lockdowns in Australia. Consumption goods posted its weakest monthly outcome in 10 months falling by 3.4% in July. Within this, household electrical items (-9%), new vehicles (-4%), textiles, clothing and footwear (-3.9%) and 'other' consumption goods (-3.5%) saw sharp declines. Capital goods were slightly down over the month (-0.6%), with the weaknesses centered in industrial equipment. However, the declines in consumption and capital goods were more than offset by a surge in intermediate goods (15.4%m/m). This was mainly driven by 'other parts for capital goods'  (80.7%m/m), which the ABS reports related to telecommunications accessories and equipment. Services imports were down 2% for the month, with the tourism-related category falling by 31.3%, consistent with the avenue for offshore travel to New Zealand closing. 

International Trade — July | Insights

The tailwinds to national income from elevated commodity prices continued through July as export earnings surged to a record high. This came after yesterday's national accounts reported that the nation's terms of trade lifted to their highest level on record in Q2. 

In review: Australian Q2 GDP: Momentum strong ahead of Delta disruptions

Momentum in the Australian economy was strong ahead of a period of significant disruption and uncertainty associated with the emergence of the Delta variant and widespread lockdowns. Real GDP expanded at a faster-than-expected pace at 0.7% in the June quarter against the market consensus for a 0.4% rise. Eased restrictions and the continuing effects of significant policy stimulus measures drove output higher by 2.6% through the first half of the year, sustaining the momentum generated by the national reopening. Growth had accelerated to be 9.6% higher through the year, with the base period coinciding with the depths of the national lockdown at the onset of the pandemic.

Australian GDP in the June quarter was 1.6% above its pre-pandemic level at the end of 2019. The containment of the pandemic to low caseloads and significant fiscal and monetary policy stimulus had been key factors in the recovery. However, GDP remained below its pre-pandemic trajectory, based on the RBA's February 2020 forecasts, due to very low population growth, reflecting the impact of the closure of the international border — a major lever being used by the authorities in the pandemic response.   

Global growth dynamics provided a supportive backdrop for Australia in Q2, with high vaccination rates and ongoing fiscal and monetary stimulus the key themes. Growth in the US economy increased slightly from the previous quarter to rise by 1.6% in Q2, seeing GDP rising above its pre-pandemic level. The economic recoveries in the euro area and UK got back on track in Q2 as activity surged on reopenings from extended lockdowns. In contrast, lower vaccination coverage amid the emergence of the Delta variant restrained the rebound in Japan from Q1's contraction. China's economy had expanded further above its pre-pandemic level, with the recovery being driven by the export sector and household spending. These factors were holding iron ore prices at elevated levels — a strong tailwind for Australian national income growth. 

During the June quarter, the Australian economy continued its transition from the recovery to the expansion phase. Domestic demand conditions were very robust, contributing 1.6ppts to GDP growth in Q2. Private demand had added 1.0ppt to quarterly growth. Household spending remained supported by high accumulated savings, wealth effects from rising equity and housing prices and low interest rates, while a robust labour market was also a key contributor. Private investment was being supported by stimulus measures boosting residential construction activity and tax incentives were encouraging businesses to invest in new equipment to meet rising demand. Meanwhile, public demand was also supporting the expansion with projects being brought forward by state and territory governments as part of the stimulus response. Overall GDP growth in Q2 was moderated by disruptions to resources exports leading to a 1.0ppt subtraction from net exports and a drawdown on inventories (-0.2ppt).  

The emergence of the Delta variant and associated lockdowns have since shifted the trajectory of the expansion significantly, as daily caseloads have risen to their highest levels of the pandemic. The early signs of this were evident in high-frequency indicators of household activity and mobility towards the end of Q2, while sentiment had also fallen from elevated levels. This was reflecting the impact of a two-week lockdown in Victoria between late May and early June and the commencement of the greater Sydney lockdown in late June. 

In light of the sharp deterioration in the economy and rise in uncertainty that has followed, the RBA Board at its September meeting will be revisiting its decision to maintain its guidance to start tapering the weekly pace of its bond-buying from $5bn to $4bn from next week. With GDP likely to contract in the order of 3% in Q3 and with the current lockdown restrictions to remain in place well into Q4 in order to reach the 70-80% vaccination rates being targeted by the National Cabinet, a delay to the start of tapering is expected by markets. 

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GDP — Q2 | Expenditure: GDP (E) 0.4%q/q, 9.6%Y/Y

Household consumption (1.1%q/q, 15.4%Y/Y) — A solid pace of growth was maintained in the June quarter as household consumption advanced by a further 1.1% to be up 15.4% from last year's national lockdown. 

The profile of consumption through the quarter remained consistent with spending patterns rebalancing to a reopened economy and eased restrictions. However, consumption growth was notably weaker in Victoria than in the other states and territories reflecting the impact of its two-week lockdown. A fourth consecutive quarter of outperformance in discretionary consumption (1.6%) compared to essentials (0.9%) pointed to the supportive dynamics for household spending from the rebounding labour market, high levels of optimism, wealth effects from strong balance sheets and low interest rates. The recovery continues to be driven by services consumption (1.3%q/q), with strength in transport services (25.5%q/q) reflecting the boost to domestic tourism from the Federal Government's discounted airfares scheme, and hotels, cafes and restaurants (2.2%q/q) benefitting from Australians going out and about more. Goods consumption advanced in Q2 (0.9%), more than reversing a decline in the previous quarter. Very strong demand for new vehicles continued with a 7.5%q/q rise to be up by nearly 60% since the national lockdown. As at Q2, household consumption was just short of returning to its pre-pandemic level (-0.3%) around an uneven mix. Spending in essentials (2.1%) and goods (6.3%) was elevated but discretionary (-4.1%) and services (-4.1%) were still substantially down on pre-COVID levels. 

Real household disposable income contracted in Q2 (-1.0%) reflecting the wind-down of the JobKeeper wage subsidy at the end of March and substantially lower social assistance payments (-10%), with both factors highlighting the strength of the recovery in the labour market. With household consumption advancing alongside a fall in disposable income, there was a draw down on the high level of accumulated savings Australians have at call. The household saving ratio fell from 11.6% to 9.7% but remains very elevated to the levels seen in the years preceding the pandemic.  

Dwelling investment (1.7%q/q, 15.7%Y/Y) — Activity in residential construction work slowed to a 1.7% rise in Q2 following the surges of 4.0% in Q4 and 7.5% in Q1. This possibly reflected some capacity constraints in the sector amid the strong upswing in the residential construction cycle, driven by policy stimulus from the HomeBuilder scheme, first home buyer incentives and low interest rates. This was in sharp contrast to the period of sustained weakness in the years prior to the pandemic.

Alterations lifted by a further 1.9% in Q2 to be up by 27.4% through the year. In addition to policy stimulus, dynamics associated with the pandemic through working from home arrangements and the unavailability of offshore travel were likely boosting renovations, as were the effects from rising housing prices. New home building expanded by 1.6% in the quarter, driving annual growth to 8.7% — its strongest in 3 years.   

The robust conditions in the major housing markets across capital cities and regions led to another surge in ownership transfer costs — relating to fees associated with real estate transactions — with a 10% rise coming through in Q2 to be 38% above pre-pandemic levels. This has added almost 1ppt to economic growth over the past year. 

Business investment (2.3%q/q, 6.2%Y/Y) — Supportive dynamics from the strong economic recovery, the extension to the temporary full expensing and loss carry-back provisions in the recent Federal Budget, accommodative financing conditions and strong sentiment continued to drive business investment, lifting 2.3% in Q2 to be 6.2% higher through the year. Equipment investment increased by a further 2.4% for the quarter and is substantially higher than its pre-pandemic level, up almost 8% over the period. Investment in intellectual property products continued to lift at a solid pace posting a 2.3% rise following gains of similar magnitude in the previous three quarters. Non-dwelling construction saw its strongest quarterly rise in nearly 2 years (2.3%) but remained at a low level. 

Overall, non-mining investment was rebounding but was still below pre-pandemic levels (-2%) while mining investment remained subdued despite surging commodity prices.  

Public demand (1.9%q/q, 5.8%Y/Y) — Growth in public demand remains robust with governments at the federal and state levels bringing forward projects to support the economic recovery. Underlying investment advanced by 4.7% in Q2, driving growth through the year to 15.2%. Consumption spending increased by 1.3% for the quarter, with health-related spending associated with the pandemic response remaining prominent.  

Net exports (-1.0 ppt in Q2, -3.6ppts yr) — Net exports remained a sizeable drag on overall activity, subtracting 1.0ppt from GDP in Q2. Exports contracted by 3.2% in Q2 as resources volumes declined sharply (-5.9%) in response to adverse weather conditions and maintenance activity. Meanwhile, imports continued to rise (1.5%q/q) in line with the strength in domestic demand conditions. Compared to pre-pandemic levels, exports remain materially lower (-13.9%) with services crunched (-45.6%) by the international border closure, affecting the tourism and education sectors. Imports are 5.4% lower than at the end of 2019, with surging goods volumes (10.5%) providing offset to the weakness in services (-55.3%) associated with the offshore travel ban.

Inventories (-0.2ppt in Q2, 1.4ppts yr) — Inventories were being rebuilt over recent quarters with the economy recovering from the COVID recession, however that stalled in Q2. Notwithstanding, inventories were a smaller-than-expected drag on quarterly GDP. Private non-farm inventories subtracted 0.7ppt from activity, though that was moderated by builds in inventories from public authorities (+0.35ppt) and farms (+0.15ppt).  

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GDP — Q2 | Incomes: GDP (I) 0.6%q/q, 9.6%Y/Y

The June quarter estimate for real GDP income lifted by 0.6%, coming in between the expenditure and production outcomes, with annual growth soaring to 9.6% from 0.9%. 

National income continued to surge on the tailwinds from elevated commodity prices and the recovery in the domestic economy. Nominal GDP advanced by 3.2% in Q2 (16.4%Y/Y) to be 7.8% above its pre-pandemic level.  

Robust industrial demand from China and the global economic recovery effort have driven prices for Australia's key commodities substantially higher, notably for iron ore, more than offsetting the weakness in volumes from the disruptions in shipments to markets offshore. In response, the nation's terms of trade have been elevating and reached a record high in the June quarter on the back of a 6.9%q/q rise; its level now 23.8% higher than pre-pandemic.

With the domestic economic recovery making stronger-than-expected progress and the boost coming through from high commodity prices, fiscal support through the JobKeeper program concluded and assistance from the Boosting cash flow for employers measure reduced further. Government taxes less subsidies lifted by $5.8bn in Q2 to $51.5bn, which was a little higher than prior to the onset of the pandemic.   

With fiscal support unwinding, small business profits have continued to retrace from last year's highs. Gross mixed income declined by 0.7% in Q2 as base effects swung annual growth to -8.1% from 11.3%. Private non-financial operating surplus was 6.4% higher for the quarter on the back of surging mining profits (18.4%q/q). Financial corporations profits posted a 1.5% rise in Q2, lifting annual growth to 4.7% from 2.1%. Low interest rates have been a headwind for the sector over recent years.  

The strength in labour market conditions continued to be reflected in wage incomes. With the unemployment rate and broader rates of underutilisation falling to their lowest levels in many years during the quarter, wages and salaries increased by another 1.3% in Q2 and were 6.8% higher than at the depths of the COVID recession.    

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GDP — Q2 | Production: GDP (P) 0.9%q/q, 9.6%Y/Y

The GDP production estimate in the June quarter advanced by 0.9% as growth through the year accelerated from 1.4% to 9.6%. 

From a broad sector perspective, services industries are driving the recovery as goods-related industries lag. Spending patterns rotating to a more open economy on eased restrictions has been the key theme. Gross value added (GVA) in services lifted by 1.3% in the quarter (11.9%Y/Y) to be 1.8% higher than pre-COVID. The goods sector saw a 0.7% lift in quarterly GVA but remained below end 2019 levels (-0.7%).   

In the goods sector, GVA in the goods distribution segment was up by 1.9% in the quarter. This was driven by the transport industry (3.7%) in response to increased tourism travel associated with open state borders and the Federal Government's discounted airfares scheme, and wholesalers (1.1%) on strong demand for new vehicles. Goods production was near flat on the quarter (0.1%), held back by the maintenance activity in the mining sector (-1.3%) that moderated increases from the construction and manufacturing industries.    

Turning to services, household services posted a 1.5% rise in GVA in the quarter to be 2.2% above its pre-pandemic level. Contributing to the rise was health (2.0%) on increased appointment volumes, other services (2.0%) led by vehicle maintenance, and arts and recreation (0.4%) with eased restrictions driving increased foot traffic at gambling facilities. GVA from business services lifted by 1.2% in Q2 and was 1.5% above pre-COVID levels. Gains came through in finance (0.8%) on increased home loan activity, rental and real estate (1.8%) due to the robust housing market and rising demand for rental cars associated with increased domestic tourism. The complete industry analysis is shown below.   

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GDP — Q2 | Prices

There were signs of a firmer inflationary pulse in the June quarter. Economy-wide inflation on the GDP deflator was sharply higher rising by 2.5% in Q2 — its fastest quarterly rise in 11 years — to 6.2%Y/Y, with the latter boosted by base effects. This factors in the strong lift in the terms of trade in the quarter (6.9%). Adjusting for the terms of trade effect, the gross national expenditure deflator showed a more moderate rise of 1.0% in Q2 (1.5%Y/Y), though that was its strongest quarterly lift in 9 years. 

Growth in the household consumption deflator — the closest proxy in the national accounts to the CPI — firmed to 0.7% in Q2 from 0.5% in the previous quarter, as annual growth returned to around pre-pandemic rates at 1.5%. For comparison, seasonally adjusted CPI was 0.8% in Q2, with annual growth boosted from 0.9% to 3.7% on base effects.  

 

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GDP — Q2 | Productivity

The productivity measures have been buffeted around by lockdown and reopening effects over the past year and will remain subject to this volatility over the coming quarters. Hours worked across the Australian economy were up by 1.9% in the June quarter for growth of 10.3% since the national lockdown. Hours worked in the market sector advanced by 2.3% for Q2 to be 12.4% higher through the year. Compared to their pre-pandemic levels, total hours are down 0.5% and are 1.4% lower in the market sector.   

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GDP — Q2 | States 

New South Wales saw growth in state demand firm to 2.2% in the June quarter from 1.9% in Q1. State demand had lifted to 3.2% above its pre-pandemic level, though that will be setback significantly by the lockdowns that struck late in Q2. Growth in household consumption increased at a 2.1% pace for Q2, with cafes, restaurants and entertainment venues (4.3%) supported by the government's Dine and Discover voucher scheme. Business investment advanced by 3.1%q/q on the continued surge in equipment spending. Activity in residential construction elevated further (1.1%q/q) to be 11.6% higher than pre-COVID levels — alterations surging over the period (34.7%). Public demand has been an ongoing source of strength, up 5.9% through the year.      

Victorian state demand slowed sharply to 1.4% in Q2 from 2.6% in the previous quarter on the effects of a two-week lockdown in late May to early June. As the state most affected by lockdowns, the recovery in state demand has been notably slower than other jurisdictions. Household consumption was little more than flat in Q2 (0.1%) with the retail sector hit by temporary closures. Residential construction declined modestly in the quarter (-0.7%) as alteration work moderated (-2.9%) after Q1's surge (11.3%). Driving state demand was business investment (4.4%q/q) on rising equipment spending and a lift in engineering work, with the latter boosted by public spending in road and rail projects.     

Moving to the other states, Queensland state demand increased in pace to 2.0% in Q2 after a modest lift in Q1 (0.3%), bringing it to 4.4% above pre-pandemic levels. Gains were broad-based across the components reflecting less disruptions from lockdowns and the impact of stimulus measures. In particular, business investment was up 7.8%q/q and residential construction activity lifted 2.3%q/q. South Australian state demand posted another solid outturn lifting by 1.8% in Q2. Household consumption, residential construction and business investment have all recovered to be above pre-pandemic levels.

  

In Western Australia, state demand advanced by 1.2%q/q to be 5.7% above its level at the end of 2019. Household consumption gathered pace in the quarter (1.9%). Very robust conditions in the housing market and stimulus support continues to boost residential construction (4.5%q/q), with both new home building and alterations up more than 4% in Q2. State demand in Tasmania posted growth of 1.4% in Q2, a similar pace to Q1 (1.7%). Residential construction and business investment in the state is significantly higher than prior to the pandemic on stimulus measures, though household consumption is still recovering, reflecting the impact on tourism from travel restrictions. Public demand continued to rise (3%q/q), led by road projects.