In review: Australian Q2 GDP: Pressures bind on discretionary spending

The Australian economy remains resilient to global and domestic headwinds, but the momentum in growth has slowed to a subdued pace. Real GDP growth was 0.4% in the June quarter - unchanged from an upwardly revised outcome (0.2%) in the March quarter - expanding by 2.1% through the year (from 2.4%). Over the second half of 2022, economic growth was a solid 1.3%; however, the pace slowed to 0.7% for the first half of 2023 as the pressure on households from the higher cost of living and rising interest rates intensified.

Growth dynamics offshore have been similarly challenged in 2023. In the G7, growth has been held up to a large extent by a resilient US economy, attenuating weakness in the euro area and the UK. In China, growth slowed sharply in the June quarter as the reopening lost momentum.   

Despite a very strong labour market, elevated inflation left Australian households significantly worse off as real incomes sustained a fall of historic magnitude over the past year. Associated with this, consumer sentiment has been at very weak levels for an extended period. 

Moreover, the transmission of the RBA's tightening cycle continued, with the earlier hikes to the cash rate (4.1%) flowing through to mortgage payments and fixed-rate mortgages rolling over to higher variable rates. Interest payments on dwellings rose to a 6.6% share of disposable income in the quarter, an 11-year high.  

In response to these headwinds, Australian household consumption growth slowed sharply over the first half of the year (0.4%), with discretionary consumption declining over the period (-0.7%). Nonetheless, aggregate consumption has still increased. Households appear to be drawing down on the large stock of excess savings accumulated during the Covid period to support consumption.  

As household consumption has slowed, two overarching factors have contributed to the resilience of the Australian economy. Firstly, rapid post-pandemic population growth (2.4%) has underpinned the rise in output over the past year (2.1%); in per capita terms, real GDP has fallen 0.3%Y/Y. 

Secondly, the reopening of the borders has facilitated the recovery of services exports, led by the tourism and education sectors. This has contributed more than 2ppts to GDP growth over the past year. 

The growth slowdown reported in the June quarter National Accounts largely validates the decisions by the RBA Board to leave the cash rate on hold at its past 3 meetings. Although the Board retains its tightening bias given the risk of persistent inflationary pressures, an extended pause looks the likely path for monetary policy from here. 

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National Accounts — Q2 | Expenditure: GDP (E) 0.4%q/q, 2.5%Y/Y

Household consumption (0.1%q/q, 1.5%Y/Y) — The momentum in household consumption continued to slow due to cost-of-living pressures and higher interest rates. Household consumption nearly stalled at 0.1% in the quarter, increasing by a tepid 0.4% in the first half of 2023, well down from the 1.1% pace realised over the back half of 2022. 

Very strong labour market conditions drove household incomes to their fastest increase since 2011 at 8% over the year to the June quarter. But that increase was eaten into substantially by mortgage interest payments that have more than doubled (106.9%Y/Y) due to RBA rate hikes and by a surge in income tax liabilities (15%Y/Y). Those factors left disposable income up by a modest 2.3%Y/Y. Then there is the effect of elevated inflation, which at 6.1%Y/Y on the household consumption deflator implies a historic fall in real incomes of around 3% over the past year. In that environment, households have been saving less and less of their disposable income in order to support consumption; the household saving ratio fell to a 15-year low in Q2 at 3.2%.

Although consumption has still risen, the real income squeeze has had a profound effect on demand patterns. Discretionary-related consumption surged coming out of the pandemic, but households have put the brakes on over recent quarters (-0.5%q/q, 0.6%Y/Y), resulting in essential goods and services (0.5%q/q, 2.1%Y/Y) taking up the running as the major impulse to household consumption. 

That said, there are still areas of consumption that remain resilient, including in discretionary-related categories. Notably in the June quarter, new vehicle purchases surged (5.8%) - partly catching up from earlier delays across the ports - while the desire the travel and go out continued to support transport services (3.2%) and hotels, restaurants and cafes (0.2%). The largest pullback in Q2 was in furnishings and household goods (-2.5%), with the category continuing to normalise after surging during the pandemic lockdowns.  

Dwelling investment (-0.2%q/q, -1.1%Y/Y) — Higher interest rates and capacity constraints have weighed on dwelling investment over the past year (-1.1%). In the June quarter, the decline was a relatively modest 0.2%. A welcome rise in new home building came through in the quarter (1.2%) driven by higher-density housing, with detached home building still under pressure from delays. Alterations (-2.4%) continued to unwind from their peaks reached in response to the stimulus measures that supported this activity during the pandemic. 

Ownership transfer costs — fees associated with real estate transactions — lifted by 3.9% in the June quarter, its first rise since Q3 2021. This came amid a tight supply-demand balance driving an upturn in housing prices. 

Business investment (2.1%q/q, 8.0%Y/Y) — A 2.1% rise in the June quarter saw business investment up by 8% through the year, an upturn that has defied the headwinds of slower global and domestic growth and tighter financing conditions. 

Key factors in this resilience have been firms responding to capacity pressures that emerged through the Covid period and progress in the transition to renewable forms of energy. In addition, federal government tax incentives that expired at the end of the 2022/23 financial year brought forward spending, reflected in business investment rising by a sharp 5.7% over the first half of the year. 

Machinery and equipment (4.3%) drove business investment in the quarter as global supply chain pressures eased. Intellectual property products (2.2%) posted the fastest quarterly rise in 2 years. Non-dwelling construction (0.3%) was subdued in Q2 but has risen materially over the past year (10.8%) as commercial and infrastructure projects have gathered pace.

  

Public demand (1.2%q/q, 2.7%Y/Y) — Public demand was a key support to growth in the quarter, adding 0.3ppt to real GDP. As a share of real GDP, public demand remains elevated averaging around 27.5% over the year to the June quarter, well above its pre-pandemic share of output. New investment accelerated by 5.2%q/q (9.4%Y/Y), reflecting progress on major transport, health and education projects across the nation. Government expenditure lifted 0.4%q/q (1.4%Y/Y).   

Inventories (-1.1ppts in Q2, -1ppt yr) — A number of factors led to a large decline in non-farm inventories of $3.4bn (chain volume terms) in the quarter, subtracting a substantial 1.1ppts from output. The clearing of port delays facilitated the delivery of new vehicles and equipment. Disruptions that previously affected mining production eased, supporting the export of these commodities. Meanwhile, offshore grain shipments led to a decline in wholesale inventories.    

Net exports (0.8ppt in Q2, 1.2ppt yr) — Made the largest contribution of all the expenditure components to GDP growth in Q2 (0.8ppt). Export volumes lifted 4.3%q/q (9.8%Y/Y), recovering to pre-pandemic levels. Reopened borders continued to facilitate the recovery of the domestic tourism and education sectors. This saw services exports advancing by a further 12.1%q/q to be up 50.9% through the year. A rebound in resources shipments (2.4%) also supported exports in Q2. Import volumes were up a modest 0.7% in the quarter, now 8.2% above pre-pandemic levels. Travel services (11.2%) were the major driver, reflecting many Australians travelling to the northern hemisphere for leisure.

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National Accounts — Q2 | Incomes: GDP (I) 0.3%q/q, 2.1%Y/Y 

Weaker global growth dynamics hit national income in the June quarter as the prices of Australia's major export commodities declined. In the quarter, export prices fell by 8.2% generating a 7.8% contraction in the terms of trade. This was the largest quarterly fall in 14 years and left the terms of trade down 12.7% on the record high from a year earlier. 

Reflecting the terms of trade fall, nominal GDP contracted by 1.2%q/q, which saw growth through the year slowing from 9.5% to 3.6%. Falling nominal GDP was driven by a 1.5% decline in prices - influenced heavily by the fall in export prices - resulting in the real income estimate of GDP lifting 0.3% in the quarter (2.1% year-ended).

Household income continued to be bolstered by the very strong labour market. Robust labour demand led to increased hiring and hours worked, the latter advancing 2.5% across the economy in the quarter (and 2.2% in the market sector). These dynamics drove the compensation of employees measure to a 1.6% rise in Q2 to be up 9.6% through the year. 

On an hourly basis, non-farm compensation was running at a 3.1% year-ended pace. But the underlying cost of labour for firms has increased at a materially stronger pace after accounting for productivity trends, which have been weak - a key concern highlighted by the RBA as it could sustain high inflation if firms respond by continuing to raise prices. Non-farm unit labour cost growth was 7.3%Y/Y and 4.9%Y/Y in real terms. 

Amid a range of headwinds from falls in commodity prices, margin pressures and slowing demand, private sector (ex-financials) company profits fell 8.6% in the quarter, their largest quarterly decline since 1991. That outcome drove a swing in through-the-year profits from 15.1% to -6.8%. 

Gross mixed income (small business and farming profits) was also hit, contracting by 2.7%q/q and 8.8%Y/Y. By contrast, financial company profits lifted 1.2%q/q to 7.2%Y/Y; more fixed-rate mortgages are rolling on to higher variable rates, while the RBA's tightening cycle has driven an expansion in net interest margins. 

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National Accounts — Q2 | Production: GDP (P) 0.4%q/q, 1.7%Y/Y

The GDP production approach estimate was 0.4% in the June quarter, in line with the outcomes for the expenditure approach and the headline figure. The year-ended growth rate moderated from 2.2% to 1.7%. Gross Value Added (GVA) increased at a similar pace for business services (0.6%) and household services (0.7%). By contrast, the goods sector was patchy: goods production advanced (0.5%) as goods distribution softened (-0.1%). 

Business services (0.6%) saw broad-based strength across the sector. The upturn in housing prices led to increased activity for real estate services (2.7%). Administration advanced (1.8%) on stronger demand for travel services and labour hire. Professional services (-0.3%) was a point of weakness. Turning to household services (0.7%), increased demand for public health services (0.9%) was the main support. Inbound tourism boosted the accommodation and food services industry (0.4%).   

GVA from goods production (0.5%) was led by construction (2.2%) and utilities (2.9%). Construction output was supported by increased sub-division activity and by progress on infrastructure projects. Cool weather in the lead-up to winter led to a lift in household electricity and gas consumption that drove utilities. This was moderated by a 1.3% fall in mining, reflecting disruptions to iron ore operations caused by Cyclone Ilsa. Goods distribution (-0.1%) was hit by weakness in retail demand and by an easing in grain trade, both weighing on the wholesale industry (-1.5%). This weakness was largely offset by the transport industry (1.1%) as demand for domestic and offshore travel remained strong.     

Australian Q2 GDP expands 0.4%

The Australian economy expanded by 0.4% in the June quarter, in line with expectations and unchanged from Q1 after revisions. This was a resilient outcome considering household consumption (more than 50% of the economy) continued to slow amid cost of living pressures and higher interest rates. Weaker offshore growth dynamics also hit, reflected in the terms of trade falling 7.8% as commodity prices unwound, driving a 1.2% contraction in nominal GDP. 

Real GDP increased by 2.1% through the year, underpinned by rapid post-pandemic population growth (2.4%). Reopened borders have also bolstered growth by facilitating the recovery in services exports, including tourism and education, adding more than 2ppts to GDP over the past year. 

Household consumption growth almost stalled in Q2 (0.1%) and has slowed sharply over the past year (1.5%). With pressures on household budgets intensifying, discretionary consumption continues to weaken, falling 0.5%q/q as year-ended growth slowed to just 0.6%.

A strong labour market has supported household incomes, but the tax burden has increased alongside this, interest rates have risen sharply and inflation has been elevated. All told, real disposable income has fallen 3.2%Y/Y. That consumption at 1.5% is still positive in this environment speaks to the resilience of the consumer and their willingness to spend out of savings accumulated during the pandemic. Whether households are able to take this much further is an open question, with the saving rate in the June quarter declining to a 15-year low (3.2%).  

Together with slowing household consumption, residential construction also remained weak in Q2 (-0.2%), albeit new home building saw a welcome lift (1.2%). However, private demand held up relatively well (0.5%) as business investment (2.1%q/q, 8%Y/Y) continued to defy the prevailing headwinds. This has been supported by eased supply chain pressures. As backlogged orders - particularly for vehicles and machinery - have been filled, inventory levels have declined, weighing on GDP (-1.1ppts in Q2). Public demand (1.2%q/q, 2.7%Y/Y) remains a growth support as progress on infrastructure projects gains momentum. Net exports (+0.8ppt) made the largest contribution to growth in Q2 as the recovery in domestic tourism and education services continued at pace. 

More to come. 

RBA extends pause in September

The RBA Board left its key rates unchanged today at 4.1% on the cash rate and 4% for Exchange Settlements. This was the 78th and final meeting overseen by Governor Philip Lowe, his tenure concluding the same way it started back in October 2016 with the Board holding a steady hand. Headwinds offshore and signs that the transmission of tighter monetary policy is in train through slower domestic growth, some easing in the labour market and declining inflation have kept the Board on hold for 3 meetings in succession now, a pause that looks likely to extend. 

Today's decision statement from Governor Lowe was largely unchanged from the previous meeting in August. The overall tone is that a data-dependent Board is seeing enough progress in the domestic economy to warrant remaining on the sidelines, particularly with uncertainty around the Chinese economy clouding the outlook for global growth. As such, the RBA's central scenario for inflation to fall back to the 2-3% target - forecast for "late 2025" - with growth and employment still increasing remains intact. The current pace of wages growth (3.6% year-ended) is not seen as a constraint to returning to 2-3% inflation, although stronger productivity growth remains a key part of that assessment. 

Reflecting the risk that inflation could remain more elevated than anticipated for longer, the Board has retained its tightening bias, noting that "some further tightening of monetary policy may be required...". The key uncertainties regarding inflation are how elevated services prices evolve and how wage and price settings adjust to slower growth. However, unless these factors materialise to prompt a revision of the inflation outlook, the Board seems set for an extended pause. 

Australia Current Account $7.7bn in Q2; net exports +0.8ppt

Australia's current account surplus narrowed from $15.5bn ($A) in the March quarter to $7.7bn in the June quarter (estimated at around 1.2% of nominal GDP), a slightly larger decline than expected ($8bn). The narrowing was driven by falling commodity prices, hitting national income by around 8% in the quarter. Nonetheless - but for one quarter in 2022 - the nation has run a current account surplus for the past 4 years, a period without precedent for Australia. The topline detail for net exports was strong, with the ABS reporting an expected contribution of +0.8ppt to Q2 GDP, well above expectations for +0.3ppt. 

The current account surplus narrowed by $4.8bn to $7.7bn in the June quarter. The drivers were the trade surplus contracting by $8bn in the period (to $31.4bn), with the income deficit improving by $3.2bn (to -$23.4bn) as returns from offshore investments lifted (3.7%).   

The value of the nation's exports has eased from record highs, declining by 4.2% in the quarter, weighing on the trade surplus. That movement was driven by an 8.2% decline in export prices, reflecting a retracement in commodity prices. Underlying export volumes advanced 4.3% in the quarter. Import values lifted 0.4%q/q, on a combination of softer prices (-0.2%) and a modest lift in volumes (0.7%).  

What this all means is that national income took a large hit during the June quarter - the terms of trade fell by 7.9%q/q, its sharpest quarterly decline in 14 years - but international trade actually added substantially to economic growth, due to export volumes (4.3%) far outpacing import volumes (0.4%).  

The contribution to GDP growth coming through from net exports in Q2 will be 0.8ppt, helping to attenuate very weak business indicators data yesterday. 

The ongoing recovery in the domestic services sector, notably tourism and education, on reopened borders continued to drive exports. Services exports were up a further 12.5%q/q and have been the major contributor to export growth over the past year. Other notable dynamics were: strong offshore demand driving rural exports (0.9%) to a record high in Q2; meanwhile, commodity exports lifted by 2.4%q/q, as shipments rebounded from disruptions in Q1. 

Import volumes were soft in Q2 (0.7%), slowing to a pace of 4.4% through the year from 5.7%. Slowing imports reflect the backdrop of weakening domestic demand; however, this has centered in goods (0.7%Y/Y) as services post-pandemic remain elevated (22.9%Y/Y). Key dynamics in Q2 were: consumption goods (-1.1%) and capital goods (-3.3%) falling on weak demand; by contrast, continued resilience was seen in services (4.7%), bolstered by overseas travel to the northern hemisphere as the Australian winter approached. 

Preview: RBA September meeting

The RBA is set to extend its tightening pause today, leaving the cash rate on hold at 4.1% for the third meeting in succession (decision due 2:30pm AEST). This is Governor Philip Lowe's final meeting of his 7-year tenure leading the RBA and will be followed by a speech titled Some closing remarks on Thursday (1:05pm AEST).   

After leaving rates on hold at the July and August meetings, the Board will very likely maintain that position today. Amid economic headwinds offshore and signs that the effects of its tightening cycle are in transmission through slower domestic growth and declining inflation, a data-dependent Board has been content to stay on the sidelines and monitor developments. 

Forecasts updated by the RBA last month showed the central scenario is for the economy to remain on the "narrow path" where inflation falls back to the 2-3% target band over the next couple of years, with growth and employment still increasing. A hint that the Board is thinking along the lines of an extended pause was evident in the August meeting minutes, which noted that there was "a credible path back to the inflation target with the cash rate staying at its present level". However, the Board ultimately retained its tightening bias that "some further tightening of monetary policy may be required...", contingent upon "... the data and the evolving assessment of risks".   

The incoming data since the August meeting looks to support the continuation of the RBA's pause. The most notable developments have been softening wage and price data. In the June quarter, the Wage Price Index eased back to a 3.6% annual pace, printing on the soft side of RBA expectations for an unchanged 3.7%. Last week, 12-month headline inflation was reported to have declined from 5.4% to 4.9% in July. Labour market conditions also softened in July as the unemployment rate ticked up from 3.5% to 3.7% on the back of employment falling by 14.6k in the month.

All in all, the cash rate appears set to remain at 4.1%, with the data continuing to allow the Board time to observe the effects of its tightening cycle on the economy and inflation. While cracks may be starting to emerge in the Board's tightening bias, this seems likely to remain in place at this juncture, on the eve of the handover to the new Governor, the current deputy Michele Bullock. 

Australian Business Indicators Q2: Inventories -1.9%

Australia's Business Indicators report for the June quarter was consistent with a backdrop of softening domestic demand. Going into Q2's National Accounts on Wednesday, inventories are set to weigh notably on the GDP outcome, while business profits were down sharply in the quarter.  

Sales volumes across the economy contracted by 0.3% in the June quarter; outside of Covid lockdown periods, this was the weakest outcome for quarterly sales since Q3 2016. Beneath the surface, the picture of demand is more nuanced, with cost-of-living pressures and higher interest rates weighing heavily on some sectors - such as manufacturing (-2%), wholesale trade (-3.4%), finance and insurance (-1.8%), and retail (0%) - as others displayed resilience, including transport (3.3%), arts and recreation (1.0%), and hospitality services (0.4%). 

Broadly speaking, a large drawdown on inventories in the quarter (1.9%q/q) appears consistent with this softer demand backdrop, with firms not having to restock. On rough estimates, this outcome maps to a 1ppt deduction from Q2 GDP. Sector volatility may, however, accentuate the weakness, with mining -5.2% - potentially on disruptions - and wholesale -2.3% - pulling back after a delayed harvest due to flooding boosted gain production in Q1. Retail inventories fell 2.1% in the quarter, consistent with slowing consumer demand. 

Gross company profits saw a large decline of 13.1% in the June quarter, or -11.8% after adjusting for inventory valuation effects. The fall was driven by a 21.3% retracement in mining profits as commodity prices declined. Profits across the non-mining sector were down 5% quarter-on-quarter, with weaker demand and margin pressures the likely headwinds. 

The positive is that labour market conditions remain resilient to the broader slowdown; elevated job vacancies suggest that strong demand for employees may see the labour market holding up for longer than in past slowdowns. Wages and salaries expanded by 1.8% in the quarter to be up 9.9% through the year.   

Macro (Re)view (1/9) | Upbeat start to September

Data through the week reaffirmed expectations that central bank tightening cycles are at or near their peaks, while additional measures from the authorities in China contributed to upbeat sentiment. The Australian dollar saw its first weekly rise to the USD in 7 weeks, reflective of the tailwinds that drove equity markets to strong gains. The recent upward pressure on front-end US yields was reversed by an easing in labour market conditions and inflation data that matched expectations. 

US data painted a constructive picture of conditions as far as markets were concerned, the mix indicating the consumer continues to underpin economic resilience, alongside an easing of labour market tightness and inflation pressures that suggest the Fed can remain on hold. Personal spending (0.8%m/m/6.4%yr) has outpaced incomes (0.2%m/m/4.6%yr), with elevated savings continuing to support consumption. Declining inflation has also been a factor, reducing the drag on real incomes. Headline (3.3%yr) and core PCE prices (4.2%yr) actually rose modestly in July, but these rates are well down from their 2022 peaks of 7% and 5.4% respectively. 

Indications are that the Fed is likely to be content with that progress, particularly with signs of better balance in the labour market. Job openings fell from 9.5 million to 8.8 million in July. Although nonfarm payrolls printed above expectations at 187k in August (vs 170k exp), with -110k of revisions to June and July the 3-month average increase has slowed to around 150k, its lowest since the onset of the pandemic. Softer labour demand saw the unemployment rate lift from 3.5% to 3.8%, though that came alongside a rise in labour force participation to 62.8%, a high back to February 2020. Meanwhile, average hourly earnings at 4.3%yr softened from 4.4%. 

Momentum for an ECB hiking pause is building, with signs the Governing Council may be shifting to a more balanced outlook on rates as the latest inflation data broadly met expectations. In light of a deteriorating growth backdrop in the euro area and elevated inflation, the account of the ECB's July meeting revealed that the Governing Council discussed the risk of a "phase of stagflation" emerging as opposed to a "more benign scenario of a soft landing". Printing at 5.3%yr on both a headline and core basis in August (from 5.3% and 5.5% respectively in July), inflation still remains well above the ECB's 2% target. Given that weakening growth will assist in bringing inflation back to 2%, the ECB's Isabel Schnabel reiterated the Governing Council remained in a data-dependent mode, yet to determine if rates are appropriately calibrated at a "sufficiently restrictive" level.

Easing inflation in Australia points to the RBA leaving the cash rate on hold (4.1%) next week, this to be the final meeting led by Governor Philip Lowe. Headline CPI fell from 5.4% in June to 4.9%yr in July - below expectations for 5.2% - with the core measures also softer, the key trimmed mean gauge into 5.6% from 6% previously (reviewed here).

Modest economic growth of around 0.4% is expected to be reported in the June quarter National Accounts next week. My detailed preview (see here) discusses that the main theme remains around the consumer, with household consumption weighed by headwinds from falling real incomes and rising interest rates. But there is an underlying resilience in spending, seen in retail sales lifting by 0.5%m/m in July (see here).

A contributing factor may be the upturn in housing prices, which lifted for the 6th month running in August (0.8%) to nearly reverse their earlier peak-to-trough fall of around 10%. Housing finance has lifted on the back of this, but commitments fell by 1.2% in July (see here). Construction activity (0.4% in Q2) continues to be held back by constraints in the residential sector (see here), and dwelling approvals slid a further 8.1% in July (see here). Despite the broader slowdown, business investment continues to advance, with capex up 2.8%q/q (see here).