What did the national accounts tell us about the economy?

 

Matthew Peter, Chief Economist

The Australian economy has the enviable record of 28 years without a recession. The recovery in growth that was evident over much of 2017 and the first half of 2018 led to a burst in optimism that the Australian economy would extend its recession-beating record. Confidence in our record beating ability was shaken last Wednesday with the release of the September quarter national accounts. These showed the economy expanded by a measly 0.3% in the quarter (qoq), knocking annual growth from above trend to the also-ran ruck of trend (2.8% yoy). Apart from the slowdown in growth, what did the national accounts tell us about the Australian economy?

We have strong public sector spending (1.5%qoq/4.5%yoy), backed by ongoing infrastructure spending in NSW. However, we have a tepid private sector, with falling business investment (-1.2%qoq/-1.2%yoy), as the last of the LNG mining projects were completed, declining new home building (-0.8%qoq/5.2%yoy), as the housing market rolls over, and sluggish consumer spending (0.3%qoq, 2.5%yoy), as growth in real disposable income stalls.

Net exports contributed positively to economic activity, adding 0.3 percentage points (ppts) to quarterly GDP growth. However, the net export contribution came almost entirely from a sharp fall in imports, as our demand for overseas-produced goods that feed into mining investment has fallen away. Export growth stalled, however, barely eking out positive growth (0.1%qoq) over the quarter. Fortunately, the Australian Bureau of Statistics tells us that the weak export growth resulted from temporary supply constraints in the iron ore industry, which once passed, should see growth return to a fast pace as additional LNG capacity comes on line.

On the income side of the economy, nominal corporate profits remain healthy (1.7%qoq/7.1%yoy) helped by an 8% rise in the terms of trade, a low AUD, and subdued labour costs. Robust profit growth and business confidence is driving strong growth in employment, which despite tepid wage growth is driving respectable growth in labour income (1.0%qoq/4.3%yoy). Notwithstanding reasonable labour income growth, weak growth in profits of small businesses and a sharp lift in income taxes eroded growth in disposable income over the quarter (0.3%qoq, 2.8%yoy). After deducting consumer-price growth, real household disposable income (the spending power of income) fell slightly (-0.1%qoq) and recorded yearly growth (1.0%yoy) about a third of its long-run trend rate.

If, indeed, we are entering a slower growth environment, compared with the last year-and-a-half, is this the portend to recession? We think not. First, while growth was weaker than we (0.5%qoq) and most other forecasters (0.6%qoq) expected, we had fully expected the Australian economy to slow over the coming 12 months from its breakneck pace of the first half of 2018. That the path to a return to more sustainable trend-like growth should not be as smooth as we had forecast should not surprise us, nor should it lead us to jump to hasty conclusions. Second, a number of factors that weighed on growth in the quarter are likely to be transitory, including the mining-related slowdown in business investment, the weak growth in exports and the jump in income taxes. Third, strong corporate profit growth, robust employment growth, and increasing growth in private sector investment in machinery and equipment speak of favourable underlying business conditions within the economy.

The real risk to maintaining trend growth in the Australia economy lies with the consumer. The consumer is impacted by two factors: slow growth in disposable income and falling house prices. Let’s look at income growth first. Growth in labour income is solid, without being stellar, and is gradually improving as wage growth grinds higher. As the one-off hits to disposable income arising from income tax spikes dissipate, growth in disposable income will begin to track labour income more closely. In addition, disposable income will receive a boost from income tax cuts next year as Phase 1 of the Government’s Personal Income Tax plan kicks in.

The fall in house prices will dent consumer spending. We estimate that a 10% fall in house prices will lower growth in consumer spending by around 0.4ppts over 2019 and 2020. Therefore, as growth in real labour income and real disposable income head towards a trend rate of around 2.8%yoy over the coming year, real consumer spending will fall short of matching income growth by around 0.4ppts. This implies a slightly sub-trend rate of growth of 2.5%yoy in consumer spending over 2019 and 2020. However, with above trend growth in business and public investment and in exports likely, real GDP growth should still reach trend growth rates of 2.8%yoy over the coming two years.

Table 1: Financial market movements, 29 November – 6 December 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,696.0

-1.5%

US

2.90%

-13.4 bps

US Dollar Index (DXY)

96.81

0.0%

Nikkei 225

21,501.6

-3.4%

Japan

0.06%

-1.8 bps

USD-JPY

112.68

-0.7%

FTSE 100

6,704.1

-4.8%

UK

1.25%

-12.1 bps

GBP-USD

1.278

-0.1%

DAX

10,811.0

-4.3%

Germany

0.24%

-8.5 bps

EUR-USD

1.137

-0.2%

S&P/ASX 200

5,657.7

-1.7%

Australia

2.45%

-15.0 bps

AUD-USD

0.724

-1.1%

Source: Bloomberg

 

 

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