Australian National Accounts March 2023: Growth slows, inflation doesn’t (enough)

A manufactured slowdown in the economy is working, with GDP rising just 0.2 per cent this quarter. But rate hikes have yet to make a big enough difference to the inflation dynamics in the economy.

From the Chief Economist

Australia is at an ugly point in the business cycle. Growth has fallen but prices and labour costs haven’t. That means the economy is digesting the Reserve Bank’s rate hikes but has not yet felt the relief from them.

Even though prices are not rising as quickly as at the end of last year, they are still moving up too fast.

The National Accounts revealed that the prices of services are still accelerating for households. The cost of employees for businesses is rising because wage growth is rising, and labour productivity is falling.

GDP grew only 0.2 per cent in the March quarter or 2.3 per cent over the year, which is well below its trend rate. On a per capita basis, GDP fell 0.2 per cent, which means that if it hadn’t been for strong net overseas migration with international students and working holiday makers returning, GDP would have contracted.

Slow productivity growth means a slower economy, which generates less income and employment. Our EY CGE model¹ indicates that if multifactor productivity growth (labour and capital) were to remain flat over the next three years, compared to a baseline assumption of 1.2 per cent growth year-on-year, GDP would end up being 4.5 per cent lower. That’s roughly equivalent to losing the output of the whole retail sector.

But as Reserve Bank Governor Lowe noted in a speech this week, some of that productivity slowdown is likely a hangover from the pandemic and will fade. There was very strong growth in employment in the health care and social assistance industry from February 2020 to 2023, where productivity gains are hard won and difficult to measure.

House building fell with finance harder to obtain and supply constraints still affecting this sector. Consumption slowed as expected, with the quarterly percentage change in discretionary spending falling below the change in essential spending for the first time since the Delta lockdowns. But even within this category there was an increase in transport, hotel, cafe and restaurant spending (possibly due to new migrants spending, as well as local residents).

Better news was found in private business investment and especially the 6 per cent rise in machinery and equipment investment which was driven by purchases of heavy vehicles and cotton-picking machinery. Electricity and transport project infrastructure rose solidly too. The ABS noted several large data center and office projects being started. There was also ongoing spending on a number of wind, solar and battery projects. Once again, iron ore exports generated strong income with high prices, a competitive Australian dollar and demand from a reopened China.

Households cut back on discretionary spending to cover essentials

Growth in household consumption continued to moderate in the March quarter as expected, rising just 0.2 per cent. This is the weakest result since the pandemic, contributing just 0.1 percentage points to growth.

This slowdown reflects the cumulative impact of rate hikes by the Reserve Bank since May last year, and which continued throughout the March quarter, as well as cost-of-living pressures, higher income tax payable and negative real wages. Household consumption growth slowed in annual terms to 3.5 per cent, down from over 5 per cent in the previous quarter.

Spending on essential items was the main driver of consumption, led by electricity and rent, while growth in discretionary spending weakened, down 1 per cent. Discretionary spending remains elevated but is coming down to be more in line with essential spending. The only discretionary spending categories that rose were travel and hotels, cafes and restaurants, along with clothing and footwear.

In nominal terms, household spending continued to grow faster than the rise in gross disposable income – which rose 0.8 per cent in the March quarter after falling 0.7 per cent in the previous quarter. Interest payable on mortgages rose just over 11 per cent in the March quarter. For households, this diminishes their ability to save and top up mortgage offset and redraw accounts.

The saving ratio took another tumble, falling from 4.4 per cent in the December quarter to 3.7 per cent in the March quarter, which is the lowest since the GFC. As interest rates rise further and cost-of-living pressures continue to bite, consumption will suffer further as will the amount saved, throughout 2023.

We expect subdued spending by consumers moving ahead. Several factors including the strong labour market, build-up in savings, high levels of low fixed rate mortgages, and the recent turnaround in house prices have been supporting consumption in the second quarter of 2023. But as many mortgages roll over to higher variable rates over the coming year and rents continue to rise, consumption growth will slow and may even recess.

Profits rise as supply chains ease and petroleum prices fall

Company profits rose 3 per cent through the quarter to be 11.5 per cent higher over the year. Total profits as a share of total factor income rose close to a record high of 32 per cent.

The increase was driven by the wholesale trade, manufacturing and accommodation and food services industries. An easing of supply chain disruptions, falling petroleum prices and increased activity across these sectors meant lower operating costs leading to larger profit margins. Mining saw a fall in profits in line with lower coal and LNG prices and decreased exports. Profits fell slightly for financial corporations as deposit balance and loan growth waned and bank margins narrowed.

While productivity growth has continued to decline, unit labour costs increased 2 per cent through the quarter, to be 7.9 per cent higher through the year. Compensation of employees (COE) also picked up further, rising 10.8 per cent through the year. This is much higher than its 10-year average of 4.4 per cent and the Wage Price Index (WPI) which picked up to 3.7 per cent, (and uses a narrower definition of wage increases).

Private sector COE saw increases reflective of skill shortages, rising 2.4 per cent in the quarter, while public sector COE rose by a stronger 2.5 per cent as governments face wage pressures amid cost-of-living pressures.

Hours worked increased 0.6 per cent after jumping nearly 2.1 per cent in the previous quarter – a sign that skill shortages persist in the economy.

Price pressures continue to sizzle

Australia’s terms of trade – the ratio of export and import prices – increased by 2.8 per cent over the quarter, increasing only slightly over the year.

Lower crude oil prices and easing of supply chain pressures led to a fall in import prices, down 4.0 per cent. This decline in import prices more than offset the fall in export prices, down by 1.4 per cent, largely driven by a fall in the price of mining commodities (LNG and coal) and rural goods. This was reflected in the Reserve Bank’s Commodity Price index which fell by 0.7 per cent in the same quarter.

Domestic prices increased by 6.1 per cent over the year in the March quarter down from the three-decade peak of 6.6 per cent in the previous quarter. International prices continued to normalise, increasing by 4 per cent over the year, while domestic prices have shown signs of peaking. As long as high prices persist, there remains a case for the Reserve Bank to continue raising interest rates.

Public sector investment continues to crowd out the private sector

Government spending rose by just 0.1 per cent in the quarter, after a 0.6 per cent rise the previous quarter. Spending was driven by the Federal Government, up 0.7 per cent in quarter, focused on non-defence spending. State and local government spending fell 0.4 per cent in the quarter.

Public investment surged 3 per cent in the March quarter, after falling 0.7 per cent in the previous quarter – mainly driven by state and local government investment in transport infrastructure and health.

Both government consumption and investment as a percentage of GDP remain elevated, exacerbating skill shortages and capacity constraints within the economy In the May Budget, the Federal Government indicated that they were planning to spend more than they saved in the short term, given the surge from additional tax collections. However, the review of the $120 billion infrastructure pipeline to ensure value for taxpayer funds is an important step in easing some of these capacity constraints.

Business investment a stand out despite economic challenges

Private sector investment rose 1.4 per cent in the March quarter after falling in the previous quarter. Business investment saw a strong rise of 3.4 per cent as the manufacturing, transport and mining industries purchased machinery and equipment (up 6 per cent). Non-dwelling construction also rose which is a welcome sign of improved materials supply.

Despite the current economic challenges, private sector investment intentions remain robust. This was reflected in capex intentions for this financial year being upgraded by 2.7 per cent, and capex plans for the next financial year being upgraded by over 6 per cent, but a little lower than usual at this time of year.

Interest rates and capacity constraints put pressure on dwelling investment

Total dwellings investment fell 1.2 per cent through the quarter as rising interest rates and capacity constraints weigh on activity.

Investment in alterations and additions fell 0.9 per cent which is the sixth consecutive quarterly fall, from record highs in 2021. Housing investment fell 2 per cent over the quarter, largely driven by a 5 per cent fall in ownership transfer costs.

Labour and material shortages continue to impede on the construction of new dwellings, resulting in a 1.3 per cent fall over the quarter. These pressures are making it difficult for builders to address the significant backlog of work, as project delays and completion times remain high.

Net exports detract from growth as import and export prices fall

Net exports detracted 0.2 percentage points from growth as the rise in imports outpaced the rise in exports.

Exports increased by 1.8 per cent, largely driven by travel services (education and tourism) and rural goods. Imports rose 3.2 per cent mainly driven by motor vehicles, mobile phones, and machinery and equipment. Australians travelling abroad contributed to the rise in service imports.