15 minute read 4 Dec 2019
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Quarterly Update, Q3 2019: Without everyone pulling together, can the economy reach its potential?

Authors

Jo Masters

EY Oceania Chief Economist

Economist. Pundit. Keen tennis player. Referee to teenage girls. Paddle board lover.

Bonnie Barker

EY Oceania, Senior Economist

Urban Renewal and housing economics specialist. Keen squash player. Stand up paddles on the weekend.

15 minute read 4 Dec 2019
Related topics Public policy

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The economy expanded by a soft 0.4% in the September quarter, with growth again driven by net exports and public spending, with a smaller contribution from household spending. In annual terms, economic growth of 1.7% y/y – while a touch higher than the previous quarter – is well below ‘potential growth’, which is the rate of growth required to lower unemployment and lift inflation. 

    The economy continues to be divided, net-exports and public spending both added 0.3 ppt to quarterly growth, at the same time private domestic demand has fallen. Private consumption added just 0.1 ppt, the weakest quarterly contribution since Q2 2013. While residential construction and private investment both detracted from activity in the quarter. Worryingly, firms have revised future capex plans lower, which could challenge the expected ‘gentle turning point’.  

    There is growing evidence that households are becomingly increasingly cautious, looking to boost savings and reduce debt, despite the rebound in house prices, tax rebates and lower interest rates. Household disposable income rose a healthy 2.5% q/q partly reflecting the delivery of the Low and Middle Income Tax Offset. This boost however, has not flowed through to faster consumption growth and, in fact, the household savings rate jumped from 2.7% in Q2 to 4.7% in Q3, the highest savings rate since Q1 2017. 

    Economic growth remains tepid and narrowly based, providing ongoing challenges to policymakers
    Jo Masters
    EY Oceania Chief Economist

    Disappointingly, productivity (defined as GDP per hour worked) fell by 0.2% year on year. Weak productivity remains a key challenge for policy makers and the economy.

    We can expect further rate cuts from the RBA in 2020 and the prospect of quantitative easing will remain a talking point. Further, moderation in private consumption would be a concern for the economic outlook and will likely add pressure on the Government to provide additional support in the Federal Budget in May.

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    1

    Growth Overview

    Signs of a turning point in the economy

    The economy grew by 0.4% in the September quarter, following revised growth of 0.6% in the June quarter.

    A (very) gently turning point.

    The economy grew by 0.4% in the September quarter, following revised growth of 0.6% in the June quarter. In annual terms, economic growth ticked up a touch, lifting to 1.7% y/y. That said, growth remains around levels last seen during the Global Financial Crisis and well below long term trend. 

    GDP 2019 Q3 Y/Y Increase

    1.7%

    Up from 1.6% in Q2 2019

    GDP Per Capita 2019 Q3 Y/Y Increase

    0.2%

    Up From 0.1% Y/Y Q2 2019

    Nominal GDP rose by 1.1% q/q and 5.5% y/y, partly reflecting strength in the terms of trade, driven once again by elevated commodity prices.

    Economic Growth

    In per capita terms the economy grew by 0.04% in the quarter, bringing annual growth down to just 0.2% year on year. A weak result indicating that economic growth is being driven largely by population, not through improved productivity or increased participation. 

    Per capita growth is weak

    A divided economy

    Once again the Australian economy is being propped up by net-exports and  public spending. Net exports added strongly to growth with exports of goods and services adding 0.2 ppt and imports a further 0.1 ppt.

    The public sector also continues to be one of the key drivers of growth in the Australian economy, with public consumption and investment contributing 0.2 ppt and 0.1 ppt to growth in GDP in the quarter respectively. 

    What's driving growth?

    In contrast, private domestic demand remains lacklustre, falling by 0.1% q/q and 0.3% over the year to the September quarter. Within private domestic demand, household consumption added just 0.1 ppt, the weakest quarterly contribution since Q2 2013. Private business investment knocked 0.1 ppt off growth, with plant and equipment spending particularly weak.

    Dwelling investment also weighed on growth, taking 0.1 ppt off quarterly activity.

    Private domestic demand is lacklustre

    Drought conditions in parts of Australia are also weighing on the Australian economy. The outlook for the farm sector remains challenged, with weather conditions expected to be drier than average . Farm GDP fell by 1.4%  q/q and 5.9% over the year. 

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    2

    Growth Drivers

    Net exports and public spending continue to be key

    Net exports added 0.3 ppt to quarterly GDP, with the trade surplus hitting a record $21.1 billion in the quarter. Public spending, which also added 0.3 ppt to quarterly activity and has risen by 4.8% over the year.

    Net exports

    Net exports continue to support growth, adding 0.3 ppt to quarterly GDP, with the trade surplus hitting a record $21.1 billion in the quarter. This largely reflects very strong export performance, iron-ore and rural exports in particular were strong, with LNG exports ramping up. Meanwhile, import growth ticked up; the result of a rise in consumer goods imports, while capital goods imports fell in the quarter. The current account recorded a surplus for the second consecutive quarter, the first time in 46 years. The surplus is currently sitting at $7.9bn, or 1.6% of GDP. 

    Australia is enjoying a record trade surplus

    While LNG exports will continue to grow and will support our trade performance for some time to come, commodity prices are expected to moderate over the year ahead. Over the medium term, increasing protectionism around the world is not positive for a small, open economy like Australia.  

    Mining, tourism and education are Australia's largest exports

    Public spending

    Public spending rose by 1.1% in Q3, to be 4.8% higher over the year. Growth in public spending over the past year has been driven by public consumption. Which is being driven by the ongoing roll-out of the NDIS as well as the increased need for services required to support an aging population.

    While public infrastructure spending is elevated, the peak growth of the infrastructure cycle is now behind us. In fact, Q3 is the first time in the past year that public investment has added to growth (although the profile tends to be lumpy). The recent announcements bring forward of $3.8 billion of infrastructure spending across the country into the next 18 months should provide some additional support.

    Public consumption continues to support growth

    Despite announcing  increasing public investment, the Government remains committed to delivering a budget surplus for 2019/20, estimated at a slim $7.1 billion at the time of the Budget earlier this year. While both iron ore prices and employment growth have been strong, delivering a surplus will still require a close focus on spending.

    Aside from infrastructure the Government is looking for ways to boost productivity, which has been in decline since the end of the mining boom. In the September quarter GDP per hour worked fell by 0.2% q/q and has been very weak in the past year.

    Productivity has been declining since the end of the mining boom
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    3

    Slowing Growth: Real Estate

    Real estate throwing mixed signals into the market

    While residential construction continues to contract, house price have turned. The turnaround in the residential construction cycle has been rapid but due to the normal lags there is likely further downside despite the pick-up in house prices.

    Residential construction is a significant drag

    The turnaround in the residential construction cycle has been rapid. Residential construction fell by 1.7% in the September quarter, and is now 9.6% lower than this time last year. The impact on economic activity is broad, not only does residential construction feed directly in to GDP, it also employs a significant number of Australians and has spill-overs in to a number of supporting industries.

    Dwelling approvals continue to decline, they are currently 24.2% lower than this time last year. In October there were 12,818 dwelling approvals which is a significant fall from the November 2017 peak of 22,822. This suggests that residential construction has further to fall. 

    Housing finance (which has started to tick up) leads private dwelling approvals

    That being said, the rebound in established house prices – of 2.9 % nationally in the past 5 months – should eventually feed through to new construction, although the lag can be considerable. This is particularly so given the shift toward high rise construction, which typically has longer lags, and given that developer finance remains tight.

    More broadly, ongoing strong population growth suggests that residential construction will not contract forever.

    And overtime construction will catch up

    What do rising house prices mean for the economy?

    Prices for established houses have bounced back – nationwide prices rose by 1.7% in November, the fastest monthly pace sine 2003. Every capital city except Darwin recorded a monthly rise, while prices are now above year-ago levels in Sydney and Melbourne (where the rebound has been particularly strong) as well as Hobart and Canberra.

    Over time, rising house prices feed through to the broader economy through two key channels, namely household spending and residential construction.

    The lag between house prices and residential construction can be considerable, particularly given the prevalence of high rise construction in the current cycle. While house prices have been rising for five months, building approvals are down sharply. This reflects a variety of factors, the normal lags and uncertainties as well as tight credit conditions for developers, still elevated levels of residential construction and completions. 

    House prices look skyward

    However, with population growth still strong and prices rising, we would expect building approvals to turn in the next few months and – over time – provide some support for residential construction.

    In terms of household spending, there are two ways that rising house prices impact. One is the fact that moving house is usually associated with purchases of furniture, renovations and the like. Importantly, at the moment, turnover is yet to recover to peak levels.

    Second is the so-called ‘wealth effect’, where households change consumption based on the (perceived) rise or fall in the value of their home or investment properties. While prices have bounced, consumer confidence has not improved. House prices are just one factor that impact confidence and the headwinds that household sector are leaning into are significant (see below). 

    (Chapter breaker)
    4

    Slowing Growth: Private Consumption & Investments

    Weak domestic demand is a challenge for growth

    Household consumption rose just 0.1% in the September quarter, and 1.2% over the year, while business investment has continued to weigh on growth.

    Consumption remains sluggish...

    Household consumption rose just 0.1% in the September quarter, and 1.2% over the year.

    At the same time household disposable income rose by 2% q/q, and 3.1% y/y. This in part reflects the payment of the Low and Middle Income Tax Offset. The ATO estimates that the average tax rebate this year is approximately $420 higher than last year, because of increased scrutiny of work related deductions.

    Private consumption slides away as income bounces

    Instead of spending the additional income, however, consumers pushed it into savings or debt repayment. As a result the saving rate rocketed up to 4.8%, up from a 12 year low of 2.7% in the June quarter (noting that this measure does tend to quite volatile and frequently revised). In addition to the rise in the savings rate, major banks are reportedly seeing a rise in the share of accounts that are ahead of repayments and very few mortgage holders are reducing monthly repayments as mortgage rates fall.

    Households boost savings

    Consumer confidence, a leading indicator for consumption, shows that consumers are cautious, with confidence both falling and weak by historical standards. The Westpac-Melbourne Institute consumer sentiment index has fallen by 4.2% since the RBA first cut rates in June. Further, unemployment expectations have risen by 13.4% in the last year.

    While consumer confidence keeps sliding away

    Business investment battered by geopolitcal risks

    Business investment has continued to weigh on growth. Perhaps this is not surprising given that business sentiment and surveyed conditions remain below long run average amid caution about the global geo-political climate as well as the state of domestic economic conditions.

    Weak business investment in a challenging profit environment

    Mining investment fell by 7.8% q/q, with the transition of the LNG platforms from construction to operation still impacting. Outside of the mining sector, business investment rose by 1.2% q/q, supported by non-residential construction. 

    A lift in business investment is needed for the economy to return to trend growth rates. Worryingly, the Q3 CAPEX survey showed a downgrade to 2019/20 spending plans and suggests that non-mining firms plan to cut investment in 2019/20. Mining investment intentions were also revised a little lower but remain firmly positive. 

    Elevated geopolitical risks weigh on sentiment
    (Chapter breaker)
    5

    Industry Snapshots

    Industry data is mixed

    In the current patchwork economy, health care and social assistance is our fastest growing sectors, but growth in agriculture, forestry, fishing and construction remains weak.

    Health care and social assistance extends its run as Australia’s fastest growing sector. Gross Value Add (GVA) grew by 2.6% in Q3 and 8.3y/y. Health care demand from the public sector is particularly strong, the result of an aging population here in Australia.

    Mining rose broadly in line with the 12 months prior, with GVA increasing 7.4% through the year. External demand, particularly from China, continues to drive the growth in iron ore output, while Oil and gas extraction was supported by the increase in LNG capacity.

    In contrast, agriculture, forestry and fishing has seen the weakest growth at –6.2% y/y, driven by falls in the output of livestock and other crops due to the ongoing drought conditions. That said, we are seeing an improvement from the previous year, when the industry slowed by more than 12% y/y.

    Construction is also struggling, contracting by 3.2% y/y, the slow down in the residential sector is a key driver of this turn. In Q3, however, overall construction rose 0.5%  driven by increased work in the non-residential sector.

    Health and mining drive economic expansion
    (Chapter breaker)
    6

    Labour Market

    Rising spare capacity in the labour market will be a challenge for wage growth

    The labour market has remained remarkably strong, creating an average of 21,000 jobs each month in the past year, despite the slowdown in the economy. Driven by strong growth in public sector employment, with 97% of employment growth in the past 12 months to Q3.

    The labour market has remained remarkably strong, creating an average of 21,000 jobs each month in the past year, despite the slowdown in the economy. This has been driven by strong growth in public sector employment, with 97% of employment growth in the past 12 months to Q3.

    Public sector has been a key driver of jobs growth

    Despite strong job creation, spare capacity in the labour market has started to rise. The unemployment rate has edged higher and is currently 5.3%, up from a recent low of 4.9%.  Importantly, this is significantly higher than the RBA’s revised definition of full employment, of 4.5%.

    Moreover, underemployment and underutilisation have both edged upwards in recent months to 8.5% and 13.8% respectively. This means that significant numbers of Australians are working fewer hours than they want to be.

    Leading indicators of jobs growths, such as job vacancies are also trending downwards. This was reinforced  by the ANZ job ads index which is 12.6% lower today than this time last year.

    These indicators, as well NAB’s capacity utilisation and profitability indices, and the fact that the labour market tends to lag economic growth, suggest that jobs growth may slow in the period ahead. , Indeed, the economy lost 19,000 jobs in October (the most recent labour market data we have), the first monthly net job loss since May 2018.

    If jobs continue to be lost and spare capacity remains, then unemployment may continue to move further away from the RBA’s target.

    The labour market is important for wages and inflation but also for consumer confidence and as a result consumption (almost 60% of the Australian economy). An individuals response to low wage growth and record indebtedness is very different if there is job insecurity.

    Wage growth is mixed and largely weaker than last year
    (Chapter breaker)
    7

    Prices and Wages

    Weak wage and inflation pressures keep a spotlight on the RBA

    Wage growth in Australia remains weak, rising by 0.5% in Q3 and by 2.2% over the year. Eight out of 16 industries have seen annual wage growth slip on the past year.

    Wage growth in Australia remains weak, rising by 0.5% in Q3  and by 2.2% over the year.  Eight out of 16 industries have seen annual wage growth slip on the past year.

    Wage growth typically needs to be running around 3.5% for inflation to be in the middle of the RBA’s 2-3 % target band. We are a long way from that pace of wage growth, and the leading indicators of jobs growth are pointing to a moderation in the year ahead.

    We can expect further rate cuts from the RBA in 2020 and the prospect of quantitative easing will remain a talking point, as will the pressure on government to provide additional support in the Federal Budget in May.
    Jo Masters
    EY Oceania Chief Economist
    Wage growth (excl. bonus) is low by historic standards

    Alongside weak wage growth, inflation remains low. Headline CPI rose by 0.5% q/q in Q3 to be 1/7% higher over the year. Underlying inflation is running at 1.6% y/y, and has now been below the RBA’s 2-3%  policy target band 15 consecutive quarters.

    With wage growth remaining low – and given ongoing soft price pressure in the housing component, retail competition and a focus on reducing cost of living – the inflation outlook remains very benign. Even on the RBA’s forecast, core inflation lifting to just 1.9% y/y by end 2021.

    Weak wages growth and low inflation  is not unique to Australia but does pose a policy challenge.

    For many industries, wage growth remains too weak to boost infation
    Inflation remains below the RBA's target band
    (Chapter breaker)
    8

    State Outlook

    Economic activity continues to slow across the states

    Economic growth continues to be varied across the country, with the ACT at top of the growth league this quarter. Economic activity increased in TAS, VIC and NSW, but have seen a contraction in the remaining states.

    Hover over chart to see data related to your state.

    Without broader based growth, a return to 'potential' growth will be challenging.

    Jo Masters

    EY Chief Economist

     

    Summary

    The economy expanded by a soft 0.4% in the September quarter, with growth again driven by net exports and public spending, with a smaller contribution from household spending. In annual terms, economic growth of 1.7% y/y – while a touch higher than the previous quarter – is well below ‘potential growth’, which is the rate of growth required to lower unemployment and lift inflation. 

    About this article

    Authors

    Jo Masters

    EY Oceania Chief Economist

    Economist. Pundit. Keen tennis player. Referee to teenage girls. Paddle board lover.

    Bonnie Barker

    EY Oceania, Senior Economist

    Urban Renewal and housing economics specialist. Keen squash player. Stand up paddles on the weekend.

    Related topics Public policy