10 minute read 1 Sep. 2021
ey-quarterly-economic-update-q2-fy21

Quarterly Update, Q2 2021: June Quarter momentum should give us some hope for a solid recovery

By Bonnie Barker

EY Oceania Senior Economist

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

10 minute read 1 Sep. 2021
Related topics Economics COVID-19

When Australian households and businesses think COVID is under control, they’re confident to spend more and today’s surprise economic strength demonstrates just how broad based this type of recovery is when it arrives. Given the challenges we currently face, this should provide comfort that we will get through this in time.

Comments from EY chief economist Jo Masters

The economy expanded by 0.7 per cent in the June quarter, above expectations, pushing annual growth to 9.6 per cent through the year.

Encouragingly, economic activity was broadly based. While the economy was dragged lower by inventories and net exports, private domestic demand maintained healthy momentum across consumption, investment and dwelling construction and public investment ramped up to the highest levels on record. In addition, the terms of trade rose to its highest level in history, continuing to boost national income, and making a significant economic contribution to the mining sector and of course, the government coffers. On the production side, 17 out of 19 industries expanded in the quarter, led by administration and support services, transport postal and warehousing and accommodation and food services.

Even the significant detraction to growth from net exports has a silver lining. While service exports continued to be crimped by the closed international borders and the volume of iron ore being shipped slowed, the sharp jump in imports, which detracts from GDP data, is in reality a sign of a very healthy domestic economy drawing in imports of consumer, intermediate and capital goods.

It was also comforting to see households absorb a fall in disposable income (as income support unwound) and increase their spending on services by leaning on their savings. This is what we want, for households to drawdown on the war-chest of savings to smooth consumption. And, after 18 months of being home, Australian’s love of travel was clear in the June quarter, lifting transport services spending by 25 per cent.

This data is, of course, dated. It reflects the period before the Delta outbreak and widespread lockdowns, which we know will have a devasting impact on economic activity, particularly in New South Wales and Victoria. EY modelling suggests that the lockdown of Greater Sydney alone is likely to detract around 2.5 percentage points from GDP in the September quarter. 

Some of the partial monthly data has already shown some loss of momentum (see table below), and there will be more headline grabbing numbers to come in the weeks ahead. 

Looking forward, there is no doubt that there will be a significant contraction in the September quarter and that the pain will be unevenly spread across the country. As such, the conversation about whether Australia will experience a double-dip recession is unlikely to be silenced by today’s positive growth numbers.

Importantly, though, the economy is coming off a solid base and policy is supporting household and business balance sheets, which means that rising vaccinations and easing of restrictions should see consumers spend and business invest and hire. That does not mean the road is easy, and the recovery is likely to be slower than the seemingly easy bounce-back last year, but a recession now likely requires restrictions across the country to tighten over the last three months of the year, and that just doesn’t seem a likely proposition.

  • Click to see how the high frequency indicators have changed

    Higher frequency indicators show the immediate impact of lockdowns Peak of the Pandemic (May 2020) Before Delta (June 2021) Latest (July 2021)
    Labour Market
    Payrolls (month end relative to March-20) -8.3% 4.3% 1.0%
    Unemployment Rate 7.0% 4.9% 4.6%
    Underemployment Rate  13.0% 7.4% 8.3%
    Participation Rate  62.6% 66.2% 66.0%
    Households
    Retail trade relative to March-20 (%) -3.6% 1.9% -0.8%
    Westpac-MI Consumer Confidence (Index) 88.1 107.2 108.8
    National dwelling prices (% change year on year) 8.3% 13.5% 16.1%
    Businesses
    NAB Business confidence (Index) -23.3 10.6 -7.9
    NAB Business Conditions (Index) -26.2 24.9 11.4
    Financials
    ASX (% relative to February 2020 peak, month average) -22% 4.3% 4.9%
    AUD/USD (month average) 0.65 0.77 0.74
    AUS 10yr bond yields (quarter end) 0.9% 1.5% 1.1%
    Other high frequency indicators
    National mobility (retail & recreation) (% relative to baseline) -28% -10% -19%
    NSW mobility (retail & recreation) (% relative to baseline) -30% -13% -38%
Chapter1
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1

Domestic economy

There was broad based strength right across the domestic economy

The domestic economy roared during the June quarter

If you had that sense the economy was roaring during the June quarter, then you would have been right. Excluding the COVID period, the growth in domestic final demand of 1.7 per cent was the fastest acceleration in domestic activity in nearly eight years.

The growth was broad based too – Households, businesses, the federal government, state governments and local governments all played a role in driving the economy higher – see the table below.

This broad-based expansion in activity is rare, not since 2009 has household consumption, dwelling investment, business investment, public consumption and public investment all expanded in the same quarter. Indeed, such a ground swell has only occurred in 14 quarters since the 1980s.

  • Click to see the broad based strength across the domestic economy

    National Accounts Results show broad based strength across the domestic economy Per cent growth, QoQ Percentage point contribution, QoQ Per cent growth, YoY Percentage point contribution, YoY
    Private Final Demand +1.3 +1.0 +14.8 +10.2
    Consumption +1.1 +0.6 +15.4 +7.9
    Dwelling Investment +1.7 +0.1 +15.7 +0.8
    Ownership Transfers +10.0 +0.2 +65.4 +0.8
    Business Investment +0.8 +0.1 +6.1 +0.7
    Public Final Demand +2.5 +0.7 +5.8 +1.6
    General Government Consumption +1.3 +0.3 +3.7 +0.8
    Public Investment +7.4 +0.4 +14.2 +0.8
    Domestic Final Demand +1.7 +1.6 +12.2 +11.8
    Inventories - -0.2 - +1.5
    Net Exports - -1.0 - -3.7
    Gross Domestic Product +0.7 +0.7 +9.6 +9.6

    QoQ – Quarter on quarter growth; YoY – Year on Year growth

Chapter2
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2

Net-exports & Inventories

Trade a large drag on activity, yet a record current account surplus boosts national income and nominal GDP

Net exports fell further in June quarter

International trade was the biggest drag on GDP in the June quarter, removing 1.0 percentage points from quarterly growth. The detraction from net exports came as export volumes fell 3.2 per cent in the quarter and imports rose 1.5 per cent.

The inventory cycle also detracted from growth (-0.2 percentage points) as businesses slowed their rebuild of stocks, particularly those businesses within Retail and Wholesale trade. This follows a large positive contribution during the March quarter.

Export volumes fell largely because of lower resource volumes during the quarter - partially due to some weather-related disruptions. Non-rural export volumes fell 2.8 per cent in the quarter and non-monetary gold was down 25.7 per cent. Meanwhile rural good exports continued their rise, up 1.8 per cent in the quarter, exports of cereals and grains are now 150 per cent higher than a year ago as the ending of the drought pushed exports to their highest level on record.

The strength in the domestic economy has translated into an expansion in Australia’s goods imports, increasing by 1.8 per cent in the quarter, to be 17.5 per cent higher over the year. This is while service imports – including outbound tourism – remains 56 per cent below pre-Pandemic levels owing to the closed international borders. The increase in good imports largely reflects strength in capital imports – consistent with solid private investment in machinery and equipment – and intermediate goods (which includes fuels) – reflecting the acceleration in domestic travel during the quarter.

Despite the drags from net trade, Australia recorded yet another record current account surplus in the June quarter of $20.5 billion. This is the 9th consecutive quarterly current account surplus, the first time such a run has been recorded.

The record Current Account surplus came off the back of strong bulk commodity prices. The iron ore price, which averaged $196 USD a tonne (China Import, Fines 62%) during the quarter, drove a record metal ores and minerals export value of $53.3 billion.

The solid lift in overall exports prices, up nearly 10 per cent in the June quarter, drove a solid lift in Australia’s terms of trade – a measure of export prices relative to import prices – to its highest level on record, surpassing the previous highs seen during the mining investment boom. Such an improvement in the country’s purchasing power has helped boost gross national income per capita by 1.8 per cent in the quarter to be 14.4 per cent higher over the year – a phenomenal result.

Nominal GDP has benefited from the lift in the terms of trade since the pandemic began, increasing by 3.1 per cent in the quarter to be 7.8 per cent higher since the pandemic began.

Chapter3
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3

Government spending

Public investment hits a record high

Lumpy government investment delivers a sizeable contribution

The public sector made a sizable contribution to economic growth in the June quarter - it’s largest contribution in nearly eight years - as both government consumption and government investment made solid contributions.

Over the course of 2020-21, the public sector has been an important support for economic activity, growing by nearly 6 per cent and adding 1.6 percentage points to annual economic growth.

Strength in the quarter was largely driven by public investment which expanded by 8.3 per cent to a record high. State and local investment continues to lead the way, increasing by 10.1 per cent in the quarter to be nearly 20 per cent higher over the year. The State and local government sector added 0.8 percentage points to GDP growth over the past year, around 8 times its historical quarterly contribution.

Increased investment on road infrastructure was a theme across the states, most notable were increases to government investment of 13.2 per cent in Victoria, 12.9 per cent in South Australia and 11.7 per cent in Western Australia.

Government consumption, which includes the provision of services and the roll out of the COVID-19 Vaccines, also rose solidly in the quarter, up 1.8 per cent, to be 3.8 per cent higher over the financial year. This expansion in activity follows a small contraction in the March quarter.

Chapter4
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4

Household Consumption

Confident Consumers spent big on fun

Consumers increased their discretionary consumption despite slower income growth

Households continued to make a solid contribution to economic growth in the June quarter, continuing their recovery from the depths of the pandemic. Household consumption rose a 1.1 per cent in the quarter to be 15.4 per cent higher than the peak of the pandemic in the June quarter last year.

Continuing the theme of broad-based growth – the expansion in household consumption was seen right across the States and Territories. New South Wales led the pack with growth of 2.1 per cent. Even Victoria, which experienced more days in lockdown during the June quarter compared to the March quarter, saw modest growth of 0.1 per cent.

After several months of lockdowns and health restrictions, consumers chose to spend big on some fun. Discretionary spending rose by 1.3 per cent, driven by a rise in both goods and services. Major contributors to discretionary spending included a 25 per cent rise in transport services, a 2.2 per cent rise in hotels, cafes and restaurants and a 7.5 per cent rise in vehicle purchases. Spending in vehicles is now 29 per cent higher than prior to the pandemic – conditions in that sector have improved markedly.

There does, however, remain a long way to go before discretionary spending returns to its pre-pandemic levels, spending on discretionary services, which includes transport services, remains 21 per cent below pre-COVID levels.

These positive outcomes in the household sector came even as disposable income fell during the quarter, down 0.3 per cent. The decline in disposable income came as income support unwound further, taxes increased, and labour income growth slowed marginally.

Household’s therefore chose to support their spending by saving less during the quarter, as the household savings rate fell further to 9.7 per cent from 11.6 per cent previously. Household balance sheets remain very healthy, as of July 2021 boasting a stockpile of cash in bank accounts of $1.2 trillion, up $92 billion since July last year.

Chapter5
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5

Dwelling investment

Residential construction ticks up as house prices continue to accelerate

In the June quarter new dwelling investment rose by 1.7 per cent, up by 15.7 per cent over the year

Residential construction continues to positively contribute to the real economy, albeit at a moderating pace. In the June quarter both new dwelling investment and alterations & additions rose, to leave dwelling investment 1.7 per cent higher over the quarter and 15.7 per cent higher over the year.

HomeBuilder, rising house prices and surplus household savings are all contributing to the strength in the residential construction sector, driving an increase in new construction as well as renovations.

The high levels of demand and some emerging skill and materials shortages across the industry are driving a lift in construction prices, both in terms of inputs and outputs. The acceleration in prices and conclusion of HomeBuilder is likely to act is a slight handbrake on further growth in activity and push out the timing of some projects.

The pipeline of future work remains solid, with recent building approvals data remaining at historically elevated levels, particularly for private houses. The current lockdowns across much of the country, and Sydney’s pause in construction activity during July, is likely to delay activity in Q3 and push out the timing of some projects.

Strength in the housing market has been a notable characteristic of the COVID Crisis. House prices rose a further 1.5 per cent in August to be 18.4 per cent higher over the year. This strength in prices will support construction activity and is likely to driver further activity in turnover of properties. Ownership transfers costs, a usually little talked about part of the economy, which captures economic activity associated with the sale of a house, have risen 65.4 per cent over the past year to reach a 17-year high. Importantly for State governments – this will translate into higher transfer duty revenues.

Chapter6
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6

Business investment

Equipment investment

Policy support has driven a strong recovery in business investment

Business investment continued its recent momentum rising by 0.8 per cent in the quarter to be 6.1 per cent higher over the past year.

The rise in business investment continues to be driven by increasing machinery and equipment investment which rose a further 3.4 per cent in the quarter and now is an impressive 10.8 per cent higher than prior to the Pandemic. Improving business conditions, higher company profits and the federal government’s instant asset write off incentive are all key factors driving this momentum.

Consistent with the broad-based strength seen across other sectors of the economy, the strength in business investment also broadened during the quarter. Non-residential building investment rose 1.5 per cent in the quarter, breaking a run of 6 consecutive quarterly declines, engineering investment increased by 3.0 per cent and intellectual property investments expanded by 2.3 per cent – the first time all four sectors have expanded in the same quarter since 2017.

There has been some uncertainty about whether strong momentum in machinery and equipment investment would continue as lockdowns in the September quarter affected confidence and businesses simply run out of machinery to purchase – instant asset write off schemes tend to bring forward investment. However, the ABS’s capital expenditure survey, which was taken in July and early August, suggests that firms will continue to take advantage of the Government’s instant asset write-off provisions, will look to productively employ their healthy balance sheets and take advantage of low interest rates even in the face of heightened uncertainty.

Chapter7
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7

Industry snapshot

Positive outcomes across the board, as services continue their recovery

Growth in the June quarter was incredibly broad based, with 17 out of 19 industries expanding.

Growth in the June quarter was incredibly broad based, with all but two of the 19 industries expanding in the quarter. Services such as administration support, transport services, and accommodation & food all continued in their recovery, helped by a relatively restriction light few months. In many cases, however, activity remains below pre-COVID levels. Transport services remains the most adversely impacted sector, with output still 9.6 per cent below pre-COVID levels. It’s unlikely that transport services will return to full capacity without less restrictions on international travel and more certainty around domestic borders.

Mining was a notable exception to the strong industry performance, contracting by 1.3 per cent over the June quarter, a consequence of weather disruption compounded by maintenance at a number of LNG plants. Despite the contraction in volumes, mining profits rose to a new record high in the quarter - off the back of continued commodity price growth.

Agriculture, forestry and fishing (not shown on the chart below), has benefited from a bumper year, with output up 41.9 per cent since the drought affected harvest last year.

Summary

This was a great result for the Australian economy and showed there was real momentum going into the latest round of lockdowns. The economy grew by 0.7 per cent in the June quarter with strong growth across nearly every indicator, from government investment to household spending and business capex and even a boom in travel spending. Net exports were the key drag on growth, and even that was somewhat positive because it reflected a strong domestic economy pulling in more imports.

Looking forward, there is no doubt that there will be a significant contraction in the September quarter, importantly, though, the economy is coming off a solid base and policy is supporting household and business balance sheets. Rising vaccinations and the easing of restrictions should see consumers again spend and business invest and hire.

About this article

By Bonnie Barker

EY Oceania Senior Economist

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

Related topics Economics COVID-19