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And we’re back! The economy and the labour market have both fully recovered from the COVID-19 shock and 15 out of 19 industry sectors expanded in the March quarter. Encouragingly, GDP per hour worked – a measure of productivity - rose after two consecutive quarterly falls, to be 2.5 per cent higher over the year.
Overview
- Private Investment
- Consumer
- Industry snapshot
- Government spending
- Net-exports
- Economic Indicators
Comments from EY chief economist Jo Masters
Not surprisingly momentum in the economy is moderating from the surge in the latter half of 2020 – the quick wins from easing restrictions are now behind us and Government support, while still substantial, is tapering.
The economy is absorbing the winding down of Government support: private demand accounted for all of the growth in the March quarter, with public final demand flat; business investment is recovering; household disposable income increased in the March quarter supported by compensation of employees (wages and salaries); and, ABS analysis of the payrolls data shows that termination payments as a per cent of total wages paid look to have peaked in all sectors in the December quarter.
Importantly, growth is not only increasingly being driven by the private sector, but within that is broadening beyond the household to include the housing construction and private business investment. In contrast, the external sector weighed on activity as strong domestic demand pulled in imports, outstripping export growth (noting that real GDP measures volumes, so does not capture the high price of iron ore).
It is encouraging to see a strong contribution from business investment, which is recovering faster than in previous recessions. Headline business investment made the largest contribution to activity in four years - reflecting the rebound in confidence, government support and tax measures to encourage investment. However, the growth in investment is not broadly based, and was driven by a surge in new machinery and equipment investment. The uncertainty here is how much of this is a ‘bring forward’ of investment to take advantage of tax settings versus investment that would otherwise have not occurred.
There is solid underlying momentum in the economy which should be strong enough to sustain the recovery and gradually make inroads into spare capacity in the labour market. Victoria’s lockdown will have an economic cost but is unlikely to derail the recovery process. It is, however, the first lockdown since the end of JobKeeper and will be challenging for those businesses already doing it tough and directly impacted by restrictions.
Australia’s economic performance in the March quarter was among the best in the world and the Government has timed the withdrawal of support well. However, Victoria’s lockdown is a timely reminder not to become complacent. The roll-out of the vaccine remains critical for further easing of social distancing and opening borders, as well as remaining competitive in the global landscape.
1
Private Investment
Private investment has become a key driver of growth
Policy support has driven a strong recovery in business investment
The drivers of economic growth have shifted, with a greater share of growth being driven by investment, opposed to consumption. In fact, in the March quarter 56 per cent of the growth in domestic activity was driven by private investment. Which rose by 5.3 per cent in the quarter to be 3.6 per cent higher year on year. This is the first annual rise since the June quarter of 2018. Private investment was broad based across each sector including business investment, dwelling investment and ownership transfers.
Headline business investment grew by 4.0 per cent in the quarter, adding 0.4 percentage points to quarterly GDP growth - its second consecutive positive contribution to GDP, the last time this occurred was back in 2013.
Growth in business investment was underpinned by surging spend on machinery and equipment, which rose by 10.3 per cent. Historically speaking machinery and equipment investment tends to take a long time to recover following a downturn – averaging around 2 years. However, improving business conditions and federal government policy support, including the instant asset write off scheme, has helped drive a faster turnaround. With equipment investment recovering in just over a year to be an impressive 7.2 per cent higher than prior to the Pandemic.
However, the strength within business investment is not broad based, with other forms of business investment delivering more mixed results.
Across the other major private investment categories only investment in cultivated biological assets, which includes farmer investment in cattle stocks is above pre-Pandemic levels. While investment in non-residential buildings (which includes the hard-hit office and short-term accommodation sectors), engineering and intellectual property all remain below pre-Pandemic levels – 17 per cent, 1 per cent and 3 per cent respectively.
Both mining and non-mining business investment rose in the quarter, the increase in investment across both sectors reflects the broad-based improvement in business confidence, low interest rates and tax incentives. Consistent with today’s data, the private capital expenditure survey tells us that much of the growth came from firms buying new machinery – particularly those firms in the manufacturing, construction and retail trade industries.
Encouragingly, the private capital expenditure survey suggests that the improvement we’re seeing in business investment will continue into 2021-22 with capital investment likely to rise by more than 15 per cent compared to 2020-21 levels.
Further out, however, a great deal of uncertainty hangs over private investment, which was declining as a share of GDP prior to the Pandemic. Policy incentives such as the instant asset write-off scheme tend to largely bring forward investment, boosting economic activity now, rather than lifting overall investment. Moreover, a large portion of the investment in machinery and equipment tends to be highly import intensive. While the extension of the instant asset write off scheme in the most recent Federal Budget will continue to support investment, it may not deliver the same dividends as the first round of the policy – after all, there are only so many new utes a small business can buy.
Accommodative policy continues to drive a lift in dwelling investment
Dwelling investment rose by 6.4 per over the quarter, contributing to growth for the third consecutive quarter in a row. Whilst new dwelling investment did rise once again, contributing 0.1 percentage points to quarterly growth, the real driving force was alterations & additions, which grew by 10.8 per cent – the fastest rate of growth since early 2001 - when renovation activity was impacted by the introduction of GST in 2000.
Accommodative policy settings are the key driver of this strong growth, with HomeBuilder facilitating a significant uptick in both construction of new dwellings and renovations. Building approvals data shows the number of private house approvals have risen by 84 per cent since the introduction of the policy.
Policy settings are impacting the housing market more broadly. Record low interest rates alongside the improving labour market have driven house prices to new record highs in 6 out of 8 capital cities. This increase in house prices tends to benefit the economy in several ways. First, by increasing demand for new housing. Second, by making consumers feel more wealth, leading to an increase in household consumption. And thirdly, by increasing the number of transactions in the housing market, which causes positive spill overs into supporting industries like real estate and legal services. Indeed, ownership transfer costs rose by 10.6 per cent in the quarter, contributing a massive 0.2 percentage points to growth for such a small component of GDP.
Looking ahead, housing construction is likely to remain supportive of economic activity as increase house prices drive further gains in building approvals and the large pipeline of work yet to be completed is gradually worked through.
2
Consumer
Easy wins are over
The consumer is no longer the driving force behind economic growth
Since the start of the Pandemic, most of the movements in GDP have been driven by household consumption – initially as the major drag on economic growth and then as the principle driver of the recovery. Now though, the easy wins of easing restrictions are largely behind us and the rate of growth from household consumption has moderated.
Indeed, household consumption rose by 1.2 per cent in the March quarter which follows the 4.5 per cent and 7.8 per cent growth seen in the December and September quarters respectively.
Though the broadening of the economic recovery to include private investment is encouraging, it’s important that momentum in the consumer’s recovery continues. There is some way to go for household consumption to fully recover, as it remains 1.5 per cent below pre-Pandemic levels.
The consumer has continued its shift in spending back favour of services (from goods) as restrictions ease and confidence rose. For example, spending on transport services (which includes domestic travel) and at hotels, cafes and restaurant both experienced double-digit growth in the quarter. The ongoing trend towards consumption of more services has more time to run, with spending on services still 8 per cent below pre-COVID levels.
Consumption in the quarter was supported by both a rise in disposable income and a decline in household savings. Driving the improvement in household income, was a lift in compensation of employees (or wages and salaries paid) largely offsetting the winding down of government income support measures, including JobKeeper and JobSeeker.
While consumers chose to save less this quarter, the rate of saving remains elevated at 11.6 per cent of disposable income, compared to 5.9 per cent prior to the COVID-19 crisis. Consumers continue to be constrained in some aspects of their spending and the lift in income during the quarter meant households didn’t have to dip too deeply into their savings. It’s encouraging that households still have the capacity to draw on savings in the future. The roll out of the COVID-19 vaccines will no doubt be important in cementing the record levels of consumer confidence and sustaining the recovery in consumer spending.
3
Industry snapshot
Service industries continue to rebound
The strong quarterly performance was observed across the majority of industries
Encouragingly, the recovery in economic activity continues to broaden across industries, with 15 out of 19 industries growing over the quarter, compare this to the decade long average of 13 industries growing in any given quarter.
The industries that have been most affected by the Pandemic experienced faster growth this quarter. The industry’s leading the charge were Arts & Recreation and Other Services, with quarterly growth of 5.7 and 5.8 per cent respectively, a clear side effect of easing of COVID-19 restrictions, as consumers were able to spend more freely on services.
Overall more than half of industries (11 out of 19) are now larger than they were before Australia started feeling the impacts of COVID-19. Although the industries that continue to be most directly impacted by restrictions - Transport Services, Accommodation & Food and Arts & Recreation – are still seeing below normal levels of activity.
4
Government spending
Public sector flat as consumption falls
The public sector’s contribution to GDP moderated in the quarter
The public sector’s contribution to GDP moderated in the quarter, growing by just 0.2 per cent in the March quarter, the slowest rate of growth in nearly 3 years.
This softening in growth was driven by a decline in government consumption, which fell by 0.5 per cent in the quarter and follows three quarters of unprecedented government spending in response to the COVID-19 pandemic. The roll-out of the COVID-19 vaccines commenced in February 2021 but did not have a material impact during the quarter.
Offsetting this decline in government consumption, was a further lift in public investment, particularly state and local investment, which rose by 4.7 per cent in the quarter. State and local investment is now 11.9 per cent higher over the year, the fastest rate of annual growth in four years. The lift in investment was broad based across the states, but led by Victoria and Queensland, reflecting increased spending on road, rail, health and education projects.
5
Net-exports
Trade surpluses continue to boost national income but trade drags on activity
Net exports fell in the March quarter as imports outstrip export growth
Despite Australia recording a new record current account surplus in the March quarter of $5.2 billion, international trade was a major drag on economic activity in the quarter. This is because on a volume basis (i.e. the number of widgets traded) net exports fell in the quarter, detracting 0.6 percentage points from GDP. The detraction from activity came as growth in imports, up 3.7 per cent, outstripped growth in exports, which rose by just 0.5 per cent.
Australia's record current account this quarter came on the back of higher commodity prices, particularly iron ore. On a nominal basis, exports of metal ores and minerals reached a record high of $48.2 billion. This rise in commodity prices helped to further lift Australia’s terms of trade (the relative price of exports to import) by 7.4 per cent to its highest level since 2011. Such an improvement in the country’s purchasing power has helped boost gross national income per capita by 2.7 per cent in the quarter to be 5 per cent higher over the year – a phenomenal result.
The rise in exports was driven by a 13.8 per cent rise in rural good exports, including a 32 per cent increase in cereal exports, and a 9.9 per cent increase in non-monetary gold exports. Offsetting these gains were declines in service exports, down 8 per cent in the quarter, and a modest decline in non-rural goods.
The strong growth in imports reflects the continued recovery in the domestic economy and the easing of previous supply chain delays which persisted during 2020. The increase in the quarter was driven by higher imports of intermediate and merchandise goods, such as processed industrial supplies and telecommunications equipment, and consumption goods, consistent with the continued recovery in household consumption.
6
Economic Indicators
Other facts and figures from the quarter
Inflation and wages growth to remain a challenge for some time to come
The economy has recovered significantly better than expected, there is no doubt about it, and many parts of the economy are doing well, however there are still pockets that are struggling.
The economy created more than half a million jobs in the first quarter of this year and the number of jobs in the economy is now above pre-pandemic levels. Such a turnaround is now leading to reports of labour shortages in specific occupations which have traditionally relied on international visa holders such as chefs, food trade workers and IT professionals.
Despite strong jobs growth, and pockets of skill shortages, there remains significant spare capacity in the labour market. The unemployment rate remains elevated at 5.5 per cent and the underutilisation rate (which includes those unemployed and underemployed) is at 13.3 per cent. EY research earlier this year modelled how this relates to wage growth and found that underutilisation needs to be sustained below 12 per cent to generate meaningful wages growth - Is jobs growth enough for economic success | EY Australia.
Wages were 1.3 per cent higher over the year to the March quarter and forecasts from both the Federal Budget and the RBA expect wage growth to lift to just 2¼ per cent by mid-2023. This suggests we can expect a weak inflation outlook. As a rule of thumb, wages growth needs to be running around 3.5 per cent annually for inflation to be at 2.5 per cent, the mid-point of the RBA’s target band.
We are however seeing some pockets of inflation. Producer price inflation for example is impacted by global supply chains, which are taking longer than expected to recover from the COVID-19 shock, leading to a production disruption. There’s also a global shortage of semi-conductors; iron ore prices have soared and shipping rates are through the roof (the Shanghai Containerised Freight Index has more than doubled since the start of 2020).
Despite some isolated price pressures, we do not appear to be seeing a generalised inflation pulse. Headline CPI rose by 0.6 per cent in the March quarter, to be just 1.1 per cent higher over the year. While the trimmed mean measure rose by just 0.3 per cent – half market expectations – to also be 1.1 per cent higher over the year, a new record low for the series. For more on inflation see our recent piece: What’s all this talk about inflation? | EY Australia
Summary
The economy and the labour market have now both fully recovered from the COVID-19 shock. Not surprisingly however, momentum in the economy is moderating from the surge in the latter half of 2020 – the quick wins from easing restrictions are now behind us and Government support, while still substantial, is tapering.