Australian economic growth was weaker than expected in Q3 with GDP up only 0.3% q-o-q reducing annual economic growth from 1.0% y-o-y to 0.8% y-o-y, the weakest annual growth rate this century barring the period of the covid recession when growth plummeted to -5.8% y-o-y in Q2 2020.
The Q3 GDP reading shows the economy propped up by public sector spending and with no contribution from private sector spending. It also shows an economy, weak as it is, still prone to inflation with poor productivity, generating strong growth in unit labour costs. In short, the weaker than expected GDP reading does not contribute to inflation coming down either more or earlier than the RBA forecast in the latest November Monetary Policy Statement leaving the timing of any cut in the RBA’s cash rate out in mid-2025 or beyond.
Another factor that will limit the influence of the soft Q3 GDP report on RBA thinking about when the cash rate should be cut is that there are signs of a marked strengthening turn in GDP growth in Q4. Some of the stronger turn in growth is statistical related to the large detraction from growth from falling inventories in Q3 which is unlikely to repeat in Q4.
However, another material turn stronger in Q4 also appears to be under way in private sector spending with a noticeable improvement in retail sales and household spending in October coming on the back of noticeably firmer consumer sentiment readings in September and October.
Taking the contribution of change in inventories to GDP growth first, an unusually big rundown in inventories detracted 0.4 percentage points from GDP growth in Q3. The rundown in inventories related to exports of commodities running ahead of mining production and retailers in Australia responding to weak demand by running down stocks rather than placing new orders. Both factors causing the sharp fall in inventories look less soft in Q4 (retail sales and exports were both stronger in October) and that means a less negative contribution and possibly a positive contribution to GDP growth in Q4.
It is worth noting that in Q3, absent the detraction to growth from the change in inventories, final domestic demand rose by 0.6% q-o-q and Q3 GDP would have been 0.7% q-o-q, 0.6 percentage points from final domestic demand and 0.1 of a percentage point from net exports. At this stage, given the likely change in contribution from inventories in Q4, calculation of Q4 GDP – a figure that will not be released until early March next year – is starting around +0.7% q-o-q.
Turning to the likely change to a material contribution to Q4 GDP from private sector spending, retail sales were up a stronger than expected 0.6% m-o-m in October and total household spending rose by 0.8% m-o-m with a strong lift in spending in all categories and notably recreation and culture spending, +1.5% m-o-m; clothing and footwear, +1.1%; health; hotels, cafes and restaurants; and miscellaneous goods and services each +0.9%. The Westpac consumer sentiment survey showed big increases in October and November of respectively +6.2% m-o-m and +5.3%, hinting that the big rise in household spending in October could continue.
In any case, household spending seems to have experienced a big improvement in October at the beginning of Q4 and relative to Q3 when household consumption spending was flat and contributed nothing to GDP growth.
At this early stage in Q4, it looks like household consumption spending will contribute at least 0.2 percentage points to Q4 GDP meaning GDP could rise by 0.9% q-o-q or more. This Q4 GDP forecast also allows that the extraordinary growth in public sector spending in Q3 with public consumption spending up 1.4% q-o-q, 4.7% y-o-y and public capital expenditure, up 6.3% q-o-q, 2.3% y-o-y will show some moderation in Q4.
When the RBA meets tomorrow it will understand the soft GDP growth in Q3 will turn noticeably stronger in Q4, and that stronger GDP figure is sitting out on the near horizon in March.
The RBA will also be concerned that the Q3 GDP report showed continuing weak productivity with GDP per hour worked down 0.5% q-o-q and down 0.8% y-o-y. In turn, growth in real unit labour costs is uncomfortably high, up in Q3 by 0.5% q-o-q and 1.6% y-o-y. Rising real unit labour costs means that underlying inflation will stay sticky and may even rise.
In our view, the RBA, has almost no leeway to lower the cash rate before March next year when it has the benefit of seeing whether demand is still running ahead of output growth – still evident even in the weak growth Q3 GDP report because of too much public sector spending and output growth constrained by abysmal productivity. When the Q4 GDP report is released in March, if as we suspect, private spending rises, demand growth will still be outstripping output making May 2025 at best a faint chance for a rate cut, but more likely later in the year.