Australian GDP growth has slowed to around 2.5% annual pace in the first half of 2013, around half a percentage point below potential growth, as the sharp slowing in mining investment has started to bite. The issue is what is coming along to take up the slack as mining investment likely falls further over the next 12 months or so and will it be timely enough and of sufficient size to more than offset the impact of lower mining investment allowing the economy to grow closer to 3% annual potential growth arresting the drift up in the unemployment rate. Because there are many difficult to predict moving parts in this rebalancing act, forecasts of how GDP growth may track over the coming year or so are subject to greater than usual uncertainty. Having said that the risks to growth are not as skewed to the downside as much of the market commentary seems to imply. As a result, we believe the RBA will tread cautiously with the cash rate, not wanting to make already very accommodating monetary conditions even more accommodating unless there is a clear need. Recent economic readings do not seem to point to a clear need to us which is why we see the cash rate on hold at 2.75% for several more months to come.

The part of the economy which is showing clearest sign of improvement is home buying activity. Since the beginning of 2013 auction clearance rates have been lifting, especially in the Sydney housing market which just this last weekend reported a 4-year high clearance rate above 79%. Housing finance commitments have been rising strongly too underpinned by the lowest mortgage interest rates since the early 1960s.The number of owner-occupier housing finance commitments rose by 1.8% in May, the fifth consecutive monthly increase and are now up by 10.4% compared with May 2012. Leading the charge in home buying, however, have been residential property investors. The value of residential property loan commitments rose by 1.5% in May, but is up by 23.7% compared with May 2012. One sign that home buying activity is broadening even further is that first-time home buyers are returning to the market with the proportion of loan commitments to first-time buyers lifting to 14.6% in May, from 14.3% in April and 14.2% in March.

The escalating signs of much more vigorous home buying activity are also starting to show in leading signals of housing construction activity. Home building approvals are very erratic on month-to-month basis influenced at times by very big multi-occupancy developments approved in one month driving up approvals followed by a fall the next. Averaging approvals removes some of this volatility and gives a better view of the underlying trend. Total home building approvals averaged 13,349 a month in the first five months of 2013, compared with 12, 956 in the second half of 2012, a 3.0% improvement. The greatest improvement has been in New South Wales where average monthly home building approvals on the same comparison are up by 6.9%. Because home building activity is rebounding from a lengthy slump in New South Wales that caused a large undersupply of new homes there is a strong likelihood that the vigorous improvement in home building activity will continue.

Improving housing activity alone is insufficient to outweigh the impact of large falls in mining investment, but it is what a housing recovery invariably leads to, a marked lift in general retail spending, that has the fire power to lift the economy even in the face of a severe slump in mining investment. Real GDP (taking out inflation) in Q1 2013 totalled $A374.2 billion of which total business spending on new buildings, equipment and machinery and minerals exploration came to $A34.2 billion, down by $A1.6 billion, or 4.5% compared with Q4 2012. Housing activity in all of its forms accounted for $A35.5 billion in Q1, the same as in Q4 2012. Almost certainly this number will start to rise over coming quarters providing some offset to further falls in business investment led by the mining sector. The bigger offset will come when household consumption expenditure improves more significantly. In Q1, household consumption expenditure was $A199.7 billion, up $A1.2 billion or 0.6% from Q4 2012. Quite likely household consumption expenditure growth will accelerate over coming quarters – population growth and the need to equip homes will be one factor, higher accumulated savings and rising household wealth is another or it may just be greater confidence once the approaching federal election is out of the way. One way or another, it is likely that that growth in household consumption expenditure alone will be sufficient to offset the worst that declining mining investment can throw at the economy. It is just that the timing of this transition is running a little slow for the time being.