Australia recorded back-to-back 3%+ real GDP growth in Q3 and Q4 2020 showing the sharpest bounce from the depths of the pandemic recession of almost all major economies. The question now is how long Australia’s out-performance will last. Another question is will strong economic growth force the RBA to lift official interest rates earlier than it is indicating currently.
Answers to these questions lie partly in what drove economic growth in Q4. GDP rose in real terms by 3.1% q-o-q in Q4, surprisingly strongly given the decline in government income support payments during the quarter. Household consumption spending was the strongest expenditure contributor to GDP, rising more than 3% in the quarter and contributing 2.3 percentage points (pps) of the 3.1% GDP rise.
The increase in household consumption spending in the quarter occurred despite a 3.1% q-o-q fall in household disposable income. A 1.5% q-o-q lift in compensation of employees (wages) did not compensate for the large fall in government support payments in the quarter caused by the first step down in job keeper and job seeker payments.
Australian households spent more in Q4 in the face of falling household income by running down savings. The household savings ratio fell from 18.7% in Q3 to 12.0% in Q4. The sharp fall in the household savings ratio was indicative of confidence about economic improvement. It was also a quarter much like Q3 when pandemic restrictions were being eased in stop-start fashion and people could get out and spend.
In Q4, restrictions had eased to where people could start to spend more on services related to recreation, dining out and travel (domestic only with foreign travel still closed). It was the turn of spending on services to shine. Unlike Q3, household spending on services, up 5.2% q-o-q in Q4, outstripped spending on goods, up 2.8% q-o-q.
Looking at the current quarter, Q1 2021, household consumption spending is increasing but at a slower pace than in Q3 and Q4 2020. Government support payments stepped down at the end of December and again a lift in employee compensation of 1%+ will be insufficient to prevent a fall in household disposable income in Q1. Households will lift spending by running down savings but the out-sized 6.7 percentage point fall in the household savings ratio between Q3 and Q4 2020 will not be repeated.
Household consumption spending may still rise 1% or a little better in Q1 but that softens the contribution to GDP from 2.3pps in Q4 to around 0.7pps in Q1.
Although the rise in household consumption accounted for two-thirds of Q4 GDP growth, another important contributor for the first time in the recovery was private investment spending. Asset ownership transfer costs (mostly related to real estate transfers) rose 15.2% q-o-q and contributed 0.2pps to GDP growth; dwelling investment (home building) rose 4.1% q-o-q contributing 0.2pps; and business investment in plant and machinery rose 8.9% q-o-q and contributed 0.3pps. Total private investment spending contributed 0.7pps in Q4.
The housing part of private investment spending continues to rise strongly and looks set to contribute 0.3pps or 0.4pps to GDP each quarter during 2021. Business investment spending may also provide positive but less consistent contributions to quarterly economic growth.
The key private sector drivers of GDP growth, consumption spending and investment spending, contributing 3 percentage points of 3.1% Q4 GDP growth are set to step down their contribution to around 1.3 percentage points in Q1. If the remaining contributions from government spending, net exports and inventories cancel each other out to zero contribution Q1 GDP growth will be around 1.3% q-o-q.
Our discussion so far has been about quarterly GDP growth. Although GDP grew more than 3% q-o-q in both Q3 and Q4 2020 that was not enough to cover the reduction in GDP during the recession when GDP fell 0.3% q-o-q in Q1 2020 and then fell 7.0% q-o-q in Q2. Annual y-o-y GDP growth was still down 1.1% in Q4 2020. Australia’s fall in GDP y-o-y compares well with the US –2.5% y-o-y; the euro-area –5.0%; Britain –7.8%; and Japan –1.2%. The only major economy that has managed better is China, first into the Covid-19 recession and first out and showing annual GDP growth of 6.5% y-o-y in Q4.
Australia’s out-performance will be less pronounced on a quarterly GDP growth basis in Q1 2021. The US economy for example appears to be accelerating and will show GDP growth above 1.3% q-o-q, but Australia’s annual growth will compare well. A 1.3% lift in Q1 GDP would lift Australia’s annual y-o-y growth rate from –1.1% in Q4 to +0.5%. During the current quarter Australia moved to recover the output lost in the recession plus a little more.
The next recovery benchmark for Australia is when GDP lifts to the point it would have achieved if the recession had not occurred. If the pre-covid 19 economy had grown at trend around 0.7% q-o-q, GDP a year ago in Q1 2020 would have been one percentage point higher than recorded. That means that our expected 0.5% y-o-y GDP growth will be effectively – 0.5 y-o-y had Covid-19 not occurred.
Australia’s y-o-y growth will be erratic this year jumping from around +0.5% y-o-y in Q1 to +7.5% or more in Q2 (a function of the –7.0 q-o-q in the base for the annual calculation in Q2 2020) before falling back to around +3% y-o-y in Q4 2021 (as Q3 2020 +3.4% q-o-q and Q4 +3.1% in the annual calculation base are replaced by +0.7 to +1.0% q-o-q readings in Q3 and Q4 2021. Even on these forecasts Australia’s GDP does not return to its pre-Covid 19 growth trajectory until early 2022.
Returning to the second question relating to the RBA and when it will lift official interest rates, while economic growth was stronger than expected in Q4 that alone is insufficient to cause the RBA to bring forward the first official rate rise. GDP growth is likely to be noticeably less strong in Q1 2021. On the best estimates GDP will not return to pre-Covid 19 growth trajectory before early 2022.
Going back before Covid 19, the RBA at that time saw the forecast growth trajectory taking time to use up excess capacity and place consistent upward pressure on annual inflation. The RBA at that time was at least a year away from considering lifting the cash rate. It is reasonable to assume that with a year to go to return to pre-Covid 19 growth trajectory and with several months beyond that point before annual wage growth lifts to consistently inflationary territory the RBA is unlikely to raise the cash before late 2022.