Australian economic growth should be noticeably stronger in the second half of 2019 than it has been in the first half of the year, or in the second half of 2018. The main reasons for the stronger showing are likely to be response to policy stimulus; less drag on growth from the housing downturn; more favourable conditions for household consumers; and booming exports. The near-term improvement may not persist far in to 2020. There are factors undermining medium-term growth prospects such as the worsening international trade war and more directly in Australia the risks associated with encouraging a still heavily indebted household sector to borrow even more.
At least near-term Australian growth prospects are brightening as the main drags on GDP growth over the past year are starting to relent. Sharply falling housing activity influencing (and combined with) slow growth in household consumption spending were the main forces holding back GDP growth since mid-2018.
In Q3 2018 real GDP grew by 0.3% q-o-q, but household consumption spending combined with capital formation on new housing and alterations and ownership transfer costs (money spent largely transferring residential real estate) contributed only 0.1percentage point (pp) of that growth. Real GDP growth in Q4 2018 was only 0.2% q-o-q, but the combined growth contribution from household consumption and housing worsened to -0.1pp.
The latest GDP reading for Q1 2019 was a little better than in Q4 or Q3 2018 at 0.4% q-o-q even though the combined growth contributions from household consumption and housing were worse at -0.2pp.
One point often missed in discussion about Australia’s slowing economic growth rate since mid-2018 is that quarterly GDP growth was better in Q1 2019 than either Q4 or Q3 2018 even though the downward drag on quarterly GDP growth from weak consumer spending growth and falling housing has noticeably intensified from +0.1pp contribution in Q3 2018 to -0.2pp in Q1 2019. The non-housing/ consumer spending parts of the economy have not only been growing but growing at accelerating pace to more than offset the incremental weakening contribution of combined household consumption and housing, no mean feat as household consumption and housing account for nearly 61% of GDP.
We are only a fortnight away from the end of Q2 2019 but the GDP report for Q2 will not be available until early September. Most likely the combined contribution to GDP growth from combined household consumption and housing will still be close to the -0.2pp contribution reported in Q1. It is still too early to expect a better contribution even though early signs of less weak conditions in the housing market were starting to show in Q2.
In Q3 2019 and in Q4 policy changes – the RBA’s June cash rate cut and easing APRA prudential lending controls – aimed at boosting housing and relieving the interest servicing burden on high household debt should work to prime house sales and arrest falling house prices.
In addition, the first round of the Government’s promised tax cuts – the increase in the low-to-middle income tax rebate to $1,080 and $2,160 for couples in their 2018-19 tax returns – will almost certainly come into effect early in Q3. A significant proportion of the higher tax rebate is likely to be spent helping to boost growth in consumer spending in Q3 and Q4. Other factors helping to lift consumer spending growth include modest real wages growth (wages growth 2.3% y-o-y compared with CPI inflation at 1.3%); still strong employment growth; and a probably sharp lift in home loan refinancing activity taking advantage of lower borrowing interest rates and freeing up more money to spend.
Household consumption spending alone should contribute 0.2pp to 0.3pp to quarterly GDP growth in Q3 and Q4 enough to offset dwindling negative contribution from housing. Assuming the rest of the economy continues to grow at least as well as it has been – if anything exports and government infrastructure spending are looking even stronger than they have been – there is good reason to expect Australian quarterly GDP growth readings in 0.6% to 0.8% q-o-q range in Q3 and Q4 2019 rather than the 0.2% to 0.4% range that has prevailed since mid-2018.
The RBA will be encouraged if quarterly GDP growth picks up pace as we expect in Q3 and Q4 but it is unlikely to discourage the RBA from cutting the cash rate further. On our GDP forecasts, annual growth will lift, but to around 2.5% y-o-y, below potential growth and not enough to either lower the unemployment rate much below 5% or push up inflation towards the middle of the RBA’s 2-3% target band.
Even with easier monetary policy in prospect, Australian GDP growth prospects still look soft in the medium-term. Lower interest rates are likely to encourage the still heavily indebted household sector to take on even more debt increasing the vulnerability of the sector to future shocks. Currently strong growth in Australian exports is also at substantial downside risk if the entrenched trade war between the US and China leads to a period of weaker growth in China as seems increasingly likely.