Australian GDP growth lifted to a respectable 0.8% q-o-q in Q2 from an anemic 0.3% q-o-q in Q1. If we annualised our GDP growth the way the Americans do, growth would have risen to an above long-term trend 3.2% in Q2 from 1.2% in Q1 implying a big improvement and mission accomplished achieving growth likely to generate relatively full employment. The problem is that economy needs to keep generating 0.8% q-o-q growth readings to keep annualised growth around 3.2% and that could prove to be a tall order. The drivers of GDP growth in Q2 were very mixed and one important positive contributor in the quarter, household consumption spending, may not contribute anywhere near as well over coming quarters. Among other contributors to GDP growth, it was a case of almost all seasons in play -early spring in parts of business investment, a burst of summer in government spending and exports, autumn in housing and a hint of winter in non-residential building activity.
Some contributors to GDP growth are notoriously erratic on a quarter-to-quarter basis. Capital expenditure by Government is particularly lumpy. In Q2 it rose by 11.9% q-o-q, after falling by 2.1% in Q1. The contribution of Government capital expenditure to GDP in Q2 was 0.6 percentage points (pps)while it detracted 0.1pp in Q1. Much of the improvement in GDP between Q1 and Q2 occurred because of this lift in contribution from government capital expenditure. It is a fairly safe call that government capital expenditure will contribute much less to Q3 GDP growth than it did in Q2. It may even detract from GDP growth in Q3 as it did in Q1.
Exports of goods and services are another bumpy contributor to growth rising by 2.7% in volume terms in Q2 and contributing 0.6pps to growth in the quarter after falling by 2.2% in Q1 and detracting 0.5pps. Much of the change in export growth between Q1 and Q2 relates to weather damage to exports from Queensland and Western Australia in Q1 being restored in Q2. The near-term outlook for the volume of exports is reasonably favourable in a growing global economy although the risk of trade wars centered on the relationship between the US and China in the context of how to deal with North Korea is a potential threat.
Among the less bumpy contributors to GDP growth household consumption expenditure up 0.7% q-o-q in Q2 and contributing 0.4pps after rising 0.5% in Q1 and contributing 0.3pps is likely to hold the key to how well the economy can grow over the next year. If household consumption continues to grow at the pace registered in Q2 relatively strong GDP growth would be assured. Some analysts, however, view the relatively strong lift in household consumption in Q2 as a spike that cannot be sustained. They argue that the heavily indebted, income poor household sector, is funding its spending by reducing savings as a proportion of income and it is unlikely the process can run much further.
The household savings ratio has been run down to 4.6% in Q2 from 5.3% in Q1 and 6.9% in Q2 2016 and more than 10% in the wake of the global financial crisis. If households become materially more concerned about their financial position the rundown in the savings ratio would halt and possibly turn towards an attempt to save more from income. If this were to occur most likely growth in household consumption would falter. While it is possible this may occur, there are several factors pointing towards a more positive outcome. In most surveys Australian households are comfortable with their current and future financial prospects. Very low wages growth may be on the cusp of improvement. Wages and salaries paid according to the Q2 GDP report showed a lift of 0.7% q-o-q, 2.0% y-o-y. The recent 3.3% minimum wage determination should lift wages further in Q3 and Q4. Most importantly, employment continues to rise strongly month-to-month.
It is a finely balanced call whether household spending stays firm or weakens. Perhaps much will revolve around the shape of the downturn in housing. Spending on housing showed flat growth in Q2 contributing nothing to GDP, but that was better than the 3.7% fall reported in Q1 that detracted 0.2pps. At this stage, the housing downturn is looking a relatively shallow affair although it may linger for longer than usual. On balance, we see household spending continuing to rise at a reasonable pace over the coming year. That is one reason why we are optimistic on Australia’s growth prospects.
Another reason for our relative optimism is that one of the most consistent detractors from GDP growth over recent years, business investment spending looks set to take a positive turn. Business investment spending detracted 0.3pps from GDP growth in Q2, but mostly because of an out-sized fall in purchases of second-hand buildings. Investment in machinery and equipment rose strongly in the quarter, up 2.9% q-o-q and most business surveys point to a lot more spending over the next year.
All told, there are still many moving parts in Australia’s growth story and with some still pulling in opposite directions. At the core of Australia’s growth story revolving around household and business spending we see more reasons to be optimistic than pessimistic in the Q2 GDP report