Every now and then an economic reading comes along that challenges one’s view about future economic prospects. For us that number was the Q3 GDP growth rate coming in at 0.3% q-o-q (well below our estimate of 0.8%) and reducing the annual GDP growth rate to 2.8% y-o-y from 3.4% in Q2. That reduction in the annual GDP growth rate will be difficult to recover over the next quarter or two mainly because the factors behind soft expenditure-based GDP growth in Q3 – soft household consumption spending, residential and non-residential construction spending – do not look like improving in the near-term. We are reducing forecast annual GDP growth for 2018 from 3.5% to 3.1% and for 2019 from 3.7% to 3.0%.
Even our latest GDP growth forecasts are still quite strong and close to long-term trend growth, but forecast growth is not now so strong that it will drive the unemployment rate down and wages growth up as much as we previously thought likely in 2019. One consequence is that annual inflation will also pick up by less than we previously thought likely leaving the RBA in a position where it has more time before needing to hike the cash rate. We now expect that the RBA cash rate will be left on hold at 1.50% through 2019 ahead of a first hike early in 2020.
Returning to the Q3 GDP report, it revealed a mix of firm and weak aspects about the Australian economy. Government spending (consumption and capital) was a firmer contributor to GDP growth contributing 0.3pps to growth in the quarter. Looking ahead, the spending plans of the Federal and State Governments (and the oppositions in the event of election changes to government) are consistent with quarterly growth contributions averaging around 0.3pps over the next year.
Net exports provided a strong contribution to growth in Q3, 0.4pps, but almost entirely from falling volumes of imports rather than growing volumes of exports. Net exports look set to contribute to growth in most quarters over the next year or two aided strength of demand in most of Australia’s major export markets.
Household consumption spending did rise in the quarter but the contribution to growth was modest, 0.2pps one of the softer quarterly contributions over the past two years and even then, achieved by running the already low household savings ratio down further to 2.4% – the lowest ratio in a decade. The growing risk is that growth in household consumption remains soft or even weakens constrained primarily by reluctance to run down the low household savings ratio further in the face of declining household wealth driven by falling house prices as well as only modest growth in wages.
One consequence of a softer-than-previously-expected GDP growth outlook is that jobs growth slows and the falling unemployment rate stalls. In these circumstances what upward momentum there is in wages growth falters adding another reason for households to be reluctant to spend more freely.
Although housing activity has been showing signs of weakness for some time, total dwelling expenditure still made a small positive contribution (+0.1pps) to GDP growth in Q3. As falling house prices continue to diminish the appetite of developers to build new homes housing activity is likely to start making negative quarterly contributions to GDP growth over the next year.
The two big detractors from expenditure-based GDP growth in Q3 were private sector non-dwelling construction (new buildings -0.1pps and new engineering -0.5pps) as well as a run-down in inventories, -0.3pps. The run-down in inventories was unusually big and may moderate or even reverse over the next quarter or two. The negative contribution from non-residential construction may not be quite so large in the future, but there is no compelling reason for a lift in private construction in the near term.
In short, it is down to government spending and net exports to provide the bulk of positive contribution to Australian GDP growth over the next few quarters. Household consumption spending may contribute a little but is under increasing constraint. Business investment spending may contribute but is weighed by weakness in non-residential construction and an uncertain local political environment inimical to long-term investment spending plans.
Housing activity looks set to remain soft for some time and the ability of the sector to find a base in the near-term is being compromised by the lingering negative impact on housing credit growth from The Banking Royal Commission and reactions to it; Government cuts to immigration; and the proposals of the Opposition to change capital gains tax and negative gearing affecting the housing cycle just as it is entering a very weak phase and is least able to cope with the proposed changes.