Australian economic growth is the strongest in six years and appears to be gaining momentum, yet most economic analysts are predicting that the lift in growth will be temporary and that weaker growth lies not far ahead. While there are hurdles in the way of stronger Australian economic growth our view is that there is already evidence that they are surmountable, and the above trend economic growth is likely to continue through the remainder of this year and in 2019.
Looking first at the Q2 GDP report, it showed a 0.9% q-o-q increase after an upwardly revised 1.1% (initial report 1.0%) lift in Q1. Annual GDP growth lifted to 3.4% y-o-y in Q2 from an upwardly revised 3.2% (initial report 3.1%) in Q1. It is worth noting at this point that the annual GDP growth rate in Q2 was 0.6 percentage points (pps) above the market consensus forecast of 2.8% y-o-y and 0.4pps above the RBA’s forecast of 3.0 y-o-y for June 2018 contained in its early-August quarterly Monetary Policy Statement. It is also worth noting that annual GDP growth of 3.4% y-o-y in Q2 is higher already than annual growth forecast by the RBA in 2018, 3.25% and 2020, 3.0%.
The growth forecasts of the market and the RBA look relatively more pessimistic when compared with the momentum building in Australian GDP growth. In the first half of 2018 annualised GDP growth calculated from the quarterly growth in Q1 and Q2 was 4.0%, compared with 2.8% in the second half of 2017; 2.2% in the first half of 2017; and 1.6% in the second half of 2016. Strongly rising annualised growth over the past two years has not come just from rising housing activity but has been broad-based encompassing household and government consumption spending; business and government capital spending; and exports of goods and services.
Moving back briefly to the 3.4% y-o-y GDP growth rate achieved in Q2, final consumption expenditure rose 3.5% y-o-y (Government consumption up 5.1% y-o-y and household consumption up 3.0% y-o-y). Gross fixed capital formation rose by 3.3% y-o-y (dwelling expenditure up 3.8% y-o-y; non-dwelling expenditure up 15.4%; spending on machinery and equipment up 6.7%, Government capital expenditure -8.1%). Exports of goods and services rose by 3.7% y-o-y. In short there was consistency in the growth rates of the major contributors to economic growth.
Barring a major set-back to one or more of the major contributing expenditure groups within Australian GDP, very strong annualised growth in the first half of 2018 will translate to further acceleration in y-o-y GDP growth towards 4% in Q4 2018 or Q1 2019.
Those forecasting softer GDP growth have a list of factors that might suppress GDP growth including housing weakness; over-stretched, income-growth-poor households facing mounting bills and reducing spending; or the international trade war containing global growth and Australian exports.
These factors could contain growth but are showing few signs of doing so in the near term. The housing down-turn is orderly so far and rather than depressing the entire sector is redistributing winners and losers in the sector. Investors in housing are suffering as lending conditions tighten, house prices moderate and rental vacancy rates lift. First-time home buyers, in contrast, are finding housing more affordable. Renters are finding that annual rent rises are the smallest in decades and in some cases rents are falling reducing pressure on budgets. The rapid pace of home building activity evident in 2016 and much of 2017 has moderated but is still up on an annual growth basis.
As far as households are concerned employment growth is strong and wages growth is starting to trickle upwards. Households are digging in to savings to help fund spending, but that is a sign of confidence. Rising mortgage interest rates could dent spending, but the opportunities to refinance mortgages at lower interest still exist. It is also worth noting that some big-ticket household budget items are coming down in price – the cost of child care and household energy prices. There is no compelling reason for Australian households as a group to spend less freely over the next year.
As far as the trade war is concerned, China, our biggest trading partner is responding to the escalating imposition of US tariffs on its goods by adopting policies to boost domestic spending in compensation for loss of export orders. Stronger domestic spending in China is more likely to boost rather than restrain Australian exports.
Taking account of the potential downside threats to Australian GDP growth it is a possibility that annual GDP growth could slide, but it seems a much smaller possibility than many analysts are making out. Rather there are good reasons to expect Australian GDP growth to accelerate. In our view an annual growth rate nearer to 4% y-o-y or more is approaching in early 2019. Yet Australia is currently in a peculiar phase of growth denial. The economy is performing very well but few are prepared to accept that is growing well and are almost seeking every possible reason why conditions must worsen.
If we are correct in our view that already strong Australian GDP growth will get even stronger there will come a point where local interest rates reflect the strength of the economy. Rising interest rates are a near certainty in our view, whether delivered on the back of rising bank-funding costs as has been the case so far or by rising funding costs reinforced by a rising RBA cash rate as we expect to start happening early in 2019.