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At face value, the Australian economy seems to be powering along registering 3.1% y-o-y GDP growth in Q2 with employment lifting by a record 121,000 in August, reducing the unemployment rate to 6.1% from 6.4% in July. Unfortunately, the GDP reading and the labour force readings do not present a true gauge of economic strength recognisable to most Australian businesses and households. As far as most stakeholders in the economy are concerned, the economy seems softer than the GDP and labour force data imply, and the RBA seems to share those concerns.

Taking the Q2 GDP reading first, there are three ways of measuring growth. The first way is to add up all the spending in the economy. Spending in what might strictly be considered the domestic economy – consumption and investment spending by all levels of government and the private sector – rose in Q2 by 0.4% q-o-q, or 1.4% y-o-y compared with total GDP up by 0.5% q-o-q, or 3.1% y-o-y. The difference, particularly striking in the annual growth readings, mainly comes down to exports. Export volumes rose by 5.4% y-o-y in Q2, the major factor explaining the difference between relatively strong annual GDP growth and quite anaemic growth in domestic final demand. The key point is that most businesses and households are influenced by what is happening in the domestic economy where annual growth is running well below long term trend. Their economy is growing just above 1% annual clip, not the 3.1% GDP growth rate.

A second way of measuring GDP is by adding up the output of various industry sectors. Of the twenty major industry sectors making up GDP, eight showed falling output in Q2, the worst being electricity, gas and water, -2.2% q-o-q and mining, -1.4%. Another six sectors showed increases of 1.0% q-o-q or less. A third of industry sectors showed relatively strong growth, the best being accommodation and food services, up 4.5% q-o-q. A third of industry sectors are showing reasonable to strong growth, but two-thirds are showing sub-par to very weak growth.

Turning to a third way of measuring GDP, by adding up incomes in the economy, the soft underbelly of the economy really starts to show. Real net national disposable income actually fell by 0.2% q-o-q and was up by only 1.0% y-o-y. Even after taking account of inflation, income based GDP at current prices was flat in Q2 and up only 3.3% y-o-y and almost all of that annual increase was accounted for by inflation. Very soft income growth looks set to persist for some time to come tending to limit spending.

Moving into Q3, surely growth must be better with employment lifting at record pace in August. The problem is that the monthly labour force survey is extremely volatile, partly a function of the way that the numbers are collected. The labour force survey covers a comparatively small number of households and those that are surveyed are on the survey for nine months. Every month a ninth of the survey group is replaced and the new group sometimes has distinctly different employment characteristics to the one it replaces and not necessarily linked to the state of the labour market. Part of the reason for the out-sized employment increase in August was that the new cohort contained an unusually big group in part-time employment relative to the group replaced, one reason to take the 121,000 lift in employment with a grain of salt.

A second reason to be suspicious is that it is odd that such a big increase in employment can follow a revised 4,100 fall in employment the previous month. Yet another reason to question whether the employment reading marked a strong bounce is that the number of hours worked in August lifted by only 0.2%, a comparatively soft increase.

All told, assessing the relative strength of the labour market is a tricky business and because of the inherent volatility in the monthly labour force survey, it often requires many months of data to iron out the quirks and make an informed assessment of relative labour market strength. Undoubtedly, the RBA will be waiting for several months more data before it decides whether employment growth is sustainably strong enough to make an assessment that the unemployment rate has peaked and is starting to decline. Even if the RBA is then in a position to make such an assessment, it would allow the improvement in the labour market to run for several more months before deciding that less accommodative monetary policy may be needed.

In our view, weak income growth still implies low octane economic growth for several more quarters ahead. In this environment, the monthly labour market readings are likely to be volatile rather than consistently strong. We still see the RBA on policy hold for at least the next 12 months with the possibility of a first cash rate hike towards the end of 2015.