Onwards and upwards
A bumper crop of Australian economic readings released over the past week covering Q4 2013 and January 2014 show that the economy started to grow faster in the second half of 2013 and also that the pace of growth was quickening early in 2014. This improvement in economic growth also occurred despite a hefty downturn in business investment spending led by the mining sector and also despite weak labour market conditions. The data also showed strongly rising company profits, the main reason why we expect a further strengthening in economic growth to above long-term trend pace through 2014 and in 2015. The comments from the RBA at the March policy meeting and in Governor Stevens’ appearance before the House of Representatives’ Economic Committee seem to indicate a similar economic outlook to ours in many respects. The RBA sees a period of stability in interest rates as appropriate given current economic conditions.
Taking a rear-view look at the economy first, GDP rose in Q4 2013 by 0.8% q-o-q, the strongest quarterly increase since Q1 2012 and after an upwardly revised 0.7% increase in Q3 2013. Taking Q3 and Q4 as a pair, annualized GDP growth was 3.0% in the second half of 2013, not far short of long-term trend growth just over 3.0%, and noticeably faster than 2.4% annualized growth registered in the first half of 2013 and 2.2% in the second half of 2012. Despite the acceleration in GDP growth in the second half of 2013, growth was still insufficient to generate growth in employment of sufficient order to prevent the unemployment rate from climbing.
Apart from the weakening labour market, another reason why many would have perceived economic growth as being weaker than it really was comes down to the composition of growth. Domestic final demand comprising consumption expenditure and capital investment spending by both the private and public sector is what most households and businesses notice and that has been growing much more softly than GDP. Domestic final demand rose at annualized pace of only 1.2% in the second half of 2013, up from 1.0% in the first half and only 0.2% in the second half of 2012. The driver of the greater strength in GDP has been exports growing in the second half of 2013 at 5.0% annualized growth pace, after an incredibly strong 7.8% annualized growth burst in the first half and 6.4% in the second half of 2012. Strongly growing exports in part enabled by the super-sized mining investment boom of recent years has been doing the heavy lifting priming GDP growth.
In the second half of 2013, domestic final demand exhibited several moving parts with two important parts pulling in opposite directions. Private gross fixed capital formation (mostly business investment spending, but also including spending on residential real estate) fell at 15.4% annualized pace, much of the big fall down to declining mining investment. In contrast, household consumption expenditure rose at 3.0% annualized pace. Even though spending on household consumption is almost three times the size of spending on private gross fixed capital formation, 3% private consumption growth was insufficient to offset the 15.4% fall in private capital spending. A bit of help was needed from growth in public sector spending – government consumption up 2.6% annualized and public gross fixed capital formation up a whopping 87.8% annualized – to generate the still soft although accelerating 1.2% growth in domestic final demand.
Looking ahead, it is highly likely that growth in domestic final demand will accelerate significantly in Q1 2014 and through the first half of this year. Household consumption expenditure growth appears to be building momentum. Retail sales rose particularly strongly in January, by 1.2% m-o-m, and with good growth in all major spending categories. Rising household wealth assisted by higher house prices is encouraging households to become less cautious even though wages growth is still slow. Households are funding higher spending by saving a little less of every dollar earned, a trend that started in Q4 when the household savings ratio dipped below 10%. As new home building gathers momentum, equipping completed new homes will provide an added boost to retail spending.
In terms of private fixed capital expenditure, mining investment spending will continue to decline. Non-mining business investment spending, however, will probably start to grow. Company profits, according to the Australian Bureau of Statistics rose by 10.7% y-o-y in Q4 2013 and prospects are good for further growth in profits. Greater employment and investment spending will inevitably follow.
Another part of gross fixed capital expenditure, spending on housing, will soon start to grow much more strongly. Spending on housing actually decelerated through the second half of 2013 to only 1.2% annualized from 1.6% in the first half and 6.0% in the second half of 2012. The home buying spree really got going around mid-2013 and about the same time builders started to sharply increase the number of applications to councils to build new homes. Much stronger levels of monthly home building approvals have been evident since August 2013 and the latest monthly reading for January 2014 showed approvals up 6.8% in the month and up 34.6% compared with January 2013. Home building work associated with these much stronger home building approvals will be evident in Q1 2014 and well beyond. Much stronger spending on housing makes it unlikely that total private capital expenditure will fall at anywhere close to the 15.4% annualized pace registered in the second half of 2013, even with the slide in mining investment continuing pace.
All told, economic growth has started to pick up pace and there are good reasons to expect growth to gather pace looking ahead. In time the RBA will move in our view from wanting stable, very low interest rates to wanting somewhat less low interest rates as the economy starts growing at above trend pace later this year.