On the face of it, Australia’s Q4 GDP report released last week confirmed that Australia’s real economic growth rate softened in the second half of 2018. Real GDP grew by only 0.2% q-o-q after a tepid 0.3% gain in Q3. Looking at the second half of 2018 annualised GDP growth was 1.0% compared with 3.8% annualised growth in the first half of 2018. There is no denying that real GDP growth in the second half of 2018 was disappointing, but it does not tell all of Australia’s growth story some of which is far from disappointing.
What is most puzzling about the pronounced slowing in the pace of Australian real GDP growth in the second half of 2018 is that it coincided with several other measures of Australia’s economic position that were undeniably strong. Employment growth was stronger in the second half of 2018 – up 136,000 – compared with the first half – up 132,400. Moreover, full-time employment grew much faster in the second half – up 150,100 – than in the first half – up 77,100. Interestingly, employment growth was again very strong in January 2019, up 39,100 in the month with an out-sized 65,400 gain in full-time employment.
Very strong employment growth and a national unemployment rate that has fallen from 5.6% in December 2017 to 5.3% in June 2018 and 5.0% in December 2018 (a 7-year low) is inconsistent with economic growth that has apparently slowed in pace markedly during 2018.
Other areas of inconsistency include the Federal Government’s budget position in 2018-19 forecast at a deficit of only $A5.2billion in the December 2018 mid-year review compared a $A14.5 billion deficit forecast in the May 2018 Budget. That order of improvement cannot occur unless Government tax revenues are more than expected and Government spending is less than expected. More than expected tax revenue speaks of strongly growing incomes for Australian businesses and wage earners. Less than expected government spending implies less pressure on government social security and welfare payments reinforcing the message that unemployment is falling.
Where the apparent contradiction between slowing real GDP growth and the strength of other indicators related to growth starts to resolve is in the income details contained in the GDP report. Unlike expenditure-based real GDP (the widely published number representing the GDP growth rate) income-based nominal GDP grew strongly in Q4 2018, up 1.2% q-o-q after lifting 1.0% in Q3. Income-based GDP rose at 4.4% annualised pace in the second half of 2018.
Cutting in to income-based GDP, in Q4 the compensation of employees rose 0.9% q-o-q and was up by 4.3% compared with Q4 2017. This measure of wages allows that more people are employed so the total wages bill is starting to grow faster and well in excess of all measures of inflation. More impressively, the gross operating surplus of non-financial corporation (a measure of company profits) rose in Q4 by 3.8% q-o-q and was up by 10.9% compared with Q4 2017. Very strong profit growth helps to explain why most Australian business surveys report buoyant business conditions and why it reasonable to expect that Australian businesses will invest more, try and employ even more people and will pay more generously for labour, particularly in those occupations experiencing skill shortages.
Despite the good news contained in Q4 income-based GDP there is no denying that parts of expenditure-based GDP were soft through the second half of 2018. The housing downturn was in full cry. Expenditure on new housing fell at 10.6% annualised pace in the second half of 2018 compared with rising at 12.4%. Household consumption spending rose at only 1.4% annualised pace in the second half compared with 2.6% in the first half. The weakness in housing combined with slowing growth in household consumption accounted for much of the slowing in real expenditure-based GDP growth in the second half.
There was some good news, however, in terms of private sector investment spending on new machinery and equipment, up at 6.4% annualised pace in the second half compared with up 2.2% in the first half.
The strength of income growth in the Australian economy, especially the strength of growth in business profits bodes well for further growth in business investment spending, employment growth and probably wages growth too. These developments should over time contribute to stronger spending by households on housing and consumer goods.
The Q4 GDP report was disappointing in terms of headline GDP growth but the detail, especially relating to income growth, looked much more promising. We still expect growth to improve slowly this year and be far from weak enough to justify any cut in the RBA’s 1.50% cash rate.