Australian economic growth gathered pace in Q4 2024 and the early economic indicators for Q1 2025 are that growth is still gathering pace. Domestic spending is driving GDP growth but supply in the economy is still limited by weak productivity. Inflation in Q4, measured by the implicit price deflator remains high, up 0.8% q-o-q and 3.5% y-o-y. While there are factors presenting headwinds that may curtail Australia’s GDP growth recovery such as President Trump’s tariff policies hurting global international trade and growth prospects as well as near term damage to growth from the storm affecting northern New South Wales and south east Queensland, Australia’s growth and inflation prospects in the wake of recent economic data will make the RBA cautious cutting the cash rate in the months ahead.
Taking GDP growth first, from the Q4 GDP report it is a story of onwards and upwards. Quarterly real GDP growth was a low 0.2% q-o-q in both Q1 and Q2 2024, lifting to 0.3% in Q3 and 0.6% in Q4. GDP per head over the same period was very weak in the first half of 2024, -0.4% q-o-q in Q1 and -0.2% in Q2, was still weak at -0.2% q-o-q in Q3, but lifted to +0.1% q-o-q in Q4, the first positive growth quarter in two years. The difference between the two sets of quarterly growth numbers – total real GDP growth and growth in real GDP per head – marks how dependent Australian growth has been on rapid population growth driven by high immigration numbers.
Population growth has been one factor driving growth in income in the economy and demand. Hours worked in the economy lifted 0.7% q-o-q while compensation of employees lifted by 2.0% q-o-q, the fastest growth in almost two years. The annual growth in compensation of employees in Q4 at 6.1% y-o-y was nearly double the 3.2% y-o-y growth in the Q4 wage price index but the difference between the two reflects very strong growth in both employment and hours worked in Q4, bolstering the growth in compensation of employees.
Nevertheless, it is the high growth in compensation of employees that is adding to factors driving up household disposable income and the ability of households to spend. Household disposable income rose by 1.4% q-o-q in Q4 and was up 5.5% y-o-y, well above the annual inflation rate. Households can apply growth in income to spending or saving. In Q4 they added to both saving and spending. Real household consumption rose in Q4 by 0.4% q-o-q (+0.7% y-o-y) contributing 0.2 percentage points to the 0.6% GDP result. The household savings ratio also increased, from 3.6% of household disposable income in Q3 to 3.8% in Q4.
The factors that drove strong growth in compensation of employees in Q4 are still in play in Q1 2025. Wages are rising at least at the 3.2% y-o-y pace recorded by the wage price index in Q4. Employment growth has accelerated early in Q1, to 3.5% y-o-y in the January labour force report. Household disposable income growth in Q1 is likely to match or better the 1.4% q-o-q growth pace reported in Q4 implying that real household consumption expenditure will lift around 0.4% q-o-q or more in Q1 contributing at least 0.2 percentage points to GDP growth in Q1.
Household consumption expenditure contributed to GDP growth in Q4 and will do so again in Q1 and at a time when public sector spending is still growing sharply. General government consumption expenditure in real terms rose 0.7% q-o-q in Q4 and was up 5.1% y-o-y. Government capital investment spending in real terms rose 1.8% q-o-q and was up 8.1% y-o-y. Annual growth in total government spending is rising at close to 6% y-o-y in real terms and is showing no signs of slowing.
This spending growth in the economy is building momentum. It is off a low base in the case of household consumption spending but with reasons to expect that even stronger growth lies ahead. Public sector spending growth is overly strong but is unlikely to lose pace. It might rise even faster if pre-election spending promises come to fruition.
Stronger spending in the Australian economy should be a welcome development but any welcome is marred by the threat of sticky or rekindling inflation. The missing part of Australia’s growth story is private sector investment spending.
Real private sector investment in machinery and equipment was down in Q4 by 0.3% q-o-q and was flat, 0.0% y-o-y. Real private spending on non-residential construction was up 0.6% q-o-q in Q4, but was down 5.0% y-o-y.
This lack of private sector investment spending means that growing demand in the economy is being serviced by businesses and the government putting on more workers and adding demand in an already very tight labour market.
It also means that productivity is not rising. In Q4, real GDP per hour worked fell by 0.1% q-o-q and was down 1.2% y-o-y. As a result, real unit labour costs continue to rise, up 0.6% q-o-q and up 2.3% y-o-y. Labour cost pressures are building placing pressure on businesses to lift prices.
The return of reasonable economic growth in Q4 is welcome as are the signs that growth is continuing in Q1. However, stronger growth without any lift in productivity means a continuing risk that progress reducing inflation will not continue. That means the RBA can only continue to reduce the cash rate if it gets news that inflation is surprisingly low. The RBA needs to see quarterly inflation reports before it can cut the cash rate. The next opportunity to cut the cash rate comes in May, but contingent on a low Q1 CPI report in late April. Beyond May, we see little likelihood that CPI inflation will be low enough to allow the RBA to cut the cash rate further.