The lucky country?


Matthew Peter, Chief Economist 

The Australian economy has just completed its 26th year without recession. A world record achievement. But avoiding a recession doesn’t mean we haven’t had our challenges. Growth slowed sharply following the dot-com crash in 2000/01 and the global financial crisis in 2008/09. And more recently, the mining investment downturn has seen the Australian economy slow from an above-trend pace of 3.6% in 2012 to just 1.8% over the year to the March quarter; the weakest performance of the Australian economy since the aftermath of the financial crisis.

However, this week we’ve seen more evidence that Australia is well and truly, the lucky country. Real GDP growth rose a solid 0.8% in the June quarter, bouncing back from the weakness seen earlier in the year. Growth would have been even higher if it were not for Cyclone Debbie, which restricted coal exports in April. Adjusting for these disruptions and growth would have likely been higher than 1% over the quarter.

The good news from this week’s National Accounts is further evidence that the Australian economy is continuing to transition following the mining boom. Real domestic final demand advanced by 1% in the June quarter to be 2.4% higher over the past year, which is the fastest rate of domestic activity since the end of 2012 when the mining investment downturn commenced. Victoria continues to lead the way, with state final demand up 4.7% over the past year, while solid growth was also evident in Queensland (+2.8% y/y), New South Wales (+2.4% y/y) and South Australia (+4.0% y/y). Despite the positive signs on the east coast, Western Australia continues to struggle due to the ongoing fallout from the mining investment downturn, with state final demand down 4.3% over the past year. In fact, since the peak in 2012, domestic activity in Western Australia has plummeted 17%.

Nonetheless, with Queensland improving and the engines of Victoria and New South Wales firing, the Australian economy looked in much better shape in the June quarter. Real business investment (excluding the impact of asset sales) rose 1.1% over the quarter, the third consecutive quarterly gain. And as we noted last week, capital expenditure intentions suggest further recovery in non-mining investment over the coming year.

The main driver of growth over the quarter was strong public-sector spending, which rose 3.4% over the quarter due to increased infrastructure spending in New South Wales, Western Australia and South Australia where the government outlaid $2.3 billion for the new Royal Adelaide Hospital. Real consumer spending also rebounded, rising 0.7% over the quarter, despite ongoing subdued growth in real household disposable incomes of just 0.1%. As a result, the household savings rate dropped from 5.3% to 4.6% during the quarter, the lowest level since the global financial crisis struck in 2008.

The June quarter National Accounts are likely to mark the turning point for the Australian economy. The year-ended growth of 1.8% that was recorded in Q1 and Q2 should be the cyclical low, with growth likely to jump to around 3% in Q3 as the surprise contraction seen in the September quarter 2016 drops out of the calculations.

While we expect conditions to slowly improve as the headwinds from the mining downturn abate and the non-mining business investment recovery continues to progress, the outlook for the Australian economy remains challenging. In particular, the housing market is starting to turn down, with prices stagnating in August and the retracement in building approvals over the past year foreshadowing a drop-off in investment in late 2017 and 2018. These headwinds from the housing market are likely to constrain consumer spending, as evident by the stagnant retail sales in July, while the recent surge in public spending is likely to slow over the next year given ongoing budgetary constraints.

Although Australia should prove lucky over the next year and continue to avoid recession, these headwinds are likely to lead real GDP growth to remain, on average, below trend in both 2017 and 2018. Below-trend growth and subdued inflation should lead the Reserve Bank of Australia to remain on the sidelines for about another twelve months.

Table 1: Financial market movements, 31 August – 07 September 2017

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,465.1

-0.3%

US

2.04%

-7.8 bps

US Dollar Index (DXY)

91.66

-1.1%

Nikkei 225

19,396.5

-1.3%

Japan

0.01%

0.1 bps

USD-JPY

108.45

-1.4%

FTSE 100

7,397.0

-0.5%

UK

0.97%

-6.2 bps

GBP-USD

1.310

1.3%

DAX

12,296.6

2.0%

Germany

0.31%

-5.4 bps

EUR-USD

1.202

0.9%

S&P/ASX 200

5,689.9

-0.4%

Australia

2.64%

-7.5 bps

AUD-USD

0.805

1.3%

Source: Bloomberg

Economic Update

United States / Canada

US labour market remains robust, but conditions ease slightly in August

  • Conditions within the US labour market eased over August, with non-farm payrolls growing by 156,000 jobs, falling short of market expectations and slowing from July’s outturn of a downwardly revised 189,000 jobs. Meanwhile, the unemployment rate edged higher to 4.4%, up from 4.3% in July, while the participation rate was unchanged at 62.9%. Average hourly earnings growth slowed to 0.1% over August from 0.3% in July. It is important to note that the household survey used for the payroll figures was completed prior to the arrival of Hurricane Harvey. The impact of Hurricanes Harvey and Irma will likely depress September employment growth.
  • Business activity within the manufacturing sector continues to improve, with the ISM Manufacturing index rising to its highest level since April 2011 at 58.8 in August, up from 56.3 in July. The lift in sentiment was driven by improvements in production, employment and deliveries. Adding to strong manufacturing sentiment was a rebound in non-manufacturing sentiment with the ISM Non-Manufacturing index rising to 55.3 in August, up from 53.9 in July.
  • The Bank of Canada surprised markets earlier in the week by raising rates by 25bps to 1.00%.


Weekly economic brief

Euro area / United Kingdom

ECB keeps monetary stance unchanged – strong euro highlighted as a constraint on inflation outlook

  • The ECB kept its monetary stance unchanged in their September meeting of the Governing Council. In the press conference that followed the meeting, ECB President Mario Draghi stated that the rise in the Euro will weigh on inflation. Accordingly, the ECB’s staff forecasts for euro area inflation over 2018-19 has been reduced, despite an upgrade to growth and employment. The staff’s EUR-USD exchange rate forecast was substantially increased to US$1.18 from US$1.09 in the previous forecast. President Draghi also stated that most decisions regarding the asset purchasing programme, which is due to end in December, will be announced at the ECB’s next meeting in October. Despite President Draghi’s more dovish tone, the EUR-USD moved through US$1.20 as the USD faded in the face of Hurricane Irma.
  • Retail sales volumes in the euro area fell by 0.3% over July, the first monthly decline since late 2016. The fall was driven by a decline in automotive fuel, as well as the food, drinks and tobacco category. Despite the slight decline in the monthly growth rate, the trend in retail sales remains strong, with the yearly growth rate in sales volumes at an above-trend rate of 2.6%.
  • Business activity within the UK manufacturing sector improved over August, bucking the recent trend of weak economic data, with the Markit/CIPS manufacturing index rising to 56.9 from 55.3 in July and exceeding the market forecast of 55.0. However, conditions within the services sector remain soft, with the non-manufacturing index declining to 53.2 in August from 53.8 in July.


China / Japan

GDP growth revised down in Japan
  • The Caixin-Markit manufacturing PMI rose to 51.6 in August, up from 51.1 in July. The reading suggests ongoing resilience in China’s manufacturing sector as reported by the more positive official manufacturing PMI, which also rose over the month. According to the survey, August saw the strongest gain in business activity in over three years, while growth in new orders received a boost from export sales. Business activity within the services sector also improved over August, as the Caixin-Markit services PMI rose to 52.7, up from 51.5 in July.  
  • Real GDP growth in Japan for the June quarter was revised downward to an annualised rate of 2.5%, well below the initial 4% estimate. This was primarily driven by a strong downgrade to business spending (from 2.4% to 0.5%).



Australia / New Zealand

Australia real GDP bounces back over Q2

  • Australian real GDP expanded by 0.8% over the June quarter, up from 0.3% in March quarter. The March quarter result maintains the yearly growth rate in real GDP at 1.8%. Growth was broadly based across the main categories of expenditure, once adjustment is made of the sale of government assets. Government spending contributed strongly to growth over the quarter, with government investment (adjusted for asset sales) and government consumption spending growing by 6.1% and 1.2%, respectively. Household consumption spending was also a significant driver to growth in quarter, up by 0.7%.
  • Retail sales growth was flat over July, down from 0.2% in June. Trend growth has also dipped slightly with the yearly growth rate sliding from 3.7% in June to 3.6% in July.
  • Australia’s trade balance narrowed over the month, declining from $0.9bn in June to $0.5bn in July. Both exports and imports contracted over the month, declining 2.2% and 0.9%, respectively.
  • The Reserve Bank of Australia left the cash rate target unchanged at 1.5% at their meeting earlier in the week. This marks the 13th meeting in a row that the bank has left the cash rate at this level.




Sources: Thomson Reuters, ABS



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