Gareth Aird, head of Australian economics at CBA, has penned the below note in response to Wednesday’s weak national accounts data from the Australian Bureau of Statistics (ABS).
Aird maintains that the soft consumer backdrop and rising unemployment will force the Reserve Bank of Australia (RBA) to commence an interest rate easing cycle in Q4 this year.
Momentum in the economy has ground to a halt
- Real GDP rose by a weak 0.2%/qtr in Q4 23 to be up 1.5% on year-ago levels.
- Household consumption inched higher but has gone significantly backwards on a per capita basis over the past year.
- Recurrent public spending grew at a trend-like pace, business investment pushed higher and net exports made a decent contribution to growth.
- Residential construction fell sharply and the supply and demand imbalance in the housing market has further widened.
- Nominal GDP increased by 1.4%/qtr due to higher domestic prices, a lift in the terms of trade and the small lift in production.
- Real household disposable income posted a welcome increase over the quarter but sits 0.6% lower over the year.
- The savings rate increased to 3.2% but still sits comfortably below its pre-pandemic five-year average of ~6.0%.
- We continue to expect 75bps of RBA policy easing by end 2024 and favour September for the first cut.
The growth picture is consistent with rate cuts in 2024
The 0.2%/qtr increase in real GDP over Q4 23 was in line with our pick and the market median forecast (the estimates across the forecasting community ranged from 0.0% to 0.5%).
There was a small upward revision to Q3 24 from 0.2%/qtr to 0.3%/qtr. Annual growth in GDP has fallen to 1.5%.
The recent run of quarterly changes in real GDP paint the picture of an economy that has slowed significantly. The quarterly changes over 2023 now read 0.6%, 0.5%, 0.3% and 0.2% (latest).
The six-month annualised pace of GDP growth to the December quarter fell to 1.0%. This compares with population growth of ~2.5%/yr. The upshot is that the economy has gone backwards a lot in per capita terms over H2 23.
The RBA’s highly aggressive rate hiking cycle has clearly worked to slow demand growth in the economy. Rising mortgage payments along with a lift in tax payable and the effects of elevated inflation have weighed on household purchasing power.
Growth in real consumer spending over the past year has been incredibly weak given the squeeze on real household disposable income (more on that below).
Real household consumption grew by just 0.1%/qtr in Q4 24 and is up by the same amount over the year. In other words aggregate consumer spend has essentially been flat for a year.
On a per capita basis, real consumer spending is down by a very large 2.4% over the year. Such an outcome would normally be associated with a large negative shock or recession.
The weakness in the consumer lies at the heart of the soft GDP outcomes.
And it is the primary reason why the unemployment rate is on a firm upward trend (albeit from an incredibly low level).
According to the ABS spending on essentials grew by 0.7% over the December quarter. But this was largely offset by a fall in discretionary spending of 0.9%/qtr. Indeed total discretionary spending by households fell by 1.6% over the year.
Spending on electricity, rent, food and health continues to gobble up the household budget. In contrast, the average Australian household has cut back their spending on eating out, clothing and recreation.
We believe this dynamic will continue to weigh on discretionary inflation. And we don’t subscribe to the view that services inflation (excluding housing) will prove sticky.
Dwelling investment posted a large 3.8%/qtr fall due to a big decline in both new construction (3.5%/qtr) and alterations and additions (4.2%/qtr). The level of new home building is well below where it was pre-pandemic.
Against a big lift in population growth the supply and demand mismatch in the housing market has put significant upward pressure on rents. It has also fed into the increase in home prices over the past year despite the big reduction in borrower capacity due to significantly higher mortgage rates.
Business investment has been a bright spot on the expenditure side of the economy. Total private investment rose by 0.7%/qtr and is up a very strong 8.2% over the year.
There was a big lift in both non-residential and engineering construction over 2023.
And investment in machinery and equipment is also up significantly over the same period (note that it posted a small quarterly fall in Q4 23).
The private investment outlook remains positive as evidenced by last week’s capex survey. That said, if the outlook for demand weakens too much further some investment projects may be shelved or put on hold.
In addition large public works programs risk crowding out private sector investment.
On that score, real public investment edged down by 0.2% in the December quarter. But it has increased by a very large 13.6% over the past year.
Rapid population growth has lifted the need for state governments in particular to deliver large infrastructure projects.
Net exports added 0.6ppts from GDP because of a large decline in import volumes (-3.4%/qtr) and a more modest fall in export volumes (-0.3%/qtr).
The ABS notes that consumption, capital and intermediate goods imports were all down. And Australians spent a lot less on overseas travel in Q4 23 (consistent with a stretched household sector).
Inventories weighed on growth due to a run down in mining inventories.
Household income improves, but the overall picture is weak
The income side of the ledger warrants close inspection, given nominal outcomes feed into the monetary policy debate. And growth in real household disposable income is the key influence on the ability of households to consume.
The news was a little better for the household sector in the December quarter after a shocking September quarter.
Household disposable income rose by 2.3%/qtr to be 5.0% higher over the year. The healthy quarterly increase was driven by a 1.4% lift in the compensation of employees and a surprise decline in income tax payable.
The ABS notes that tax payable leapt in the September quarter due to a change in timing of final tax return submissions compared to previous years.
Notwithstanding, tax paid is still up a lot more than growth in income over the past year.
For context, the compensation of employees rose by 8.1% over the year to Q4 23, while tax paid increased by 11.5%. Fiscal drag (otherwise known as bracket creep) has seen households hand over a larger share of their income to the Commonwealth Government.
Tax cuts will kick in from Q3 24. But that is still some time away. And the tax relief will only drop the tax paid to income ratio a little bit.
Interest paid on housing debt continues to push higher and is up by 39.4% over the past year. The ongoing expiry of ultra-low fixed rates will see interest paid continue to grow at a decent clip until the RBA cuts the cash rate.
For context, interest paid on housing debt is up by a massive 162% from pandemic lows.
Real household disposable income posted its first quarterly increase since Q3 22. But that was largely because tax paid dropped. Smoothing out the bumps shows that real household disposable income is down by 0.6% over the year and has fallen by 6.6% since its peak in Q3 21.
The erosion of household purchasing power largely explains why consumer sentiment has been at levels consistent with a major negative economic shock for the past year and a half.
Growth in nominal income was stronger than growth in nominal consumption. As such, the savings rate increased from 1.9% to 3.2%.
The savings rate has averaged ~3% over the last five quarters – comfortably below its five year pre-pandemic average of 6%.
Nominal GDP, the broadest measure of national income, rose by 1.4%/qtr in Q4 23. The terms of trade increased by 2.3% over the quarter and now sits 3.9% lower over the year. The level of our terms of trade is still very favourable for our exporters and by extension government revenue.
The household consumption implicit price deflator increased by 0.8%/qtr in Q4 23 (the same magnitude as the increase in the trimmed mean CPI over the same quarter). We expect a similar outcome in Q1 24 before the quarterly pace of consumer inflation is expected to further moderate.
Hours worked declined by 0.3% over the December quarter, which means there was an increase in GDP per hour worked (i.e. productivity).
Measured productivity is choppy on a quarterly basis. But there has been a welcome lift over the past two quarters.
Concluding thoughts and implications for the RBA
Today’s national accounts were a touch softer than the RBA anticipated.
The RBA forecast GDP growth of 1.5%/yr in Q4 23, which implied a quarterly increase in GDP of 0.3% (i.e. the RBA would not have incorporated an upward revision to Q3 23 into their forecast for annual growth).
Perhaps of more significance is that the consumer has been a lot weaker than the RBA anticipated. In November 2023 the RBA forecast household consumption to be 1.1%/yr in Q4 23. That number was revised down to 0.4%/yr in February 2024.
Today’s data indicates the outcome was just 0.1%/yr. The upshot is that the RBA will be surprised at the lack of growth in household consumption.
Economic growth will remain below trend over coming quarters and the unemployment rate will continue to lift. This will in turn alleviate wages pressures and see disinflation continue.
We remain comfortable with our base case for an easing cycle to commence in Q3 24 (we have pencilled in September).
We expect a string of rate cuts once the RBA eases policy to prevent the unemployment rate from rising to ~5%.
We have 75bp of easing in our profile by end-2024 and a further 75bp of cuts in H1 25 that would take the cash rate to 2.85% (a level we assess to be roughly neutral).
A full chart pack on the national accounts will be published shortly.
