Australia beats odds to outperform

By Paul Brennan

The Australian economy is growing faster than anticipated and part of the reason is household’s desperate to maintain lifestyle and dipping further into already dwindling savings.

Household consumption increased 0.7 per cent in the first half of the year to be a respectable 3 per cent higher than the same period a year ago. Furthermore, spending was spread across a range of categories from food, clothing and footwear to communications, recreation and education.

However, households had to dip further into their cash savings to maintain this yearly pace of expenditure growth. At 1 per cent, the household savings ratio is the lowest in over a decade and well below the peak of 10per cent hit as we emerged from the global financial crisis in 2009-10.

Low levels of savings make households vulnerable to economic shocks, rising interest rates or inflation and job loss.

But for the economy it’s good news. In the first half it grew by 0.9 per cent (Citi/consensus 0.8% and 0.7% respectively). The small miss from our forecast was because of stronger residential investment. In yearly terms, GDP growth increased by 3.4 per cent (Citi and the consensus both 2.9%). Even if quarterly growth slows in the second half to the average 0.7 per cent pace post-GFC, yearly GDP growth would still average above trend at 3.4 per cent for the year.

The key takeaways we can take from the pace of growth is that:

• Credit slowdown is not stopping the economy.
  While credit growth has slowed in part due to the tightening of lending standards around housing, economic growth has picked up to above trend and is growing faster than credit growth.. The full impact of the peaking of housing construction and correction in house prices is yet to play out, but there is broad support for growth away from housing including non-mining business investment, infrastructure, government recurrent spending and exports.
• Income growth split again highlights low wage growth.
  Compensation of employees and company profits both rose by 0.7 per cent in the quarter, leaving the wage and profit share of GDP relatively unchanged. However, the bulk of the increase in employee compensation occurred through higher employment. Compensation per employee only rose 0.1 per cent in the first half and 1.8 per cent in the past year. Consistent with that, even though productivity fell slightly in the quarter, unit labour costs fell in the quarter and were up only 1.4 per cent in the year. As the RBA Governor has previously highlighted, it will be difficult to achieve the mid-point of the 2-3 per cent inflation target with this low pace.
• Implications for monetary policy.
  Recently, RBA Governor Philip Lowe remarked in Perth at the RBA Board dinner that he expected the data to “confirm that over the first half of 2018, the economy expanded at a faster than trend pace, making inroads into spare capacity.” The GDP data delivered on that expectation, which will keep the RBA’s central scenario that “economic growth this year and next will be a bit above 3 per cent”. So despite some stronger global headwinds recently, the RBA is likely to maintain the view that the next move in interest rates is likely to be up, not down. However, the lack of unit labour cost pressure argues against any meaningful upside wages pressure, so the next rate move remains some way off into the future. We still expect no RBA rate change for another nine months at least.

Paul is chief economist for Citi Australia