Australian economy not as weak as June quarter GDP figures suggest

It wouldn’t be at all surprising if politicians and other commentators who have never seen an increase in interest rates that they thought was warranted seized on yesterday’s June quarter national accounts as grounds for criticizing the Reserve Bank’s decisions to lift interest rates in May and again in August.

After all, yesterday’s figures show that the Australian economy grew by a mere 0.3% in the June quarter, the smallest increase in three years, and by just 1.9% since the June quarter last year, the smallest annual increase in four years.

Yet, as was also the case with the attention-grabbing 4% increase in the consumer price index over the same period, it’s important to look behind the ‘headline’ figure in order to understand what the numbers are really telling us about the state of the Australian economy.

The key number in yesterday’s national accounts is that final domestic demand (that is, spending on goods and services by Australian households, business and governments) grew by 1.2% in the June quarter (or by 3.8% from a year earlier). Demand from foreigners (that is, exports) also grew by 1.4% in real terms.

However less than one quarter of this increased demand, from Australians or from foreigners, was met by increased Australian production of goods and services (which is what is measured by ‘real GDP’) during the June quarter. More than half of it was in fact met by ‘taking off the shelves’ things which had been produced in earlier quarters that is, by a run-down in inventories or stocks. And nearly one third of it was met by increasing imports (goods and services produced by foreigners).

It would thus be quite wrong to conclude from the weak ‘headline’ number for economic growth during the June quarter that the Reserve Bank had made a ‘mistake’ in raising interest rates last month, or that the likelihood of another increase in rates later this year had appreciably diminished.

Rather, what the June quarter national accounts show is that demand continued to grow strongly, notwithstanding the increase in interest rates in May (one-third of the way through the quarter) and generally rising petrol prices; but that Australian private and public enterprises found it difficult to meet that demand by increasing output.

In the absence of any compelling evidence that the constraints on the capacity of the ‘supply side’ of the Australian economy to meet demand during the June quarter were merely temporary and the only evidence along those lines is that some resources exports out of Western Australia were affected by cyclones this combination of strong demand and constrained supply suggests that ‘underlying’ inflation is more likely to rise than to fall.

And since ‘underlying’ inflation is already very close to the upper end of the Reserve Bank’s 2-3% target band, that in turn suggests that interest rates are more likely to rise than to fall over the months ahead.

Of course, yesterday’s numbers tell us absolutely nothing about how the economy has been affected by the August interest rate rise.

Indeed, apart from the sharp fall in consumer confidence which followed that move, we have yet to see any ‘hard’ evidence, one way or the other, as to the reaction of households and businesses to it.

However we do have at least some evidence to suggest that the tax cuts which took effect from the beginning of July and which, in aggregate, more than outweigh the impact on household finances of the two increases in interest rates and the rise in petrol prices so far this year have boosted household spending.

The Reserve Bank will therefore be watching closely the flow of official and private sector data over the next few months to ascertain whether domestic demand slows in response to the most recent increase in interest rates, thus making it harder for firms to pass on higher labour and other input costs on to their customers in the form of higher prices for goods and services (which will show up, one way or the other, in the September quarter CPI to be released in late October); or whether the tax cuts and other positive influences on real incomes and spending outweigh the effect of higher interest rates so that domestic demand remains strong, allowing underlying inflation to rise further.

All of which means that the Reserve Bank is unlikely to raise interest rates at its next meeting in October, but that a rise in November remains a distinct possibility.

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harry clarke
15 years ago

Saul, I’d be interested In your views on what seem to be very high rates of growth in broad money aggregates over recent years – since 2002. In fact they have been pretty high for longer than that.

Is this driving irresponsible lending and an eventual collapse with much higher interest rates?

Overall growth has slowed over the last few years and inflation is quite high.

Jc
Jc
15 years ago

Soul
Good post

Here’s my take.

CPI
we’re basically seeing energy/ commodity prices catching up. Whereas most of the increase was initally absorbed by a stonger Aussie dollar ( went from 50 cents to 75) the recent increase in commodity prices could not be so well abosrbed seeing the $A has been basically flat for the past few years.

Economic growth

The real worry is that we are starting to see a slowdown in manufacturing particularly in the big ticket long lead time capital equipment. A lot of the growth in hiring is at the closet point to the consumer, which is the last part of the economy to fell the pain. In other words employment is a lagger and really indicative of whats going on.

Worst worry
Cash rates are now well above the 10 year bond rate and any more inversion ought to be watched really carefully as it does portend to a slowdown. Even now it’s very inverted.

RBA’s concerns
They’re spooked by the bad CPI are looking at employment growth and silently concerned with what it means for the C/A.

The cash/bond rate invserion is really worrying when one considers whats going on with manufacturing.

Lastly … what Harry said but in spades. They have been adding so much that braod money has expoloded the aggregates.

Looks like we’ve peaked and the bottom of the barrel could easily fill up with over leveraged consumers without jobs but lots of debt by middle of next year.

am i wrong to think like this?

Saul Eslake
15 years ago

Both Harry Clarke and ‘jc’ point out, correctly, that money supply and credit have grown rapidly – more rapidly than broad measures of economic activity such as nominal GDP – in recent years (indeed, as Harry says, for much longer than that).

As my colleague Paul Braddick has explained in a paper he presented to a conference in May this year (which can be downloaded from our website at http://www.anz.com/business/info_centre/economic_commentary/CreditGrowth.pdf) this reflects (and has contributed to) not only the sustained economic growth which Australia has enjoyed since the early 1990s but also the on-going upward trend in prices of assets such as property and shares and structural changes in the financial system which have led to credit becoming more widely available on more competitive terms.

But as Paul says, “we do not believe a household balance sheet correction is imminent”.

Without doubt some participants in the financial system have extended credit on terms which, with the benefit of hindsight, will be seen to have been unduly generous, if not irresponsible. That’s what is meant by the saying “it’s only when the tide is going out that you get to see who’s been swimming naked”.

‘Jc’ is also correct to point out that the ‘yield curve’ is now inverted, that is, short-term interest rates (such as the cash rate or the yield on 90-day bank bills) are currently higher than long-term interest rates (such as the yield on 10-year bonds). Historically, an inverse yield curve has been a precursor of a down-turn in economic activity.

In recent years, however, long-term interest rates all around the world have been ‘held down’ by the low level of cash rates in most economies (other than Australia) as major central banks sought to ward off the risk (as they saw it) of deflation after the ‘tech wreck’ of 2000-01; and, according to some analysts (including Ben Bernanke before he became Chairman of the US Federal Reserve), the massive buying of long-term bonds by Asian central banks associated with their huge build-up in foreign reserves funded by their substantial current account surpluses. Some analysts also argue that long-term yields have been ‘pulled down’ by increased purchases of bonds by pension funds after following the ‘tech wreck’.

Because Australian long-term interest rates are much more influenced by long-term rates in major overseas financial centres than are Australian short-term rates (which are in turn largely determined by market expectations of where the Reserve Bank will set the cash rate), these global factors have contributed to the present inversion of the Australian yield curve.

For that reason, I’m skeptical that the present inversion of the yield curve is telling us as much about the outlook for the Australian economy as it has done in the past. Time will tell whether I’m wrong about that!