The Australian economy remains in an unusual spot, beset by sluggish headline growth alongside sticky inflation, a relatively tight labour market and low productivity.
The national accounts data released last week show the Australian economy grew by a meagre 0.2% in the June quarter of 2024, and by only 1.0% over the past 12 months.
Outside of the pandemic, this was the slowest rate of real annual economic growth since the early-1990s recession, as well as the sixth consecutive quarter in which gross domestic product (GDP) per capita has contracted.
These headline growth figures also mask an unhealthy reliance on record government spending, given increasingly anaemic private sector activity.
The Consumer is Struggling Against High Living Costs and Interest Rates
Household consumption fell by 0.2% in the quarter – the weakest result since the September quarter of 2021, during the COVID-19 lockdown. With population growth running at around 2.5%, this means that per capita spending declined 2.0% over the past year.
Consumers have pulled back on non-essential spending, as they manage the pressures of higher mortgage rates and elevated inflation. Discretionary spending fell 1.1% in the June quarter, following a lift in the preceding three months.
Business investment also beginning to slow
There are signs that the weakness in consumer spending is spilling over into businesses. Private business investment fell by 1.5% in the June quarter, to be a moderate 1.6% higher over the last 12 months.
Housing Shortage Not Translating Into Stronger Construction
Strong underlying demand for housing is still failing to translate into strong dwelling investment, which rose by just 0.1% in the quarter and is still 3.0% lower over the year. The shortage of housing has been a key source of inflation due to rental increases. This has been exacerbated by booming immigration flows (now slowing).
Public Spending the Last Man Standing
In stark contrast to the softness in the private sector economy, total new spending by government (federal and state) continues to grow strongly and is now at a record share of the economy (27.3% of GDP, from the previous peak of 27.1% of GDP in the September quarter 2021).
This surge was led by social assistance benefits to households, expenditure on national programs providing health services, state and local government expenditure, and increased employee expenses across most states and territories. In nominal terms, public demand is booming (2.6% q/q; 8.7% y/y), which is undoubtedly contributing to the ongoing inflation pulse in the economy. Further growth is expected next quarter, as the cost-of-living measures announced in recent budgets come into effect.
Inflation Another Area of Strength in the National Accounts
The national accounts reinforce that inflation across the economy is still high; with the consumption deflator rising at a hefty 4.7% y/y. This measure of inflation remains much faster than headline CPI (1.0% q/q; 3.8% y/y), with the latter technically lowered by government subsidies.
Productivity Remains Weak
Productivity (i.e. GDP per hour worked)has fallen again (-0.8% q/q; 0.4% y/y) and is running well below long-term average levels. Hence, nominal unit labour costs are slowing, but remain elevated (1.2% q/q; 5.4% y/y); and too high for (underlying) CPI to sustainably fall back to the RBA's target band of 2% to 3% y/y.
Measurement difficulties associated with determining output in the non-market sector (health care, education etc) could be weighing on productivity estimates, but Australia’s productivity performance is clearly less than stellar (see figure 6).
Sluggish Growth but the Economy is Capacity Constrained
Apart from the drag of a maxed-out consumer, part of Australia’s growth problem is undoubtedly supply driven. Overall spending (including government spending) is still relatively high compared to the economy’s current supply-side potential. This is a complex problem, but centres around the interaction of relatively high interest rates (by recent standards) constraining investment, excessive net immigration and excessive government spending, alongside poor productivity outcomes.
In its recent August economic outlook, the RBA suggested that the Australian economy is battling against a positive output gap. This means demand is exceeding supply in an aggregate sense. The economy’s overall output gap is difficult to measure, but is likely to gradually become looser, with real GDP continuing to grow well below its long-term trend. However, this approach to fixing Australia’s supply-side problems is likely to be a torturous one.
Most Consumers Not Saving, Cutting Back on Non-Essentials
With the consumer stretched, it is unsurprising that the (net) household savings ratio held at only 0.6%, around the lowest level since 2007. However, we estimate that the stock of 'accumulated' savings since COVID is still large, at ~$200bn, or a ~13% share of annual household income. The issue is this accumulated savings pool is very unevenly distributed toward wealthier, older households.
In aggregate, real household disposable income remains a considerable 4.7% lower than in the September quarter 2023. Essential spending increased 0.5% in the quarter. This was led by utilities, which saw 2.4% growth due to a reduction in electricity rebates provided during the quarter, and increased demand for heating during the winter months. Food spending decreased by 1.0%, as higher prices forced households to turn to more affordable eating options.
Real GDP Growth Still Weak, but Inflation Remains Sticky - RBA to Stay on Hold Into 2025
While the pace of growth in the June quarter met the subdued expectations of economic forecasters, real GDP growth remains stubbornly weak. Importantly, inflation also remains relatively sticky across much of the economy.
With the benefit of tax cuts and other payments to households, growth will likely lift in the current September quarter. This suggests last week’s data might well represent the bottom of the cycle. As a result, we see recession risk as relatively low. However, we expect any pickup to be relatively subdued, while current imbalances within the economy remain worrying from a structural perspective. We see an RBA rate cut in February next year as close to the best case scenario, with the potential for sticky inflation to delay any rate cut relief.
Australia’s Rebalancing Challenges
Australia’s soft headline growth rate hides a worrying divergence of public and private sector activity. Indeed, Australia’s private sector has effectively ground to a halt, with only government spending keeping economic growth in positive territory. Household consumption has fallen in the past three months, despite population growth remaining strong. Indeed, real retail spending has gone backwards for almost two years.
The Australian economy is facing the challenges of an over-reliance on population increases and high government spending to support growth, which in turn is leading to sticky inflation and little in the way of productivity improvements.
Sluggish private consumption and moderating private investment should see easing inflation pressures in terms of both product and labour markets. This should ultimately allow the RBA to ease policy next year, which should help to rebalance the drivers of economic growth. It is proving, however, to be a drawn-out rebalancing.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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