Look for the bad
It is perhaps a sign of the times when analysts and the media go trawling for bad news in what is on balance a reasonable economic report, such as Australia’s Q2 GDP report. The bad news in the report was that annual real GDP growth slipped from 1.7% y-o-y in Q1 2019 to 1.4% in Q2, the weakest result in a decade. The good news in the GDP report that went largely unremarked is that the annual growth rate is likely to lift in Q3, mostly because the year-on-year growth rate in Q2 2019 provides a measure that overstates how weak GDP growth was in Q2.
In quarter-on-quarter terms, real GDP rose by 0.5% in Q2 after an upwardly revised 0.5% gain in Q1. Effectively the annualised GDP growth rate was 2.0% in both Q1 and the first half of 2019. Going back to the second half of 2018, quarterly GDP growth rates were softer than in the first half of 2019. In Q4 2018 real GDP rose by only 0.1% q-o-q (0.4% annualised) and in Q3 2018 was up 0.3% q-o-q (1.2% annualised). In the second half of 2018 annualised GDP growth was 0.8% compared with 2.0% in the first half of 2019.
Real GDP growth has improved noticeably in the first half of 2019 compared with the second half of 2018. In the current quarter, Q3, and in Q4 2019 those softer growth readings in the second half of 2018 become the base quarter readings for the year-on-year comparisons and there is a very strong likelihood that measured annual growth will lift off the 1.4% y-o-y low point recorded in Q2. If quarterly real GDP growth just maintains 0.5% q-o-q gains, annual growth will lift to 2.0% y-o-y in Q4 2019. There are, however, several tentative signs in the Q2 GDP report that better than 0.5% q-o-q gains may be achieved in the second half of 2019.
The first tentative sign is in the main expenditure components of GDP and how they grew or contracted in Q2 and what they are likely to do going forward. Most expenditure components expanded in Q2, including household consumption expenditure, up 0.4% q-o-q in real terms, contributing 0.2 percentage points (pps) to total GDP growth in the quarter. Notwithstanding slight slippage in nominal retail sales in July, real household consumption spending is likely to grow at least 0.4% q-o-q in Q3, assisted by tax cuts boosting household disposable income; lower home mortgage interest rates; and signs of improving house prices limiting pressure on households to try and save more (interestingly, the household savings ratio fell in Q2 2019, boosting spending).
Another sign in Q2 that households and businesses are becoming less income-constrained was the growth rate in nominal income-based GDP, up 1.2% q-o-q and 5.4% y-o-y. Two major components of income-based GDP showed compensation of employees up 1.3% q-o-q, 5.0% y-o-y and the gross operating surplus (profits) of non-finance companies up 2.9% q-o-q, 14.9% y-o-y. There are quirks in the numbers, with much of the growth in employee compensation coming from employment growth rather than wages growth and profit growth bolstered by higher mineral prices, but it is still fair to say that measured income growth in Q2 is more consistent with households and businesses spending more rather than less freely in Q3 and Q4.
A further sign of better spending growth in Q3 comes from the spending items pulling down growth in Q2 housing and non-residential construction spending. In Q2, spending on dwellings fell 4.4% q-o-q detracting 0.2pps from GDP growth in the quarter while non-dwelling construction spending fell 5.9% q-o-q detracting 0.3pps. Neither of these two categories of spending are likely to lift in the near-term, but they are not likely to fall as much as they did in Q2, reducing their drag on GDP growth in Q3. While housing construction spending was falling in Q2 the first sign of improvement in housing sales started to show. Spending on ownership transfer costs rose 4.3% q-o-q contributing 0.1pps to GDP in the quarter.
Stronger home sales evident in rising Q2 ownership transfer costs; higher weekly auction clearance rates and most recently rising house prices in Sydney and Melbourne are likely to moderate the pace of decline in spending on housing construction. Other major contributors to GDP growth in Q2 were Government consumption spending up 2.7% q-o-q contributing 0.5pps and net exports contributing 0.6pps (0.3pps from rising export volumes and 0.3pps from falling import volumes). Government consumption spending is likely to keep rising – the ramp up of the NDIS scheme is a key reason why spending is rising rapidly. Export volumes continue to rise strongly. There are still likely to be more strong contributions to GDP growth from government spending and net exports in Q3 and Q4.
In summary, Q3 2019 GDP growth and Q4 should match and will probably better the quarterly growth rates in Q2 2019 and Q1. That means annual GDP growth measured year-on-year will lift above 2% in Q4 2019, well off the 1.4% y-o-y low point just recoded for Q2. Maybe that is not very good news, but it is certainly not bad news.