SCOREBOARD: GDP setback

The data

- Australian GDP was weaker than expected, rising just 0.4 per cent, compared to my forecast for 1 per cent and the market's forecast for 0.8 per cent. This follows a downwardly revised rise of 0.8 per cent in the third quarter (was 1 per cent). Annually, GDP is 2.3 per cent higher.
- GDP by expenditure was up 0.8 per cent, by production it rose 0.3 per cent (after 0.8 per cent in the third quarter) and it rose 0.3 per cent by income (in the third quarter).
- Real gross domestic income fell 0.6 per cent in the quarter, after a 1.6 per cent rise, to be 3.9 per cent higher annually.
- The main detractors to GDP (expenditure) were farm inventories which took of 0.6 percentage points from growth, private investment which took off 0.4 percentage points and housing which took off 0.2 percentage points.
- Excluding inventories and exports, domestic demand was soft this quarter, rising 0.2 per cent quarter-on-quarter, after a 2.2 per cent, gain, to be 4.4 per cent higher annually.
- The key drivers of this rise in domestic demand were household consumption (plus 0.5 per cent quarter-on-quarter), public consumption (up 1 per cent) and public investment (also up 1 per cent).
- In nominal terms, GDP rose 0.5 per cent quarter-on-quarter to be 5.6 per cent higher annually.
- The household savings ratio fell to only be up 9 per cent from 9.6 per cent last quarter.
- The terms of trade fell 4.7 per cent in the third quarter and is 7 per cent higher annually.

Well as it turned out my initial concerns on Monday about a weak GDP print were borne out. Never change a good forecast, right? Not really because the composition of GDP was all over the place. GDP on an expenditure basis (on which forecasts are primarily based) did indeed come in broadly as expected at 0.8 per cent. But, GDP by income and production was weak at 0.3 per cent a piece. Income, fair enough, profits fell. But I wasn't expecting the weakness on the production side to be honest which is why, following leading indicators on the expenditure side, I lifted my forecast to 1 per cent.

Realistically it doesn't change anything although as I mentioned on Monday, my expectation is that the call for the RBA to cut rates will pick up now. Some analysts will likely note this as a material decline in economic activity – which demands a response from the RBA. Certainly, I think market pricing will move in that direction and I'd note that this process was already building in the lead up to the GDP figures. Some analysts had been suggesting (wrongly in my view) that this number today was a line in the sand. Unfortunately, life is not that simple. Just as the third quarter wasn't a line in the sand – where we saw the strongest demand growth in four years – neither is today's data.

Volatility is the issue here and these accounts are showing plenty of it. Check it out – machinery investment up 8 per cent in the third quarter, down 2 per cent in the fourth quarter, building up 12 per cent in the third, down 4.5 per cent in the fourth– etc, etc, you get the gist. Thing is, it's all related and on the production side of the accounts, third quarter construction was up 4 per cent in line with strong investment on the expenditure side, but down 2.4 per cent in the fourth quarter – in line with investment on the expenditure side. Accommodation rose 2.2 per cent in the third quarter and fell 2.2 per cent in the fourth, in what was likely a weather related decline – it's been an atrocious summer, let's face it. Excluding those two components, GDP by production would be up about 0.8 per cent.

The smartest thing to do when you are confronted with so much volatility, rather than jumping at shadows, is to smooth things out. Was the economy really growing at its fastest pace in four years in the September quarter? Probably not. Neither is it weak for the fourth quarter. Smoothing it out we have GDP averaging 0.6 per cent quarter-on-quarter and domestic demand at a much stronger 1.2 per cent quarter-on-quarter. That's demand at an annualised pace of 4.8 per cent in 2H11 which is well above trend. GDP is below trend at 2.4 per cent in 2H11 – because of the floods and because of the extraordinary strength in import growth – annualised at 13 per cent for the half year which is nearly twice the average. I've said it a million times before and I'll say it again – strong import growth does not point to a weak economy.

For mine then, It would be a mistake to characterise growth as soft right now. That isn't what today's numbers show when you look at it in detail.
There are a few other points of interest I'd like to highlight. Manufacturing is widely regarded as being weak but today's accounts show this as a misnomer. Manufacturing grew at a solid 1.2 per cent this quarter to be 3.5 per cent higher annually – growth in the 2H11 annualised to 6.2 per cent! That's strong. Obviously this is good growth and at odds with the anecdotes.

On the household spending front. Growth at 0.5 per cent isn't great – it's not the stuff of recession but it is well below the average of 0.8 per cent. Again, this follows solid growth over the last three quarters, and was largely the result of softness in three key areas, where previously, we have seen extraordinary strength. That is – ‘recreation and culture', ‘cafes and restaurants' and ‘furnishings and household equipment'. These babies have posted growth of about 1.5 per cent per quarter over the last three quarters – 6 per cent annualised. All we've seen this quarter is a correction from that extraordinary growth, the trend hasn't changed, but it is unreasonable to expect these components to grow at 6 per cent annualised pace every quarter. That's not how the data rolls. So this quarter, spending in those three components fell – each down about 0.1 to 0.3 per cent. That doesn't mean a change in trend and the thing is, spending momentum outside of these components was little changed, growing at 0.8 per cent quarter-on-quarter after a 0.8 per cent quarter-on-quarter increase last quarter (see below chart). To me that suggests consumer spending momentum was unchanged this quarter – and again, we are just witnessing volatility.

The bottom line? Today's number was softer than expected, but it is misleading in my view to now characterise the economy as weak following the strongest growth in four years that we saw in the third quarter. I would certainly be very surprised if the RBA's view on the economy has changed after today's result, noting the very evident volatility. Consequently, I maintain my view that the RBA is on hold for some time, with the next move a likely hike in the fourth quarter. As noted though, I expect market talk for a near-term cut to increase with pricing to move accordingly.

Adam Carr is senior economist at ICAP Australia. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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