GDP growth in the September quarter printed at 0.5 per cent. This was broadly in line with expectations (market median 0.6 per cent and Westpac 0.6 per cent for the quarter, 3.1 per cent for the year). This follows a rise of 1.4 per cent in the March quarter and growth of 0.6 per cent in the June quarter. Annual GDP growth moderated to 3.1 per cent, from 3.8 per cent.
The Reserve Bank has indicated that its key policy priority is to rebalance growth towards the interest rate sensitive parts of the economy. Having reduced the cash rate by 125 basis points in the lead up to the September quarter, they would have been encouraged by the strong recovery in new housing construction (up 3.7 per cent), and plant and equipment investment (up 6.2 per cent).
However, that encouragement would have been more than offset by the tepid growth in household spending (up 0.3 per cent), the weakest quarter since March quarter 2010. A weak overall domestic demand outcome of only 0.2 per cent was driven by a plunge in public spending of 4.4 per cent, including a collapse in public investment of 18.8 per cent (all states experienced a sharp downturn in public demand). While this result will be a one-off, it highlights the difficulties faced by a fragile economy where the public sector, both commonwealth and state, is tightening policy.
Soft household spending was driven by weak income growth compounded by households' insistence on maintaining a high savings rate. Labour income contracted by 1 per cent (in real terms), with annual growth slowing to just 2.2 per cent. Lead indicators point to ongoing softness in employment and wages growth, indicating that income growth is likely to remain modest in 2013.
With their leverage still near record levels, households perceive the need to sustain a high savings rate (only down slightly from 10.9 per cent to 10.6 per cent). That points to subdued prospects for household spending. Lower interest rates will support disposable income growth, while a recovery in the housing market will boost employment and confidence. However, this report emphasises that there will be a considerable challenge to stimulate discretionary spending.
The key will be business investment outside the mining sector.
The third quarter rise in plant and equipment investment appears to be concentrated in mining, a lumpy jump in telecommunications and a double digit spike in vehicle sales encouraged by a tax break.
Surveys of broader investment intentions indicate that this surge in business investment is unlikely to be sustained. Certainly no encouraging signal from business' customer base – the household sector – is apparent in this report.
In summary, the Australian economy is being impacted by weak international conditions, public sector balance sheet contraction and persistent consumer caution at a time of labour market softness. Moreover, the peak in the level of mining investment is approaching. The turning point in the housing construction sector is at a hand, but the likely strength of the upturn remains uncertain.
With the Australian dollar remaining high and employment prospects looking subdued, it appears that the report is pointing to a need for further monetary stimulus. Hence we remain comfortable with our view that another rate cut can be expected from the Reserve Bank in the March quarter.
In that regard, we received a range of signals from the bank in keeping with our view that rates will go even lower.
Firstly, in the Governor's Statement following the decision to cut rates by 25 basis points at the December board meeting, he noted that the peak in the mining investment boom was approaching, showing a greater air of urgency than we had seen in previous communications from the bank.
Deputy Governor Philip Lowe noted in a speech on Wednesday that mining investment might plateau in the first half of 2013. Recall that the capex survey, which printed on November 29, saw a scaling back of mining expectations from growth of 33 per cent in 2012-13 to 18 per cent – also consistent with limited additional growth in 2013.
Dr Lowe was also not optimistic that we would see a return to strong consumption growth fuelled by households being prepared to reduce their savings and increase spending faster than income growth – despite the marked fall in interest rates. As we saw in the September quarter National Accounts, such behaviour can lead to very weak household spending when income growth slows.
Softening employment growth and a slow down in wages growth in 2013 do not indicate a strong boost to household spending.
Prospects for growth are being focused on housing and non-mining business investment. While the signs in the National Accounts were supportive of a turnaround in housing construction, there were some complications.
Firstly, spending on renovations and additions continued to contract, now being down by 12 per cent over the year. The decision to commit to renovations is likely to be influenced by similar factors to those that affect some components of consumer spending. Secondly, the National Accounts registered wide disparities across the states in new dwelling construction, with NSW (11 per cent), WA (12 per cent), and VIC (4.5 per cent) rising strongly while Queensland (-19 per cent) and South Australia (-5.7 per cent) were particularly weak.
As discussed above, the boost to non-mining investment in September was explained by a number of factors that appear to be unsustainable – prospects for the required substantial boost to non-mining investment then remain uncertain. Of particular concern is likely to be the impact of political uncertainty during an election year on business confidence and the propensity for businesses to delay implementing investment and employment plans during such periods.
In Dr Lowe's speech, he indicated ample flexibility around the policy outlook. Clearly the bank is relying on housing and non-mining investment to deliver its growth expectations. He indicated that there was a level of the cash rate below which lower rates would have little effect, but nominated 1 per cent as that level. Beyond that, ("hypothetically") unconventional means would be required.
However, he did not describe current conditions as comparable to the "emergency" conditions the world experienced in 2009, when the cash rate last reached 3 per cent. Policy was focused on private sector lending rates.
To date, the standard variable mortgage rate has reached 6.45 per cent, compared to 5.75 per cent during that "emergency" period. He also postulated that the "neutral" rate may now be lower than during that "abnormal" period, when spending, credit, and asset prices increased at a faster pace than incomes. Further, rates are likely to stay lower for longer in the "new normal" period.
Overall, current growth, risks to the outlook, and new insights from the authorities support our expectation that the cash rate will fall further in the March quarter.
Bill Evans is Westpac's chief economist.