Weekend Economist: State of the states

The Australian economy lost momentum from mid-2012 as world growth slowed, mining investment peaked and domestic headwinds persisted. GDP growth at 0.6 per cent per quarter, 2.6 per cent a year in the June quarter 2013  is clearly below trend. So where to from here? GDP growth is forecast to be 2.2 per cent in the year to the second quarter of 2014, improving gradually to 2.5 per cent in the year to 2014 fourth quarter. This is as international conditions remain challenging.  It is instructive to inform our view on the Australian economy via a state-by-state assessment.

Our analysis of the state economies reinforces our big picture view: namely, that current conditions are subdued and that any near-term improvement in conditions is likely to be gradual.

In the June quarter 2013, domestic demand nationally expanded by a tepid 0.3 per cent and annual growth slowed to 0.6 per cent. The loss of momentum evident at the national level is apparent across each of the six states.  Victoria reported flat demand in the June quarter, Tasmania another decline, while a gain of around 0.5 per cent was recorded in Queensland, New South Wales and South Australia. In Western Australia, demand was up 1.3 per cent, but that failed to reverse hefty declines over the previous half year.  In the mining states of WA and Qld, mining investment is cresting.  This has led to a sharp slowing of domestic demand and the effects are being felt beyond the mining sector. Across the southern states of Victoria, South Australia and Tasmania, demand conditions have been particularly weak against the backdrop of sub-trend global growth and a still relatively high dollar. Consumers and business alike have been reluctant to spend. Consumer spending growth slowed across every state over the past year.

The most abrupt slowdown was in the mining states of Western Australia and Queensland. Consumption increased by less than 2 per cent nationally over the past four quarters, and no state exceeded 2.5 per cent. Household wage incomes came under greater pressure as labour markets softened. In addition, households remained focus on maintaining a high saving rate and paying down debt. 

We assess that the household sector is at a turning point. Interest rates declined further in August to be around historic lows. The housing sector is responding and house prices are advancing. A more positive consumer mood is now apparent, which points to some improvement in spending momentum.  We anticipate only a gradual improvement in consumer spending.  Labour market conditions will remain critical to household income growth and to consumer spending, absent a material fall in the household saving ratio. Notably, firms remain cautious about hiring and we see the risk that jobs growth disappoints. Job ads are soft and have weakened across each state.

Businesses have revealed a preference to use overtime to meet fluctuations in new orders.  A cap on public sector employment is another factor weighing on labour market conditions. This reflects an attempt by state governments across the nation, as well as the Federal government, to repair their budget position.  The strength of the Australian dollar, significantly eroding the competitiveness of the trade exposed sectors, is adversely impacting the labour market. The bounce in the currency to US95¢ (well up from US89¢ a month ago) on the Fed's decision to delay tapering underscores the challenges faced by Australian business in the current world of unconventional monetary policy. 

Australia's housing upturn is gaining more traction and media attention, with some already speculating a bubble may be brewing. While conditions are clearly strong in the Sydney  auction market, with a record 80 per cent plus average clearance rate in September so far, the housing recovery overall looks far more mundane, with conditions much more uneven outside of Sydney.

Price-wise, all major capital cities are now recording growth, although conditions vary markedly. Annual growth remains below inflation for Brisbane and Adelaide, 'middling' for Melbourne and at a more robust single-digit pace for Perth and Sydney.  Finance approvals have shown a gradual upturn so far, but an upturn nonetheless coming across all states. First home buyers remain a clear weak spot. Dwelling approvals are showing a more muted recovery. Construction has been high in Vic but very weak elsewhere with clear under-building in NSW, Qld and WA.  Business investment spending weakened over the first half of 2013.  Nationally, business investment in the first quarter of 2013 was 1 per cent lower than a year earlier, in contrast to a 20 per cent rise the year prior. Over the past year, business investment contracted in each state, except Qld ( 7 per cent), ranging from declines of 3.5 per cent in NSW and Victoria, to a 6.5 per cent drop in WA and an 11 per cent fall in Tasmania. 

Household demand growth slowed to a below trend pace and business cut investment accordingly. As discussed above, we assess that household demand is now set to strengthen, albeit modestly. This and a bounce in business confidence point to a lift in business investment in the non-mining sectors, but this is more likely in 2014 given significant excess capacity across the economy.  By contrast, mining investment will deflate over the next five years, from almost 8 per cent of GDP in 2012/13 to around 3 per cent in 2017/08. 

State governments across the south-east expect a strengthening of economic growth in 2013/14. An upturn in housing construction in response to historically low interest rates will be a key driver of this improvement. Critical will be the flow-on effects to consumer spending and business investment.  This outlook is also premised on an improvement in international conditions, with world growth strengthening from the current subtrend rate of 3% to around 3.8% in 2014.

If international conditions disappoint in 2014, as we anticipate, then this would pose a downside threat to these forecasts. The mining states of WA and Qld expect a loss of momentum in 2013/14. The run of outperformance has most likely come to an end. Mining investment is deflating, with spill-over effects to other sectors, transmitted in part by a softening of jobs growth and of wage incomes. Mining export volumes are expanding, but the largest step-up — particularly for gas — is beyond 2013/14.  Our quarterly publication "Coast-to-Coast", to be released on Monday, will provide a more comprehensive review of the states.