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Economic and Financial Market Update: Travelling In Top Gear

04 June 2021

Summary:

The economy was doing a lot better than anyone had envisaged in the March quarter;
And further good news is on the way;
But not all regions and sectors have done well;
COVID remains the key short-term risk to the economy.

For the third quarter in a row the Australian economy busted all expectations. The leading indicators look good. The third Melbourne lockdown is a negative (particularly for Melbournians). There will be an impact on the economy. But the history of the past six months suggests that the impact may not be big (providing the lockdown doesn’t extend much past two weeks). While the aggregate economy is now bigger, that is not the case for all industries. A number of sectors are smaller in size than they were pre-COVID.

As is typical in the early stages of an economic recovery, consumption is leading the way. The main driver has been stronger consumption spending by the state and (particularly) the federal government. The pattern of household spending is starting to return to ‘normal’ (spending more on services).

In recent months firms have started to splurge on capex. Plant and equipment investment has notably risen, although the surveys suggest non-residential investment could also rise strongly over the next year. Government investment has been a growing positive for the economy. But actual government spending has not been as much as what they had planned on in last year’s budgets.

Residential investment has also picked up strongly, for similar reasons as the rise in business investment. The contribution to the economy from the building of new standalone homes may rise further in coming quarters. The other big plus for economic growth in the March quarter was a significant rise of inventories. Inventory levels still looks low when compared to sales, particularly for retailors. This suggests that stock rebuilding may still be a positive for economic growth in coming quarters.

One of the reasons that households are happy to spend more is that their disposable incomes are growing (despite the fall in social benefit payments). The reason is that more workers are in jobs (although their wages growth has been modest). There are few signs that the end of JobKeeper at the end of March will have a significant economic impact. Intriguingly, household saving rates remain elevated. Declines in the household saving ratio are very likely over the next 1-2 years.

Not all states are enjoying the same economic momentum. The mining states have done best. By contrast, the lockdowns have hurt the Victorian economy. And the lack of students and international travellers has been a negative for the two largest states. But all states need to do better. All states unemployment rate remain well above the 4.5% level that Treasury has suggested is ‘full employment’.

What are the key implications from the release of the GDP numbers. First, the economy is doing a lot better than what anyone had thought. And the forward indicators suggest that there are further good times ahead. Second, there is very strong demand. The question is whether supply constraints that are struggling to meet the strong demand are short- or long-term. The answer to that question will determine the outlook for inflation. And the outlook for interest rates.

Third, the numbers are a reminder that although the outlook for the Australian economy is good there are areas of the economy not doing well. Finally, events over the past couple of weeks is a reminder that while Australia has largely handled the virus well COVID remains the biggest short-term risk to the outlook.