Australian economy maintains strength in Q4 2015 aided by consumption, supporting central bank's decision to hold interest rates

After a strong recovery in exports drove the leading contribution to growth in the September 2015 quarter, Australia's growth slowed in quarter-on-quarter (q/q) terms during the December quarter. However, the December-quarter result was better than expected, despite the net export position providing no support to growth. Between upward revisions to previous quarters and better-than-expected growth in the December quarter of 2015, Australian annual real GDP growth came in at 2.5% for 2015, marking a decent performance in light of global economic conditions.

Domestic demand supportive of growth during the quarter, despite mixed performances

Consumption and inventory-building offset continued weakness in private-sector fixed investment activity during the December quarter. Private consumption was the primary growth driver, adding 0.4 percentage point to growth, although it is noted that consumption activity slowed marginally against the previous quarter. Based on data from the Australian Bureau of Statistics (ABS), the most notable shift in consumer spending during the December quarter was the 3.2% q/q (in real [volume] terms) plunge in motor-vehicle purchases, with spending appearing to shift towards recreation and culture as spending on that category rose 2.6% q/q. Government-consumption growth also surprised on the high side during the quarter, driven by increased non-defence spending by the federal government and increased state-level expenditures. An additional significant growth driver was inventories – though this inventory build-up is a cause for concern, since there was a significant increase in the retail-trade sector, hinting at demand potentially falling short of expectations. Also of note was a significant plunge in manufacturing-sector inventories as the sector shrank 2.1% q/q, with most of the fall led by coal and metal products, and machinery and equipment.

Regarding fixed-investment activity, government investment made a positive contribution to growth – worth 0.2 percentage point – due to public-corporation investment activity. There were also minor positive contributions to growth from dwelling construction (up 2.2% q/q in real terms), and machinery and equipment investment, which rose for the first time in over one year (up 1.8% q/q). However, the continued unwinding of mining-sector-related fixed investment unsurprisingly outweighed all other factors, with the related fixed investment into new engineering construction contracting 12.3% q/q to deduct 0.6 percentage point from growth.

External trade made no contribution to growth, current-account deficit widened under terms of trade pressure

The zero-impact on growth from the net export position was a favourable result; exports could potentially have retrenched sharply after the weather-related recovery in the September quarter, while imports could have likewise recovered after a significant fall. Although the ABS does not release a break-down of export volumes by type in its national accounts data publication, it does so in the equivalent balance-of-payments (BOP) publication, in which the bureau has pared down the data to solely reflect goods versus services. These data show that in real terms, goods exports rose a meagre 0.3% q/q after rising 5.5% during the September quarter. As a result, services exports were the more significant driver of real export growth during the quarter. Imports were fortunately subdued during the quarter, with goods imports rising just 0.5% q/q against a rise in services of 1.0% q/q. This is largely due to the unwinding of mining investment owing to its heavy reliance on capital-goods imports, as well as the weakness of the Australian dollar discouraging imports.

While the net export position had no effect on growth during the quarter, it should be noted that a significant deterioration in the terms of trade had a huge impact on the current-account balance. The current-account deficit rose 12% q/q, despite a 3% q/q narrowing of the dominant primary-income-account deficit on the back of the merchandise-trade deficit jumping 47.5% q/q. The merchandise-trade deficit was dragged down by a 3.2% q/q worsening of the terms of trade – with the data indicating a 4.9% q/q plunge in goods-export prices versus a 0.7% q/q fall in goods-import prices – as major export commodities prices underwent a further bout of weakness in the December quarter.

Central bank continues to monitor data, but remains open to policy easing

The Reserve Bank of Australia (RBA) met on Tuesday (1 March) – one day prior to the GDP release, but at that time the only components of GDP not already released by the ABS were the private-consumption figures. The RBA regardless decided that the incoming data pointed to an economy not in urgent need of monetary stimulus, as the bank left the leading interest rate on hold at 2.00% for an 11th consecutive month. The policy statements made by governor Glenn Stevens following the decision did not differ substantially from those made in February; Stevens alluded to more recent economic trends, including more favourable labour-market conditions in the final months of 2015, and low headline inflation. The sole major difference in the governor's sentiment from the previous statement was replacement of the word "may" with the more assured "would" in a statement confirming that "continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand". Stevens' comments hint more specifically at the bank's openness to additional interest-rate cuts to bolster demand if necessary; but all of the governor's other statements indicate that the bank remains committed to monitoring the data rather than taking specific action at this time.

Outlook and implications

The stronger-than-expected growth in the final quarter of 2015 should place Australia on a surer footing for 2016. IHS expects to modestly upgrade our 2016 forecast as a result, but we do not expect growth to exceed that recorded in 2015. There are a significant number of downside risks and pressures constraining the growth outlook: the export outlook is unlikely to improve in 2016, being affected principally by a continued deceleration in the Chinese economy as it gradually moves away from heavy industry. This will continue to weigh on the terms of trade and profitability of firms in the mining and energy sectors, and may begin to undermine production. The major upside to the export outlook is Australia's new liquefied natural gas (LNG) projects coming online over the next year, in which export volumes are under contract and are therefore not as heavily affected by prices. Imports will remain constrained by the weak investment environment, but these trends will eventually reach a trough.

On the domestic-demand front, household consumption could remain a growth driver, supported by low interest rates and healthy housing-sector activity. Conversely, this will remain constrained by weak growth in wages, which is limiting growth in household disposable income and will ensure that households remain frugal, choosing between "luxuries". Considering fiscal pressures from weaker revenue inflows, government consumption activity may become less supportive of growth over the next year, depending on the direction of the government's forthcoming 2016 budget. The fixed-investment situation will remain dominated by the unwinding mining boom: this is unavoidable, due to the magnitude of build-up as well as the lack of significant improvement in non-dwelling, non-mining business investment. Considering the factors outlined above, IHS expects the RBA to cut interest rates at least once more in the first half of 2016, in order to strengthen confidence and bolster households and the non-mining sector.