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Australian GDP: steady as she goes

What Happened?

Australian GDP grew 0.6% in Q2/2013. The pace of growth was  marginally above the (downwardly revised) 0.5% recorded last  quarter. Annual GDP growth increased from 2.5% to 2.6% in the quarter, but remains slightly below trend (generally seen as  between 3% and 3.5%). More subdued growth over the past year reflects the headwinds of an unwinding of the resource investment boom and a lag in the domestic economy in responding to the stimulus of lower interest rates. Evidence of improved domestic economic activity in the  Q2/2013 figures remains tentative at best. However, GDP figures  are always very backward looking and more recent partial  indicators of economic activity have lent some support to the proposition that this transition of economic drivers is underway.

The Composition of Growth

Lower interest rates are yet to entice less cautious consumer behaviour. Household consumption growth slowed further to 0.4% in quarter, with the annual pace of growth slipping to 1.8% and its lowest level since the depths of the global financial crisis (GFC) in 2009. Likewise, the household saving rate edged 0.3 percentage points higher to 10.8% of household disposable income, its highest level in two years. Despite this weakness, household consumption is the largest component GDP and still contributed 0.2% (or a third) of the growth recorded in the quarter. Dwelling investment again disappointed in Q2/2013 and contributed nothing to GDP growth for the second consecutive quarter. Over recent quarters it has been the case that investment in new dwellings has grown, but has been offset by weakness in alterations and additions investment. However, this quarter was the opposite with new dwelling investment declining 2.1% and alterations and additions rising 1.9% Business investment and public sector investment figures have once again been greatly skewed by second hand asset transfers from the public sector to the private sector. As a result, business investment contributed 1.3 percentage points to growth in the quarter and public sector subtracted a roughly equivalent 1.4 percentage points. Abstracting from second hand asset sales, business investment levels were soft, reflecting the impact softening mining sector investment. Non-residential construction of new buildings fell 1.6% in the quarter, new engineering construction fell 0.8%, while machinery and investment declined 2.5%. Similarly, second hand asset transfers accounted for all but 0.1 percentage points of the 1.4 percentage point contraction from public sector investment in the quarter. Net exports made a neutral contribution to growth in Q2/2013, after contributing 0.9 percentage points to growth last quarter. Exports continued to grow in spite of deterioration in the terms of trade in the quarter, expanding 1.3%. However, the impact on GDP growth was offset by a 1.6% increase in imports. In annual terms, exports have increased 6.4% over year-on-year, while imports have declined 1.8%. The decline in imports reflects in part reduced imports of bulky capital goods as the resource investment boom slows. Inventories had a significant influence on GDP in the quarter, contributing 0.2% to GDP growth after two consecutive quarters of subtracting from growth. Weak sales growth in the quarter suggests the rise in inventories was largely unintentional. By State After a sharp decline last quarter, Western Australian State Final Demand (SFD) bounced back strongly and recorded the strongest growth (1.3%) of all states in Q3/2013. Queensland (0.6%) New South Wales (0.5%), South Australia (0.5%) and the ACT (0.3%) all recorded moderate growth in SFD in the quarter, while Victorian SFD stalled this quarter. Over the past year, growth has been strongest in Queensland (1.8%) and weakest in South Australia (-1.3%) and Western Australia (-1.0%). A slightly broader measure of state economic growth is given by looking at SFD plus international Net Exports (the difference between this and Gross State Product is interstate net exports). Queensland and Western Australia remain the strongest states on this measure, with South Australia and Victoria lagging, and NSW somewhere in the middle.

By sector

Only two out the 19 industry sectors contracted in Q2/2013, 14 recorded growth in Gross Value Added (GVA), while two were broadly unchanged in the quarter. This represents an improvement on the past two quarters where around six industries have experienced contraction in each quarter. The two sectors that contracted in Q2/2013 where the electricity, gas, water and waste services and the transport, postal and warehousing sectors.Information and telecommunication (2.4%) and financial and  insurance services (2.1%) recorded strong growth in GVA in the quarter, but perhaps most encouraging was a 1.9% rise in construction sector GVA after several weak quarters of growth. Mining sector GVA rose 0.6% in Q2/2013, which is a much slower pace of growth than over recent years and masks wide differences growth across the sub-sectors of the industry, including a 7.4% decline in exploration and mining support services.

Implications

The Q2/2013 national accounts data showed an Australian economy that is subdued and vulnerable during the transition in drivers of growth from the mining sector investment to domestic economic activity. There is still very little evidence of improved household consumption or dwelling investment activity to date, while a fall in business profits (gross operating surplus of corporations) of 3.2% in 2012/13 confirms that businesses have been doing it tough. Nevertheless, there is equally no real evidence that conditions are deteriorating and that lower interest rates will not still have their desired effect. Indeed, more recent partial economic data have been slightly more positive, particularly in the housing market, which lends some support to the proposition that this domestic recovery may be getting under way. There also remains a perception that a clear Federal election result will boost business and consumer sentiment and help any emerging recovery gain momentum. Often perception can become reality and sentiment is certainly the hardest thing for economists to predict. As well as improving domestic demand, exports should prove a boost to GDP growth in coming quarters. The price of several of Australia’s key commodities, particularly iron ore, has recently recovered, while the 15% depreciation in the Australian dollar (AUD) will also boost income for many resource contract  denominated in US dollars. The lower AUD should also support other Australian exporters and dampen import growth, making net exports a strong contributor to growth. The Reserve Bank of Australia (RBA) has maintained an easing policy bias since cutting the cash rate to a record low of 2.50% in August. Subdued inflation pressures have afforded them the scope to support domestic demand with such a stimulatory position. However, recent stronger house price data will concern the RBA that this stimulus is going directly into house prices rather than boosting construction and consumption. Notwithstanding on-going global risks, the RBA should still have the luxury of at least a few months to see how the domestic recovery evolves, but it is certainly becoming less clear which direction the next move in rates will be.

For Property

From a broad property perspective, the fundamentals of the Australian economy are still solid: unemployment is relatively low, wages are rising and population growth is strong. Nevertheless, the transition of economic drivers is clearly being felt by property markets, particularly office markets. The impact of slowing resource investment and contraction in the public sector is clearly evident in office markets across Australia, while a broader more general pick-up in other sectors of the economy is not yet evident. For retail and industrial property markets that are more domestically orientated and that have been largely immune from the mining boom, there is increasing evidence that business confidence is slowly improving from the bottom up and that leasing activity is improving. For capital markets, Australia’s relatively stable economic outlook remains appealing to offshore investors. While the recent retreat in the AUD is an indicator that global sentiment has moderated slightly towards Australian assets, it should be recognised that the currency is still trading above post-float averages, and the weaker AUD may help convince some offshore investors that currency risks associated with Australian property investment have receded. At an even broader level, the recent volatility of financial markets appears to be supporting demand for physical property assets over financial assets. With the unwinding of quantitative easing programs in major developed countries still yet to play out, there is likely to be further volatility in bond and equity markets for some time to come. This should support property asset demand.

Retail Sector:

The caution that has been evident among consumers over the past few years was as evident as ever in Q2/2013. Household  consumption growth slowed to its slowest pace since the onset of  the GFC, and at 1.8% annual growth is well below long-term  average levels. Rather than receding, the household saving rate also rose in the quarter to 10.8% of household disposable income. Despite this weakness the Westpac/Melbourne institute consumer confidence index was a healthy 105.7 in August 2013 and has only dipped below the neutral 100 level once in the last 10 months. This suggests consumers are slightly more optimistic about conditions, but are taking the opportunity of lower interest rates to continue paying down debt levels (hence the still high savings rate) rather than spending the gain. For retailers, sales growth has been weak and recent retail turnover data suggests it has stayed weak into the third quarter. Price deflation in many retail turnover categories has affected turnover growth over the past few years, but the recent softening of the AUD is likely to see more upward price pressure emerge on imported items in coming quarters. The lower AUD is also likely to dampen the outbound international tourism boom that has led to significant leakage in spending over recent years, plus it should boost inbound tourism and make domestic retailers slightly more price competitive with international online retailers. All these factors should support stronger retail turnover ahead.

Nevertheless, a lower AUD could also mean further retailer stress. Price competition may mean that higher import costs cannot be passed on to consumers and that retailers need to absorb them into lower margins. The extent of this is likely to largely depend on whether interest rate cuts are ultimately successful or not in inducing some greater spending and strong retail turnover volume growth.We remain optimistic that at some point the process of household balance sheet restructuring will be complete and shoppers will reemerge. A post-election boost to sentiment, plus the boost to confidence from growing house prices might be the circuit breaker to boost consumption levels in late-2013 and 2014. Regardless, when consumers do re-emerge, they will have some fire power as a result of repayment of credit card and home mortgage debt. A return to pre-GFC levels of retail spending growth, which was fuelled by rising asset prices and rising household debt, is unlikely in the near future.

Office Sector:

The impact of generally weak business sentiment is clearly evident across all major office markets. The first quarter of the year saw particularly sharp negative net absorption across the major CBD markets, which reflected public sector contraction in a number of markets as well as the cooling of the resource sector, particularly in Perth and Brisbane. These factors were again present in Q2/2013 and net absorption was again negative across the major CBD markets, but this impact of these factors has already started to recede. Much of the negative net absorption and the rise in vacancy that has been recorded in 2013 has been a result of sub-lease vacancy. The sub-lease market is very sentiment driven and historically has turned around quickly once a recovery begins. As discussed above, there remains a widely held hope that business sentiment will pick up after the September 7 federal election, which may well become self-fulfilling. White collar employment will likely lag a general economic recovery and make the office sector one of the last parts of the property industry to enjoy stronger demand. However, an improved outlook will give businesses the confidence to once again start factoring in growth to their accommodation requirements and prompt the reduction of sub-lease vacancies. Such a decline in the sub-lease vacancy will bring forward an improvement in the office sector ahead of a real pick up in hiring. We believe the Australia’s major office markets are approaching a trough in 2013. Real improvement in demand will be slow and unlikely to gain momentum until into 2014. Recent data suggests that business profitability has improved slightly and productivity growth has increased substantially. In a slow sales environment, this is likely to reflect a strong cost focus among corporates and labour shedding over the past 12 months. While this process is not conducive to office demand growth in the short-term, it is often a necessary precondition to future jobs growth that corporates reset their cost base and focus on productivity. While the relationship can sometimes break down, there appears to be a leading relationship between Gross Value Added (GVA) in the major white collar industries and CBD office market net absorption (Figure 5). The breakdown in this relationship in the early 2000s reflects the impact of international finance and insurance companies contracting in the period, particularly in Sydney and Melbourne. The weaker relationship at present at least partly reflects the impact of the resources sector, which is out of sync with other drivers of white collar employment. The good news is that GVA across these sectors has gained momentum over the past three quarters and annual growth has risen to 4.5%. This bodes well for an improvement in net  absorption in coming quarters.

Industrial Sector

Much of industrial property sector is highly cyclical and will be among the first to benefit from increased consumer spending and housing construction. Nevertheless, a large part of the demand that has existed over recent years has been from very large occupiers and has been counter-cyclical in nature. That is, many large warehousing and logistics operators have responded to a slower sales environment by looking at their improving their operational efficiency and their property holdings have been a large part of this efficiency drive. Modern automated warehousing and strategic location selection to minimise transport costs have been a large driver of this push. We expect this drive for operational efficiency to continue to drive demand, but to shift slightly down the size profile of occupiers that pursue such a strategy. This demand will increasingly be supported in our view by a bottom up recovery in tenant demand as domestic economic activity gains momentum. The lower AUD is likely to limit import volume growth, but it is also going to support manufacturers that have been struggling to compete globally for some time now.

Source: Jones Lang LaSalle Research

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