Contraction in Q3 GDP raises questions about non-mining recovery

• Today’s National Accounts saw real GDP growth come in well below market expectations at -0.5 % q/q, with year-ended growth dropping to just 1.8% – below Australian growth potential. This is the first contraction in GDP since Q1 2011 and highlights the lingering risks to the growth outlook. Growth is forecast to remain well below 3% in the medium term.

• While the slowdown was relatively broad-based, our assessment is that the headline figure is probably overstating magnitude of the decline in the economy. Indeed, we do not anticipate another negative print in the December quarter – our early forecast is approximately 0.9% q/q, as a few one offs (such as weather disruptions affecting dwelling and non-dwelling construction, and the unwinding of strong public investment in Q2), although year-ended growth still only picks up to 2% y/y.  That said, softness in key categories such as household consumption and non-mining business investment, as well as in Victoria and NSW are troubling.

• Today’s figures, in conjunction with slowing employment and weaker business conditions, raise the possibility that the non-mining recovery has run out of steam earlier than expected. We remain comfortable with our view that the RBA will need to cut rates further in 2017 (see below for further detail).

• The weakness in GDP growth was relatively broad based in the quarter, with investment, public spending and trade all contracting. Dwelling investment saw a surprise decline in the quarter (‑1.4%), largely related to weather disruptions, although the extremely elevated construction pipeline suggests an increase in activity going forward.

• Household consumption was the only expenditure component to show positive, albeit fairly modest growth at 0.4% q/q. Nevertheless, indications going forward look somewhat mixed. Retail sales data has improved in recent months, but the NAB Business Survey has shown a clear deterioration in business conditions for retailers of late. As expected, mining investment contracted again in the quarter (as evidenced by another fall in engineering construction), with further declines still likely in coming quarters. Resource exports failed to provide an offset – despite the recent strength in prices – with net exports contracting 0.2 ppts from GDP. Non-mining private investment was a little more upbeat than expected, but that is not a trend that extends into investment plans for the year ahead. Public investment also declined, following strong growth last quarter, although given the large infrastructure initiatives underway, this component is likely to remain ‘lumpy’.

• The recovery in the non-mining economy has become much less pronounced, although the services sector still appears to be performing reasonably well – our estimates of non-mining GDP decreased by 0.2% in the quarter and year-ended growth eased to 2.6%.  The agricultural sector was a clear standout in the quarter, consistent with a bumper grain harvest. Elsewhere outcomes were generally soft. In particular, construction subtracted 0.3 ppts from GDP growth in the quarter. Some services continue to outperform. Finance & insurance, health and education meanwhile have enjoyed consecutive quarters of positive growth.

• State final demand (SFD) was soft across most states, with the weakness most pronounced in WA – driven by big declines in investment (both private and public). Tasmania and the ACT also saw declines in SFD, but Victoria’s decline was the most surprising – driven by a big contraction in public spending. NSW SFD growth also slowed noticeably to 0.1%, in line with softening employment and business conditions in the state. Queensland meanwhile encouraging signs of pickup in household consumption and private investment, although SFD was weak at 0.1% q/q.

• The terms of trade rose by 4.5% in Q3, and added to income growth – following a prolonged period of decline. However, the sustainability of recent rallies in commodity prices remains questionable. Nevertheless, the temporary support saw real gross domestic income rising 0.4% q/q and real net national disposable income per capita rising 0.5% q/q. Nominal GDP saw similar growth at 0.5% q/q and 3% y/y.

• Labour productivity measures took a noticeable step backwards in the quarter, with GDP per hour worked falling by 1% q/q and market productivity down 0.9%, as aggregate hours worked rose in the quarter despite the weak GDP outcome. However, data released by the ABS earlier in the week suggested multifactor productivity grew at 0.6% in 2015/16, an improvement on the previous year.

• Price indicators in the National Accounts were mixed in the quarter.  The GDP deflator – the broadest measure of inflation – rose 1.1% q/q. However measures of consumer prices were subdued overall to be consistent with the modest outcome seen in the Q3 CPI.

• In terms of labour income, the growth in total compensation of employees rose to 1.3% in Q3, which is a little surprising considering some of the soft trends evident in the employment data and appears to reflect higher average hours worked in the quarter. Average compensation of employees rose by a slightly more modest 0.8% q/q, but weaker than other price measures in y/y terms at 1.1%.

For more information please refer to the attached report.

• Australian Economic Update:  Q3 GDP 2016 (PDF, 859kb)

More from NAB:

• NAB Australian Wellbeing Index: Q3 2016
• NAB Rural Commodities Wrap: November 2016