Economic growth slows but ‘per capita recession’ talk is unhelpful

There was a lot of hand-wringing and gloomy commentary last week when the December 2018 quarter national accounts were issued. At just 0.2 percent GDP growth, they certainly were disappointing, and reflected a marked slowdown in the Australian economy in the second half of 2018 – just 2.3 percent growth year-on-year.

This week the sombre mood has continued, with the Westpac-Melbourne Institute Index of Consumer Sentiment falling 4.8 percent in March. The result was clearly influenced by the GDP announcement, with Westpac noting the respondents had a marked difference in confidence pre- and post- the release of the GDP figures. Not surprising perhaps, given all the headlines that Australia had entered a ‘per capita recession’.

Our view is not as gloomy as some. While overall KPMG sees the short-term economic outlook remaining mixed, we remain optimistic that growth should start to lift through 2019. As a country we have to be careful of talking ourselves into a downturn.

While it is true that real GDP per capita in seasonally adjusted terms has recorded negative growth over the September 2018 and December 2018 quarters, this notion of a ‘per capita recession’ may not be particularly meaningful. A better summary measure of how the slowdown in the economy is impacting at the individual level is real net national disposable income per capita, which has recorded positive growth in the second half of 2018.

So what were the primary causes of the disappointing GDP results? Collectively, a 3.4  percent decline in dwelling investment; the combined effect of a 0.7  percent fall in exports and a 0.1  percent rise in imports, resulting in net exports dragging down GDP growth for the quarter by -0.2  percent; and a substantial decline in investment by large companies and defence spending.

Marginal real wage growth meant slow household consumption growth, which we see remaining soft. There was at least employment growth, albeit weaker than that experienced in 2017 and 2018. Private sector investment was weak in the second half of last year and will continue to be so, with both housing investment and business investment worsening in early part of 2019. But we do see them turning around in the latter part of the year.

The figures would have been worse but for government consumption, which continues to help boost overall economic growth – although government investment needs to be prioritised and lifted in order to counter weakness in investment in the private sector. This should be a policy priority for both State and Federal Governments. The contribution of exports to GDP growth will lift due to the price increases already experienced for bulk commodities and base metals during 2019Q1.

In terms of interest rates, KPMG remain of the view that a cash rate around 1.50 percent is appropriate in the current environment. Some analysts are calling for the cash rate to be cut by 25bp to 50bp to help reverse ‘below trend growth’. In considering this call, we believe it is important to reiterate what the RBA mandate is; which broadly speaking, is to use monetary policy keep inflation between 2 percent and 3 percent and achieve full employment.

In our view, a reduction in the cash rate may be required if economic conditions deteriorate further, but our central case forecasts suggest that the RBA Board will be able to keep rates on hold for the next year before resuming the process of returning rates to more normal levels. However we have also assessed a ‘downside scenario’ – characterised by slower global growth and a further correction in the property market – and if that was to materialise, then cuts to official rates from current levels would be justified.

But for those putting all their eggs in the interest rate basket, it is worth noting that any benefit from a reduction in the cash rate will be diluted by the time it reaches households and businesses via retail lending rates due to higher foreign wholesale funding costs brought about by higher bond yields (reflecting perceived increases in risk) and exchange rate adjustments. We also think that the RBA will value keeping some headroom above the lower-bound in case there is a serious external shock to the global economy.

So much for Australia – what about the wider world?

Recently the talk has been all about Brexit, with a series of crucial votes in the UK Parliament,  yet we are still no nearer knowing what the outcome will be.

The Brexit uncertainty remains simultaneously a handbrake and an on-going distraction for the UK economy. Having said that the world’s 5th biggest economy has still been experiencing record levels of employment, solid public finances and robust wages growth.

For the purposes of this forecast round we have continued to apply a ‘soft-Brexit’ scenario, which explicitly allows for a continuation of frictionless borders and the Northern Ireland peace agreement to be maintained. Should the UK exit the EU without a deal, then the likelihood is for an economic outcome, at least in the short term, to be worse than our base case forecasts. How much worse is difficult to predict as it depends significantly on the fiscal and monetary policy response employed by the government to manage the Brexit transition period.

Like Australia, growth in the UK slowed in 2018Q4, down from 0.6 percent to 0.3 percent. Output for the manufacturing sector fell away across all four sub-sectors; the first time this has occurred since late 2012. Despite the recent strong growth in wages the Bank of England is now likely to adopt a more cautious wait-and-see approach, delaying the previously expected increase in the Bank Rate.

Crossing the Atlantic, the US economy continues to enjoy its longest period of economic expansion since the end of WWII – though there are darkening clouds. Annualised economic growth in 2018Q4 fell to 2.6 percent, down from 3.4 percent (2018Q3) and 4.2 percent (2018Q2) primarily due to softer residential construction expenditure and lower state and local government spending. Employment continues to outperform expectations, and average hourly earnings grew by around 3.5 percent in December 2018 and January 2019, representing the strongest pace of growth since the end of the GFC.

The downside is that the stimulus effects from the US tax reforms and increased government spending that were initiated over the past 12 months have now wound their way through the domestic economy. This wind-down of fiscal policy stimulus, combined with higher interest rates and the recent government shutdown due to the Mexican standoff between President Trump and the Democrats regarding the funding of the border wall (which has been estimated to have cost up to 0.1 percent of GDP growth per week), will see economic growth for the US moderate during 2019 to around 2.5 percent, and 2.2 percent for 2020. Higher import prices due to tariffs from the US-China trade war will also have an adverse effect.

This is the case for China too. The ongoing disputes with the US is now starting to drag down sentiment and elements of the real economy. Having said that, manufacturing output in China remained solid during 2018, and the bringing forward of exports and the subsequent devaluation of the Yuan insulated the Chinese economy to some degree last year. Much of the slowdown witnessed during 2018 (from 6.8  percent in Q1 to 6.4$ in Q4) is as a result of the planned structural reforms creating a more inwards focused domestic economy – consumption and investment – rather than low value-added exporting.

Europe saw overall growth of less than 2 percent in 2018, as did Japan, while India’s growth dipped slightly from 7.1 percent to 6.6 percent. Results are mixed across the world, but, as with Australia, we don’t share some of the gloomier commentary.

World growth has now peaked in this cycle and is starting to moderate as economic headwinds start to appear, but we forecast global growth to be around mid-3  percent’s for 2019 and 2020, which also the expected growth rate for the world economy into the medium term.

There are ongoing geo-political risks such as the trade war tensions and the rise of populist politics leading to inwards focus, but we don’t see the world economy falling off a cliff any time soon, whatever happens with regards to Brexit.

Read the full Quarterly Economic Update March 2019


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