Sharp slowdown in growth in 2023
This weeks national accounts emphasised that the Australian economy, especially the consumer, is robust, for now.
The Australian economy expanded by 0.9% in the June quarter for annual growth of 3.6%. For 2023 we expect growth to slow to 1.0%.
That solid growth in the June quarter was being driven by strong household spending (around 54% of GDP) from a boost to expenditure through the reopening of the economy, particularly discretionary services. That was supplemented by a substantial fall in the still elevated savings rate which freed up scope for more spending.
We had anticipated growth in household spending of 2.6%, compared to the actual result of 2.2%. But spending growth in the March quarter was revised up from 1.5% to 2.2%, confirming our positive view of the household sector.
The detail around household spending was also in line with our thinking – the savings rate fell from 11.1% to 8.7%, freeing up $7.6 billion to largely finance the additional $10.8 billion in spending during the quarter. Discretionary services boomed in the quarter – transport services up 37.3%; hotels cafes and restaurants up 8.8% and recreation and culture up 3.6%.
But residential construction contracted by 2.9% and non–residential construction (private and public) was down by 1.8%. This unexpected contraction in construction (subtracted 0.3% from growth in the quarter) represented around a 0.6% setback in the growth outlook for the quarter.
Looking forward, we expect to see a slowdown in the growth rate of consumer spending in the September and December quarters. The reopening effect will begin to fade, and the recent interest rate increases will start to impact households.
There were two rate hikes in the June quarter (0.25% in May and 0.5% in June). The impact on household finances from those rate increases in the June quarter will have been minimal.
But by the September and December quarters, which has seen rate 0.5% increases in July; August; and September the impact will be substantial.
We expect further increases of 0.25% in each of October; November; and December with a final increase of 0.25% in February.
Although around one third of households hold a mortgage; one third are renters; and one third own their properties outright, rate increases impact all groups through a range of channels – the cash flow of borrowers; the indirect impact from investors who pass on higher funding costs to renters, particularly as rental vacancy rates are near record lows in many cities and regions; the wealth effect of falling house prices on those who own their properties outright and borrowers; and the recent collapse in Consumer Confidence.
Nationally, house prices have already fallen by 4%, with, our forecast of another 12% likely to follow through to the second half of 2023.
The contraction in construction in the June quarter has been attributed to weather delays and supply constraints. We expect to see construction lifting modestly through the second half of 2022 reflecting the build-up in the construction pipeline. A further contraction can be expected in 2023 as rising rates weigh on demand – effectively reducing the pipeline.
Reflecting these changes, we have lowered our growth forecast for 2022 from 4.4% to 3.4%.
Growth in consumer spending during 2022 is expected to slow from 4.4% in the first half of the year to 1.8% in the second half.
But with the expected recovery in the construction cycle we see dwelling construction lifting by 5.4% in the second half of this year, a turnaround from a contraction of 3.4% in the first half of 2022.
Related recoveries are expected for commercial building and engineering.
Overall, with the expected short term recovery in the construction cycle partially offsetting the slowdown in the pace of consumer spending we expect growth in the second half of 2022 to hold around the same 3.2% annualised pace as we saw in the first half – albeit conditions in the final quarter of 2022 are likely to more subdued than those during the September quarter.
We have not changed our downbeat view for growth in 2023.
We expect GDP growth in 2023 to slow to 1.0% with private domestic demand growth slowing to 0.2% (a sharp deceleration from an expected 5.4% expansion in 2022).
We cannot rule out a negative quarter of growth in 2023 but do not expect a classic recession.
Consumer spending growth is expected to slow from 6.3% in 2022 to 1.2% in 2023.; business investment growth will slow from 5.8% to -1.0%; while dwelling construction growth will slow from 2.0% to -4.0%.
That slowdown in consumer spending growth will include a very modest further fall in the savings rate from 3.6% by the end of 2022 to 2.3% through 2023.
We assess that the equilibrium savings rate is around 6% so reductions in the savings rate to below that level will be associated with households drawing down some of their accumulated excess savings. We expect that stock of excess savings accumulated during the pandemic, which currently stands at around $275 billion, to fall to around $200 billion by end 2023.
The economy in 2023 will experience the full accumulated effect of the lift in the cash rate from 0.1% in April 2022 to 3.35% in February 2023. Other negatives for growth in 2023 are: a total fade out of the “reopening “effect; a limited further fall in the savings rate to below equilibrium as households continue to draw down those excess savings albeit at a slower pace than in 2022; a rise in the unemployment rate from 3.0% to 4.2%; and a fall in house prices from peak to trough of around 16%.
The slowdown in 2023 will be necessary to contain any build up in “inflationary psychology” where businesses expect to be able to raise their prices and households accommodate in the expectation of out-size wage increases.
Flat demand conditions will mean that business’ confidence in their flexibility to continue raising prices will dissipate and we can return to a period of steady inflation.
If we are wrong and demand is much more robust than we expect in 2023 (perhaps the “even keel”) then the risk is that further rate increases will be required much later in the year.
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