Australian National Accounts December 2022: Students and tourists boost GDP, as locals face rates reality

From the Chief Economist

Students and tourists flocked back to Australia in 2022 boosting GDP, while domestic spending slowed in response to the Reserve Bank’s rate hikes.

GDP rose 2.7 per cent in the year to the December quarter, but the per capita equivalent was up just 0.8 per cent. That gap is the largest since 2009.

Households – which are at the frontline of the Reserve Bank’s manufactured slowdown – lifted their consumption by just 0.3 per cent in December quarter, much slower than in the previous two quarters, and below market expectations. Much of that was boosted by returning students and holiday makers spending up on transport, hotels and restaurants. Exports of travel services were more than double levels of a year ago and the highest since March 2020, although still below normal levels.

There was a pullback in purchases of clothing and footwear, and furnishings and household equipment, with home renovations proving to be ‘so 2021’.

House buying has slowed and house prices have fallen, leading to 11 per cent decline in profits in the rental, hiring and real estate services industry in the year to the December quarter.

But the rate of price increases in consumer purchases pushed higher, rising 6.7 per cent. This is the strongest rate of growth since 1990, and in line with the worryingly high Consumer Price Index (CPI) in the December quarter.

This means that even though the domestic economy slowed down in the December quarter, price growth didn’t. The Reserve Bank needs that slower growth to translate into disinflation, and until it does, rate hikes and the threat of more won’t stop.

On a positive note, monthly CPI data released today showed that some of the heat in prices may have tamed in January. The cost of transport and holiday travel, and accommodation and new dwelling purchases – all the items that had experienced super strong rises – are growing a little less ferociously.

Exports were the hero of the quarter, with services exports rising 9.8 per cent. The resources sector benefited from stronger production and commodity prices, with this sector helping push the total profits share of factor income to a new high.

Mining production – and particularly iron ore mining – was by far the strongest, contributing 0.3 percentage points to the 0.5 per cent quarterly rate of growth of GDP. Oil and gas extraction also bounced back, after maintenance slowed down production in the September quarter.

Disposable income fell 0.7 per cent, failing to keep up with the rise in household spending. For households, the ability to save and top up mortgage offset and redraw accounts diminished as interest payable on mortgages rose a whopping 23 per cent.

At 4.5 per cent in the December quarter, the saving ratio was well below the 7.1 per cent recorded in the September quarter, and the lowest since September 2017. As interest rates rise further and cost-of-living pressures persist, consumption will suffer further, or savings will fall further throughout 2023.

Consumers are aware of the uncertainty and challenges ahead, and finally seem to be responding as low consumer confidence levels suggested they would.

We expect to see a continued pullback in spending by consumers. The ongoing strength of the labour market, and higher than normal share of mortgage holders still on very low fixed mortgage rates, could somewhat support consumption in the first half of 2023. But as many of these mortgages roll over to higher variable rates over the coming year, consumption growth will slow and may even recess.

Mining profits surge, while wages moderate in a tight labour market

Company profits in both mining and non-mining industries rose, and total profits as a share of total factor income rose close to a record high of 31.8 per cent. As has been a common story in recent years, mining profits posted a solid increase due to both stronger production and commodity prices. Industries more sensitive to interest rate rises, such as rental, hiring and real estate services, have seen a 11 per cent fall in profits over the year.

With the return of international travel and pent-up demand for domestic travel coming through, accommodation and food services, and transport, postal and warehousing continues to see double digit growth in profits (each up over 30 per cent over the year).

Despite the tightest labour market conditions in decades, the Q4 Wage Price Index (WPI) continued to undershoot market and Reserve Bank expectations. It rose 0.8 per cent in the December quarter, with annual growth picking up to 3.3 per cent (compared to 3.2 per cent in the previous quarter and the Reserve Bank’s 3.5 per cent forecast).

A surprise was the Reserve Bank’s preferred wage measure, average non-farm earnings per hour which did not grow in the quarter and was up only 2.9 per cent over the year.

However, the broad Compensation of Employees (COE) rose by 2.1 per cent during the quarter and over 10 per cent over the year. This is significantly higher than its 10-year average of 4.4 per cent, and indicates that bonus payments and employee movements (which are accounted for in COE but not WPI) have played a key role in lifting the wages bill. The private sector continues to be the main driver, as firms compete for labour.

The Reserve Bank’s liaison program indicates around one third of private sector liaison contacts are reporting sharp increases to wages of above 5 per cent. If this occurs, it will make the Reserve Bank’s job of bringing inflation down even more difficult.

Australia’s terms of trade – which is the ratio of export to import prices – rose 0.6 per cent after a large fall in the previous quarter, helped by the rise in commodity prices (mainly metal ores and minerals). But the Reserve Bank’s Commodity Price Index fell nearly 6 per cent this quarter as all commodities, apart from base metals, witnessed falling prices.

Hours worked jumped nearly 2 per cent after remaining relatively steady in the previous quarter, up 6.5 per cent compared to pre-pandemic levels, largely due to skill shortages in the economy.

As expected, inflationary pressures continue to bite, with domestic prices continuing to rise to around 6.5 per cent through the year. This is the fastest quarterly growth since 1990.

International prices rose at a slower pace of 12.7 per cent over the year compared to the September quarter, due to a continued moderation in global energy prices. But the growth rate still remains historically high. With inflationary pressures continuing to bubble along and upside risks to wages growth, the Reserve Bank will continue to lift interest rates, with markets expecting another three 25 bp hikes in the months ahead.

Service-based industries continue to benefit from resilient consumption

Despite cost of living pressures and negative real wage growth, households continue their enthusiasm for discretionary services. This is reflected in the industries that exhibited the most growth over the quarter, other services – which consists mainly of maintenance repairs and personal services – rose 4.9 per cent over the quarter. Arts and recreation services production rose 2.4 per cent over the quarter.

Other service-based industries that saw growth included accommodation and food services and transport, postal and warehousing – as evidenced by continued demand for restaurants, cafes, and pubs, as well as increased demand for international travel.

The mining industry saw the second strongest growth rate through the quarter, rising 3.2 per cent. The strength is largely attributed to increases in iron ore mining on the back of increased production and supply chain improvements.

The electricity, gas, water, and waste services and agriculture, as well as forestry and fishing industries, experienced the biggest falls (-4.9 per cent and -2.6 per cent respectively). This was largely attributed to wet weather events on the east coast of Australia adversely affecting grain production, cotton planting and livestock. It also reflected falling demand for electricity due to milder weather, partly offset by a rise in gas supply following a fall in previous quarter.

Elevated government spending crowding out private sector investment

Government spending rose by 0.6 per cent in the quarter, after also experiencing a slight rise the previous quarter. Spending was driven by the Federal Government, up 1.6 per cent in quarter. It was focused on non-defense spending, while state and local government spending fell.

This was offset by a fall in public investment of 0.7 per cent – despite the large pipeline of infrastructure projects across the country – with falls in both federal and state and local government spending. This was offset somewhat by government owned public corporations.

Both government consumption and investment as a percentage of GDP remain elevated, exacerbating skill shortages and capacity constraints within the economy, as well as adding to inflationary pressures – making the Reserve Bank’s job harder. Early indications from the Federal Government are that it will aim to constrain spending, although we think there is a case for spending cuts in the upcoming federal and state budgets.

Business investment is weak but future intentions remain strong

Private sector investment fell 1.7 per cent in the December quarter, with falls in both residential and non-residential construction. Business investment was down 1.4 per cent – falling for the first time since the start of the pandemic – dragged lower by non-dwelling construction as projects came to completion. There were also falls in machinery and equipment investment (down 1.2 per cent).

Despite the current economic challenges, private sector investment intentions remain robust. This was reflected in capex intentions for this financial year (2022-23) being upgraded by over 2 per cent, and an 11 per cent increase in capex plans for the next financial year (2023-24) compared to the 2022-23 estimate.

Dwelling investment continues to ease as house prices fall and mortgage rates rise

Total dwellings investment fell 0.9 per cent through the quarter. Investment in alterations and additions fell 4.2 per cent as the effects of Homebuilder and other incentives in place during the pandemic continue to wane. This is the fifth consecutive fall, from record highs in 2021.

Investment in new dwellings increased by 1.4 per cent. An easing of labour and material shortages, a strong pipeline of housing projects and severe weather events in most states and territories (further increasing demand for construction) represented tailwinds for the industry.

However, rising interest rates and declining house prices – with the five largest capital cities combined dwelling prices falling 10 per cent since the peak in April last year – have contributed to fall in house sales and auction clearance rates.

The three consecutive 25 basis point interest rate hikes in the December quarter and falls in housing market activity have continued to push ownership transfer costs lower. They were down 6.2 per cent in the quarter. Compared to pre-pandemic levels, transfer costs are still up 11.5 per cent.

Net exports key driver of growth

Net exports contributed 1.1 percentage points to growth boosted by service and non-rural commodity exports.

Exports increased by 1.1 per cent, which was largely driven by an 18.9 per cent increase in travel services and a 20.6 per cent increase in transport related services. This reflects the continued recovery of tourism and education thanks to the return of international students and tourists. This was partly offset by a fall in exports of goods, driven by a 23.7 per cent fall in non-monetary gold (which is usually very volatile), and a fall in wool and meat exports partly due to wet weather impacting the agricultural industry along the East Coast.

Imports fell by 4.3 per cent, mainly driven by a broad-based fall across consumption, capital and intermediate goods. Services imports also contributed to the decline as Australians preferred cheaper, short haul destinations.

Changes in inventories detracted 0.5 percentage points from growth in the December quarter. Retail inventories declined, reflecting the fall in consumption goods imports.

Strong consumption across the states and territories

During the quarter, three states experienced a rise in state final demand – the ACT (0.3 per cent), Victoria (0.2 per cent), and Western Australia (0.1 per cent). The rest either remained stagnant or declined, with notable decreases in the Northern Territory (-0.5 per cent) and Queensland (-0.3 per cent).

Public consumption saw solid growth in most states and territories, mainly driven by the Federal Government increasing expenditure on aged care and pharmaceuticals. Western Australia and the Northern Territory saw falls in public consumption, however, this is likely to increase during the next quarter with Ex-Tropical Cyclone Ellie having impacted Western Australia and the Northern Territory just before the start of the new year.

Household consumption increased in all states but South Australia and Queensland. The rise was primarily driven by increased household spending on hotels, cafes, and restaurants as well as transport services, although this was partly offset by a reduction in spending on other discretionary items such as recreation and culture, as well as clothing and footwear.

Private investment stagnated or declined across all states and territories. This was largely due to a slowdown in the residential property market, leading to a decrease in ownership transfer costs, and construction for both non-dwellings and dwellings. Public investment fell in all states but Queensland, Western Australia and Tasmania, due to a fall in utilities and roads investment.