Australia has now seen three very strong quarters of real GDP growth in a row, but the respective drivers of growth in those quarters have been varied. This raises questions about which sector of the economy can be counted on to support growth at these levels. Net exports did all the heavy lifting for the first’s quarter 1.1% quarter-on-quarter increase. Net exports added 1.1% alone and consumption added 0.5%, helping cancel out the drag from capital expenditure and the statistical discrepancy (the difference between GDP and Gross Domestic Income).
Arguably, the impressive contribution from net exports was primarily driven by China’s massive increase in stimulus in the first quarter. China saw the biggest surge in credit growth in the first quarter since the first half of 2013, and much of that credit went into the industrial and real estate sectors, both of which are key drivers of commodity demand. Correspondingly, there was an incredible run up in commodity prices associated with the stimulus, and Australia, as a major commodity exporter, was a huge beneficiary of this.
But early indications of China’s second quarter activity appear to show stimulus activity slowing noticeably. Alongside this, we have seen the Chinese government release an important op-ed from the ‘Authoritative Person’ on 9 May criticising precisely this sort of debt-driven investment activity.
Australian data has been somewhat contradictory with strong GDP growth and very weak inflation. Employment growth has also continued to be robust, but much of it has been contributed by part-time jobs while full-time jobs have continued to decline over the past few months. Nominal GDP is now starting to diverge dramatically with real GDP, underlining the RBA’s concerns over low inflation. The GDP deflator declined 1% year-on-year, its biggest decline since the first quarter of 2015. This has rarely bode well for the economy. It also points to the issues for Australian companies trying to grow earnings when nominal GDP is so low.
The weak inflation outlook is a key factor for the RBA, which runs a strict inflation targeting framework. The significant weakening in consumer price index growth in the first quarter prompted May’s rate cut. The massive weakness seen in all of the RBA’s core CPI measures in the first quarter bode ill for inflation in the economy going forward. We are quite likely to see another weak CPI number in the second quarter, and this is why we continue expect the RBA to cut rates at its August meeting and probably follow that rate cut up with another in December. As such, we are expecting the Aussie dollar to decline to US$0.65 in the third quarter and drop below this in the fourth quarter.