Australia Drops Into The Recession

Australia Drops Into The Recession

Today’s GDP report for the December quarter showed the economy contracted for the first time in eight years. It seems, therefore, that we have entered our first recession since the early 1990s. Australia’s economy unexpectedly shrank 0.5%q/q in 4Q (J.P.Morgan 0.4%, consensus 0.2%), after expanding only 0.1% in 3Q. This sluggish performance dragged growth over the year down from 1.8% to only 0.3%, the slowest rate of expansion since the recession of the early 1990s.

The “good” news is that inventories were the biggest drag on the economy in the fourth quarter, subtracting 1.6%-points from growth. Not surprisingly, firms were aggressive in ridding their shelves of unwanted stock amid expectations of a further, significant deterioration in final sales. The good news for GDP growth going forward is, of course, that firms will need to rebuild stock as sales improve, although this process will be gradual given expectations of a prolonged period of weak demand, both locally and abroad.

A solid contribution from net exports prevented an even sharper contraction in GDP in 4Q. Net exports added 1.5%-points to growth, the largest contribution since 1997. Exports fell 0.8%q/q, owing to fewer shipments of commodities, including those of mineral ores (-7%), but imports slumped 6.8%q/q. Business investment also rose, but by a mild 1.1%q/q. The outlook remains bleak, however, given firms are likely to scale back their investment plans as global economic conditions continue to deteriorate, meaning there almost certainly will be material downward revisions to spending plans going forward. Dwelling investment fell 1.2%q/q in 4Q, a decline that was expected given the recent weakness in building approvals (which fell 6% on average in the final three months of 2008).

Other GDP components made negligible contributions to growth. Government spending was flat in 4Q. Importantly, though, this GDP component was affected by the first payments arising from the Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding. The ABS said that these payments were treated as a fee for a service, paid by financial corporations to the government, so in the national accounts they were recorded as an offset to government consumption. Consumer spending rose 0.1%q/q in 4Q, although should contract in coming quarters given the massive wealth destruction underway in the household sector, the reduction in credit availability, and rising unemployment. The scaling back of investment plans, in particular, will leave a serious dent in the employment outlook, which underpins our view that the jobless rate will rise sharply this year and next.

The price indicators in the 4Q national accounts showed that growth in the deflator for household final consumption, a good proxy of economy-wide inflation, rose just 0.6%q/q, compared to 1.3% in 3Q. The terms of trade, previously a significant source of national income, grew 2.8%q/q, slowing significantly from 6.2%. Hours worked in the market sector, a useful measure of productivity, fell 0.8%q/q after rising 0.4% in 3Q.

Looking ahead, household spending will remain subdued as consumers boost precautionary saving and pay down debt, and exports will be curbed by the onset of global recession. Increased public spending will take up some of the slack, but probably will be insufficient to keep GDP from contracting again in coming quarters. We forecast another negative GDP outcome in 1Q09, which will satisfy the technical definition of a recession. The extent to which GDP falls in 1Q09 will depend on how the economy responds to the significant monetary and fiscal policy stimulus delivered in recent months.

RBA officials indicated (following their decision to leave the cash rate unchanged at 3.25% yesterday) that they need time to gauge the impact of the stimulus already delivered. That said, we suspect the RBA’s easing cycle is not yet over, and maintain our forecast for a terminal cash rate of 2.75%. In our view, combined with further weakness offshore, adverse domestic data prints now will play a prominent role in forthcoming RBA decisions. In particular, in our view, it will be very difficult politically for RBA officials to sit on their hands as the jobless rate soars, and we do expect that the unemployment rate will rise sharply (from 4.8% currently to 9% by the end of 2010).

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