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GDP for March – the narrow path to a soft landing

The release of the March quarter GDP data showed growth in the economy of 0.2% for the quarter, and 2.3% for the year-ended March 2023. Though the aggregate number was still positive – pretty much in the target band – the data also shows the economy is slowing, which is the aim of the interest rate rises which commenced in May 2022.

As the first chart shows, quarterly GDP (the blue bars) has been stumbling downwards under the weight of the interest rate hikes, but the full effect of the continuing increases is probably not yet clear in this lagging data.

Significantly, the contributions to growth have come from household consumption, which is just barely afloat, showing an increase of 0.1%, and a small rebound in business investment, coming in at 0.2%.

In terms of household consumption, the 0.1% increase has to be compared with the 0.9% increase recorded in the corresponding period a year earlier.

The impact from the tightening of monetary policy – the raising of interest rates – on household incomes has seen discretionary spending evaporate and fall below essential spending for the first time since September 2021. Some of that is reflected in falling imports of things we desperately need until we find the cost of living means we can no longer afford them.

At a structural level, as the next chart shows, it is relatively uncommon for household expenditure on essential items to exceed discretionary items. If we take the pandemic ‘events’ out, the gap between in favour of essential expenditure has not been greater for many years. The interest rates are having an impact, but collectively, we are still spending a lot more than was the case prior to the pandemic.

Inevitably, this means household savings are being eaten into. The buffers households built up during the pandemic are being whittled away by higher mortgage payments, as well as by general inflation.

This reduction in household buffers is therefore reflected in the reduction in the household savings ratio which declined to 3.7% during the quarter. The last time it was this low was June 2008 when it was 2.6%.

Some might argue therefore – many are – that the interest rate hikes have done their job and prices and inflation will commence to moderate, as demand has been sapped from the economy.

With all these obvious signs that the economy slowing it raises the question why the RBA is continuing to increase interest rates. The March quarter data was released on 7 June and does not cover the more recent interest rate rises.

The June quarter GDP will contain the full impact of the rate rises in February and March and some of the interest rate rises in May and June. It follows we will need to wait until the September quarter data to see the full impact of May and June rises.

So, despite these significant lags in the data, at the RBA meeting on 6 June, the decision was made to increase rates a further 0.25% to 4.10%, the twelfth increase in this cycle.

The quarterly GDP data appears to have been overrun by the more current April CPI (Consumer Price Index) annual result, which was 6.8%, up from the previous month’s result of 6.3%. This appears to have been coupled with concerns expressed by Governor Lowe that wage rises without associated productivity gains could be inflationary.

So, while it appears inflation peaked in December 2022 (8.4% monthly series, 7.8% quarterly series) this increase suggests there is still greater demand than supply in the economy, resulting in price increases.

A more detailed update on the April CPI is covered elsewhere in this edition of Stats Count.

Despite the economy slowing significantly in the March quarter, the recent increase in rates and the expectation of more to come, reflects the view that the trajectory to return to the RBA target range for inflation is not fast enough.

It is the pace of the change that is critical to ensure “inflationary expectations” do not become “anchored” in the economy. What may be lost on the RBA at the moment is that the pandemic saw many households and businesses unable to spend, even where they planned to do so. That money and the expenditure linked to it, may be transitory and temporary, just not ‘momentary’. There may be no impetus for anchoring inflation anyway.

Governor Lowe still points to a “soft landing” for the economy, which means getting inflation back into the target range without crashing the economy. This is finely balanced right now and is as much art as it is science. We can see how tight this is by overlaying the recent RBA forecasts (updated in the May Statement of Monetary Policy) on the March quarter GDP data.

History suggests that where Household Disposable Income (HDI) goes, so goes the economy. The RBA forecasts are for six month periods. The forecast outlook from December 2022 through to December 2023 already sees the decline in actual HDI (-4.05%) lower than forecast (-3.3% Dec 22, -2.5% June 23).

Due to the time lag in the data, HDI will need to be picking up now if the soft landing is to be achieved. That will be influenced by such factors as level of employment, hours worked and wages growth. There is plenty to keep an eye on between now and the next GDP data, which will be published on 6 September.

The risk of further interest rate rises pushing the economy into recession gets higher as every rate increase is introduced.

Posted Date: June 21, 2023

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