Australia’s economic growth weaker than expected, could lead to early rate cut

Disappointing economic data could see the RBA adopt a more dovish tone at next week’s board meeting, potentially setting up a February rate cut.

Could a weaker-than-expected domestic economy spur Michele Bullock and the RBA to a February rate cut? Picture: Monique Harmer

Australia’s weaker-than-expected national accounts data for the September quarter have reinforced market expectations the Reserve Bank will be cutting interest rates in 2025.

Quarterly GDP growth of 0.3 per cent for the September quarter missed a 0.5 per cent rise expected by economists. Annual growth of 0.8 per cent was the lowest since the December quarter of 2020 and the weakest non-pandemic reading since the early 1990s recession.

While most of the undershoot of expectations came from government spending, the data still showed a weak underlying picture as government spending drove all of the rise in quarterly GDP.

“The main takeaway from the September update is that an expected tentative recovery in private demand has not formed,” said Westpac senior economist Paul Bustamante.

Financial markets reacted by shifting the implied timing of an initial 25 basis points rate cut by the RBA to April from May, pushing government bond yields down about 8-10 basis points across the curve and slamming the Aussie dollar by as much as 1.2 per cent to a four-month low of US64.08c.

The share market found support with the S&P/ASX 200 index halving its intraday fall.

Total new spending by state and federal governments continued to soar, hitting a record 27.5 per cent of the economy versus the previous record of 26.9 per cent last quarter.

New public investment rose 6.1 per cent on increased defence spending and infrastructure investment. Public consumption continued to grow at a solid pace of 1.4 per cent quarter-on-quarter and 4.7 per cent year-on-year as cost-of-living measures announced in recent budgets kicked in.

Private demand rose just 0.1 per cent on-quarter and 0.7 per cent on-year, and with the population surging 2.25 per cent on-year, private demand per capita continued to go backwards.

“The consumer sector continues to be sick, recording a flat outcome over the quarter to be just 0.4 per cent higher in annual terms,” said Westpac’s Bustamante.

“It suggests that per capita consumption has fallen by almost 2 per cent over the past year.”

Actual consumption was estimated to have risen about 0.3 percentage points in the quarter as governments used rebates and other cost of living measures. The household savings rate rose from 2.4 per cent to 3.2 per cent, reflecting the impact of lower taxes from Stage 3 tax cuts.

But, cost pressures continued to moderate as the impact of the larger than average 2022-23 minimum award wage increase rolled out of annual calculations.

Growth in average earnings per hour moderated to 3.2 per cent on-year, from 6.5 per cent in the June quarter. Not only was this a step down, but the pace of the decline gathered speed.

Average earnings per hour rose just 1.3 per cent on-year in six-month annualised terms versus 2.3 per cent on-year in the June quarter and well below the pre-pandemic average of 1.8 per cent.

“This is leading to a moderation in unit labour costs — a key measure of domestic cost pressures,” Bustamante added.

Unit labour cost growth fell to 4.3 per cent, the slowest pace since the June quarter of 2022.

Productivity fell 0.8 per cent on-year, but excluding non-market sectors like health and education, annual productivity growth remained positive at 0.7 per cent on-year.

“Tight financial conditions are weighing heavily on the interest rate sensitive parts of the economy and broader inflationary pressures,” said Goldman Sachs Australia chief economist Andrew Boak.

“We don’t view the tailwind to growth from public demand as sustainable alongside legislated efforts to consolidate growth in public programs like the National Disability Insurance Scheme.

“From a policy perspective, the RBA’s November forecasts for December quarter GDP growth now look likely to be downgraded and — alongside softer inflation pressures — we expect the RBA to adopt a more dovish tone at next week’s board meeting.”

But, while the national accounts suggest there is downside risk to the RBA’s GDP forecasts, the Bank doesn’t target GDP growth, and the labour market remains tight, as evidenced by ongoing strength in total wages growth for the economy, said Citi economist Faraz Syed.

“Moreover, productivity growth in the market sector remains weak, and the board has suggested it needs to see two good inflation prints before cutting interest rates.

“We don’t see this result having a material impact on the RBA’s reaction function.”

In Mr Syed’s view, the RBA remains on track to start cutting rates in May, with a total of 75 basis points of cuts likely in 2025, depending on the outcome of employment and inflation data.

While demand was clearly weak in the September quarter, and private demand much weaker than public spending, the national accounts also showed the supply-side of the economy is still being heavily constrained by weak productivity, according to HSBC.

“The key challenge here is that, despite some slowing in wages growth, weak productivity is supporting growth in unit labour costs that is still too high to be consistent with the RBA’s 2-3 per cent inflation target,” said HSBC chief economist Paul Bloxham.

Mr Bloxham said the data showed higher interest rates are weighing on demand, as expected, but at the same time the still very weak supply side of the economy is likely to support the central bank’s view the economy is still operating at, or slightly beyond, its sustainable capacity.