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G’day, forex mates! I asked in yesterday’s write-up if Australia will be reporting its first GDP contraction in 5 years. And, well, we got our answer earlier today. Australia’s Q3 GDP contracted by 0.5% quarter-on-quarter, which is a major bummer. And as a result, the Aussie tanked across the board.

AUD/USD: 1-hour Forex Chart
AUD/USD: 1-hour Forex Chart

But why did GDP fall? What happened, yo? Time to find out! But first…

Putting things into perspective

Before we discuss why Australia’s GDP slumped, let’s first put the numbers in their proper context, shall we?

Okay, Australia’s Q3 GDP contracted by 0.5% quarter-on-quarter. This is a significant miss from the expected 0.2% expansion. And as already mentioned, the drop is significant because it is the first negative reading in five years (since Q1 2011 to be exact). Aside from that, the drop is also the sharpest fall since Q4 2008, so that’s a double whammy right there.

Australian GDP q/q

Year-on-year, GDP expanded by 1.8%, which is significantly slower than Q2’s 3.3% annual rate of expansion. Moreover, Q3’s reading is the weakest since Q1 2013 and broke four straight quarters of ever faster year-on-year growth. So, yeah, not very pretty even on an annual basis.

Australian GDP y/y

Okay, time to take a closer look at the GDP components.

The Drivers

Household Spending

The 0.4% quarter-on-quarter increase in household spending was the major driver among the major components, contributing 0.3% to total GDP growth. But even then, the 0.4% growth in Q3 is weaker than Q2’s +0.5%.

A dent to consumer spending is not all that surprising, I suppose. Australia has been suffering from underemployment after all, with job gains coming mainly from part-time employment.

Inventories

Net change in inventories added 0.1% to Q3 GDP growth. This is smaller contribution when compared to Q2’s +0.2%, though. According to GDP report, both wholesale trade and retail trade reported an increase in inventories.

Unfortunately, the GDP report does not mention if the increase was due to expectations of higher demand or because demand during the quarter was weaker. But based on the weaker household spending and weaker increase in exports during the quarter, we can probably safely say that the increase in inventories was due to weaker demand.

The Drags

Government Investment

The 10.4% slump in government investment, otherwise known as public gross fixed capital formation, was THE major drag, subtracting 0.5% from Australia’s quarter-on-quarter GDP growth. Back in Q2, the rather large 16.8% increase in government investment was THE main driver, adding 0.7% to GDP growth. So there’s obviously been a reversal of fortunes here.

Private Investment

The drop in government investment may have been disappointing, but the continuing slide in private investment is more worrying for Australia’s future. You see, private investment has been contracting for seven consecutive quarters already as of Q3, with the 0.8% slide in Q3 subtracting around 0.2% from total GDP growth.

Looking at the sub-components, investment in residential buildings fell by 1.6% (+1.9% previous) while investment in non-residential construction tumbled by 1.3%, which is better than Q2’s very hard 13.0% slump. According to the GDP report, the slide in construction activity “can be partly attributed to high rainfall levels.

Investment in machinery and equipment, meanwhile, increased by 0.5%. This marks the second quarter of increase after Q2’s +3.3%.

Overall, the persistent slide looks disappointing, but the continuing increase in machinery and equipment, as well as the slower slump in non-residential construction may hopefully be signs that Australia is finally transitioning away from its dependence on the mining sector for economic growth.

Net Trade

Net trade had a negative contribution of around 0.2% to quarter-on-quarter GDP growth, thanks to the 1.3% increase in imports, which overshadowed the 0.3% increase in exports.

Government Spending

Government spending slid by 0.2% but only had a minimal impact, subtracting less than 0.1% from total GDP growth. Still, it’s rather noteworthy because the 2.0% increase in government spending back in Q2 was one of the major contributors to GDP growth after government investment.

Final Thoughts

Overall, Australia’s GDP report was indeed pretty bad, so the Aussie’s reaction was rather understandable. However, there have already been warning signs of this weakness.

In September’s Economic Snapshot of the Australian Economy, for example, I quipped that: “Basically, the Australian economy was kept afloat by the government” after pointing out that the main drivers were government investment and government spending. And now that those two components ended up being drags instead, we got served with the first negative GDP reading in five years.

Also, we probably can’t expect the government to keep the Australian economy supported. After all, the Australian government’s desire to return to budget surplus has made the government reluctant to increase government spending and investment, so much so that an IMF official encouraged the Australian government to boost public spending to protect Australia’s AAA credit rating and to reduce the burden on monetary policy.

Still, there were some positive points, with the main ones being the slower decline in non-residential construction and the continuing increase in machinery in equipment, since those imply that Australia is successfully moving away from the mining industry. Although the transition is admittedly far from over.

 

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