With attention in the Australian market well and truly focused on today’s Q1 GDP release, it is important to put today’s result in context. Importantly, as Figures 1 and 2 highlight, the weakness in Q1 GDP growth (% q/q) can be largely attributed to mining sector weakness in Queensland. Indeed, with the added exception of manufacturing at the sector level and South Australia at the state level, the Australian economy delivered decent growth in Q1.
Figure 1: Q1 GDP – sector breakdown
Source: Bloomberg, Barclays Capital
Figure 2: Q1 GDP – state breakdown
Source: Bloomberg, Barclays Capital
Figure 3 helps to place today’s Q1 GDP outcome into context. According to our exogenous-factor GDP model, fair value for Q1 nominal GDP growth was 1.7% q/q versus the actual outcome of 0.7% q/q.
§ Consistent with our longstanding view that Australian economic growth is largely determined abroad, we developed a model to forecast nominal GDP growth using only exogenous variables, such as current commodity prices and their lags. Since 2004, when a rolling 10-year window delivered a correlation coefficient of around 1 between Australian nominal GDP growth and commodity prices in USD (see Figure 3), our exogenous factor model has delivered an R-squared of 0.88 (see Figure 4).
Figure 3: Rolling 10y correlation coefficient between Australian nominal GDP and commodity prices
Source: Bloomberg, Barclays Capital
When an economy suffers a temporary negative growth shock, a bounce-back in the subsequent quarter is typically expected. In the case of Q1 Australian GDP, it is far less certain that such an event will happen. This view largely reflects two factors:
§ the negative shock is primarily focused on mining output; and
§ mines typically work at full capacity with little scope to produce more to cover lost production at a later stage.
Accordingly, the reduced economic activity in Q1 should be best viewed as largely lost. However, we expect some rebound in consumer spending and capex to the extent that these expenditure components were temporarily affected by the floods.
Armed with this fact, we add only a small proportion of GDP lost in Q1 to the forecast from our exogenous factor model. We forecast nominal GDP growth of 1.9% q/q in Q2 11. In y/y terms, the nominal GDP growth nonetheless slows to 5.4% versus 7.1% y/y in Q1 and 8.9% in Q4 10.
Figure 4: Australian nominal GDP growth q/q (%) vs model fair value
Source: Bloomberg, Barclays Capital
Bottom line:
Looking to Q2 11, some bounce back in GDP q/q growth is to be expected. Looking beyond that, a flattening out of the commodity price trajectory for Australia’s basket has major implications for Australia’s growth performance outlook. In our opinion, a flattening out the commodity price trajectory is indeed in prospect based on the emerging and broadening tightening cycle outside Australia.
It may even be the case that Australia’s nominal growth in y/y terms has already peaked in this cycle, despite the Reserve Bank of Australia’s above-trend forecast for the next two years. While we clearly view the risks around the RBA’s growth to the downside, we ultimately expect the RBA to act on its growth and inflation forecasts over coming months. The RBA rarely has the luxury of waiting around to see whether its forecasts are correct. At current levels, pay June and July RBA board meeting OIS contracts offers very attractive risk/return pay-offs, in our view.
BARCLAYS CAPITAL
ECONOMICS RESEARCH | INSTANT INSIGHTS