Floods hit coal exports but domestic demand strong

PRESS RELEASE

1 June 2011 For immediate release

Australian GDP washed out Floods hit coal exports but domestic demand strong

Domestic demand was strong! That should be today’s headline. Instead, most will report that GDP fell by its largest amount in 20 years. True. It did. Down 1.2% in Q1. But this was due to the Queensland floods severely disrupting coal exports, which we know is pretty much irrelevant for domestic inflation and rates, given it is temporary and supply-driven. More importantly, consumption growth was robust and investment rose solidly in Q1. All-in-all we have a strong underlying economy hit by a temporary supply shock. There is nothing here to change our call for the next hike in July or August and two by year-end.

Facts - Real GDP fell by 1.2% in Q1 2011, slightly less than we expected (HSBC’s forecast was -1.3% post-trade data) and slightly more than the consensus forecast (-1.1%). Over the year, GDP growth slowed to 1.0%, from 2.7% previously.

- The fall was driven by the Queensland floods and their effect on coal exports. As we already knew yesterday, net exports subtracted 2.4ppt from growth, which is a record. Exports fell by a massive 8.7% and coal exports were down by 27% in volume terms. Of course, we know this is temporary and indeed the monthly data show that there was already a 40% bounce in coal export volumes in March. Plus we know coal contract prices have risen sharply (45%) so income will be boosted.

- Domestic final demand rose by a very strong 1.3% in the quarter, with inventories subtracting 0.5ppt to leave domestic demand (or gross national expenditure) a strong 0.8% higher in Q1 and 3.1% higher over the year, which is around trend.

- Across the components household consumption rose solidly (+0.6 q-o-q and +3.4% y-o-y), dwelling investment was strong (+4.6% q-o-q and +6.6% y-o-y) and solid business investment (+2.8% q-o-q and +5.9% y-o-y).

- Nominal GDP rose by 0.7% in Q1 and by 7.7% y-o-y, underpinned by a 5.8% rise in the terms of trade in Q1 and a 22.4% rise y-o-y.

Implications If it weren’t for the headline GDP number being severely hit by a sharp fall in coal exports, today’s numbers would be universally judged as strong.

Domestic demand was strong, driven by rising consumption, solid growth in business investment and continued modest support from public demand. Overall domestic demand rose by 3.1% y-o-y, which is around trend and a good result for an economy affected by significant natural disasters during the quarter, including the Queensland floods and cyclone Yasi.

Despite the stories of weak retail sales, household consumption growth was a solid in Q1 and increased by a strong 3.4% over the year. Business investment rose due to continued strength in the mining sector – and there is lots more of this to come.

Of course, the headline number was very weak. GDP fell at its fastest quarterly rate since the early 1990s recession. But that was due to sharp fall in coal exports. Coal exports fell 27% in volume terms. As we have discussed a number of times before this means very little for the inflation outlook or for interest rates. All it reflects is a lack of ability to supply coal to the ships waiting off the Queensland coast. It does not reflect weaker demand for coal. In fact, coal contract prices have risen due to continued strength in foreign demand. Timely data also show that coal exports bounced back in March.

We know the RBA will also see things in these terms. In the quarterly official statement we were told that they will be watching domestic demand, not production indicators. And demand looks strong.

So there is nothing in today’s report that would suggest the RBA would back away from its current outlook for rising inflation or the need to lift rates ‘at some point’ to contain growing inflationary pressures.

Bottom Line GDP fell in the quarter largely because coal exports were constrained by the floods in Queensland. The rest of the accounts showed that domestic demand was strong.

We continue to expect the next hike to be in July or August and two hikes by year-end.

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