This article first appeared on the Yahoo7 Finance website at this address: https://au.finance.yahoo.com/news/what-is-driving-australia-s-economic-growth—042520309.html 

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What is driving Australia’s economic growth?

Can you believe it?

Australia’s economy grew by 3.3 per cent in the year to the June quarter 2016, to lock in the fastest rate of growth in four years.

It’s a growth rate that is hard to fathom given how weak the recent labour market data has been, and given that inflation is well entrenched below the bottom on the Reserve Bank’s target range. Think also of a sluggish stock market, the fact that the RBA has been compelled to cut interest rates to a record low 1.5 per cent and the stubborn widening of the budget deficit and you’d be convinced that the growth performance of the Australian economy was in the slow lane.

So what is happening?

About 63 per cent of the GDP growth of the past year has come from a lift in export volumes – mainly things like iron ore, coal and gas, with a little help from tourism and education. For the commodities exports, the tonnages of bulk commodities which are driving the overall growth rate filter through to the rest of the economy in a piecemeal way.

There are very few jobs with this ramping up in mining output and the price that the mining companies are getting for these commodities is still remarkably weak, meaning that profits are being crimped with little if any spin off to the rest of the economy.

Another 43 per cent of the 3.3 per cent GDP growth rate is from a surge in government demand linked to the Federal government spending at an alarmingly rapid rate and the state government sector ramping up its infrastructure spending.

In other words, more than all of the 3.3 per cent growth in real GDP in the last year has come from just exports and government demand. The private sector has gone backwards.

This is dreadfully weak and it fits with the unimpressive labour market data where hours worked per person are falling and part time jobs are rising more rapidly than full time jobs. The general buoyancy in consumer and business sentiment normally associated with economic growth above trend is notably absent.

For the Reserve Bank, there is a case that the real GDP data are not the best guide to monetary policy settings. This is simply because of the mining output surge which looks good in volume terms but is underwhelming in price terms.

The price deflators in the national accounts, which measure inflation, remain very low and in line with the consumer price index. Inflation remains dead. This is the reason why the RBA cut interest rates in both May and August this year and why a further interest rate cut (or two) is still likely in the months ahead.
It is good to see the export sector contribution so much to the bottom line growth of the economy but it is creating a false picture of the underlying health of the economy. The weak domestic private sector side of the economy is the area targeted by the RBA with its interest rate cuts.

On available evidence, easy monetary policy is not having the desired effect which is why is would be wise to factor in another rate cut, or two, from the RBA in the months ahead, despite the seemingly good headline GDP result.