Australia economy surprisingly strong, rates on hold

Gross domestic product (GDP) rose 1.2 percent in the second quarter, handily beating forecasts and more than recouping the first quarter's flood-driven 0.9 percent decline. Growth for the year was 1.4 percent, again well above predictions.

Wednesday's gloom-defying result sent the local dollar higher and supported an optimistic outlook from Reserve Bank of Australia (RBA) Governor Glenn Stevens, who poured cold water on market assumptions that emergency rate cuts might be needed.

"Basically this validates the RBA's view that the Australian economy's entered into the current period of global turmoil in pretty good shape," said Katie Dean, head of Australian economics at ANZ.

"We actually think the RBA's probably going to stay on its hands for a fairly extended period," she added. "Whilst the economy is going very well at the moment, it does still face some challenging times over at least the next six months."

The RBA held its September meeting on Tuesday and kept rates unchanged at 4.75 percent for a tenth month.

Markets have been betting that the concerns over global growth would push the central bank into easing policy, in part because it is one of the few developed nations that has room to actually cut rates.

Interbank futures still imply around 68 basis points of cuts by Christmas, but that has come back from a peak of more than 160 basis points last month.

In a speech in Perth, the RBA's Stevens emphasised that it was far too early to say how the turmoil in markets might affect global growth, or policy at home.

"Periods of sudden increases in anxiety within international financial markets are moments when, if at all possible, it is good to be in a position to be able to maintain steady settings," Stevens told an industry conference.

EPOCHAL EVENT

Adjusted for inflation, Australia's annual economic output reached A$1.3 trillion for 2010/11, or A$58,167 for each of its 22.5 million people. That compares to $42,468 of GDP for each US citizen in the second quarter.

The major surprise last quarter was a 1.0 percent jump in household consumption, double what many analysts had expected and a stark contrast to complaints of tough times by retailers.

The spending was also broad-based with the only weakness being in new vehicles and that was largely due to a lack of supply following Japan's earthquake and tsunami.

"The resilience of households was the stand-out factor," said Brian Redican, a senior economist at Macquarie. "These are good numbers for the RBA and should quieten talk the economy is somehow falling apart."

Consumption was underpinned by strong incomes growth across the economy, which in turn owed much to sky-high prices for Australia's commodity exports, particularly iron ore and coal.

The country's terms of trade, or the ratio of export prices to the cost of imports, jumped 5.4 percent in the quarter to an all-time high.

It is hard to overstate the impact of the terms of trade. It is now over double the average of the 1990s and every year it stays up here it is worth perhaps 12 to 15 percent of GDP in extra income, or A$150 billion to A$200 billion in hard cash.

Since most of this extra income comes from a change in relative prices, it gets stripped out of the main inflation-adjusted measure of GDP. But it does show up in current price GDP which grew 6.3 percent in the year to June, a pace usually only enjoyed by emerging economies.

Australia's resource companies are using this windfall to expand production, with more than A$148 billion of investment spending planned for 2011/12 to meet burgeoning demand from the industrialising masses in China and India.

For the RBA's Stevens, the rise of these giant emerging nations is an "epochal" event for Australia.

"It is without doubt overwhelmingly positive for us, even if our tendency to dwell on the downside is more prominently on display at present," he said

Copyright Reuters, 2011