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Australia's Economy Buoyed by Strong Spending

Australia's economy expanded at its slowest pace in a year last quarter but only because strength in consumer and government spending was tempered by a big drag from the country's trade deficit.

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Gross domestic product (GDP), or the value of all goods and service produced in the economy, rose 0.6 percent in the fourth quarter, compared to the third quarter when it rose 1.1 percent. That was in line with market forecasts and took growth for the year to 3.9 percent, from 4.3 percent.

Still, domestic demand ran at a far faster 5.7 percent pace for the year as consumers spent more on everything from cars to clothes while firms invested heavily in new capacity.

"It's a very solid report, with growth broadly based across households and business," said Brian Redican, a senior economist at Macquarie. "Domestic demand was incredibly strong and it was only trade that pulled down the headline result."

That strength was a major reason the Reserve Bank of Australia (RBA) raised interest rates to a 12-year high of 7.25 percent this week, its second increase in as many months.

The central bank has warned that demand will have to slow substantially if it is to curb core inflation, which accelerated to a 16-year peak of 3.6 percent last quarter.

There are tentative signs the central bank might be getting its wish, with retail sales flat in January and consumer and business confidence waning. A survey of the services sector out on Wednesday showed growth slowed in February for a second month.

RBA Assistant Governor Malcolm Edey on Wednesday noted there were "significant dampening forces" at work on the economy including rising borrowing costs and slower global growth.

The evidence of financial strain was clear on Wednesday when Macquarie Group announced it would slash its Australian residential mortgage business because of high funding costs.

"There is a slowdown here in these numbers, but demand is really strong and the RBA is still focusing on demand rather than GDP," said Paul Brennan, co-head of market economics at Citi. "I don't think it resolves things either way with regards to whether the RBA is going to do more tightening or not," he added.

Investors are generally betting the RBA will not have to hike again, though that may change if the inflation report for the first quarter due in April shows a further acceleration.

A Trillion Dollar Year

Overall, Australia's GDP amounted to A$257.75 billion (US$238.66 billion) in the fourth quarter of 2007, bringing total output for the year to over A$1.0 trillion for the first time.

Household consumption alone added 0.9 percentage points to GDP growth in the quarter with government spending contributing another 0.3 percentage points.

Investment in factories, mines, schools and hospitals added another 0.4 percentage points, so that domestic demand expanded by a torrid 1.6 percent for the quarter.

So strong was demand that local producers, short of spare capacity after 16 years of uninterrupted growth, could not satisfy it. Instead imports filled the hole and the resulting trade deficit lopped a hefty 0.9 percentage points from GDP.

The trade shortfall might be much less of a drag this year given huge price increases are expected for coal and iron ore contracts. As these were Australia's two biggest export earners, that would further boost the country's terms of trade -- what it gets for exports compared to what it pays for imports.

"The main message from today's GDP was that the economy finished 2007 strongly, with domestic demand rising at a pace appreciably above its long-term average," said Scott Haslem, chief economist at UBS. "Despite the slower annual pace of total GDP, the RBA is unlikely to draw much comfort from this data," he concluded.