Update The Australian economy grew surprisingly strongly in the June quarter, rebounding from a rare contraction in the previous three months when floods hit much of the eastern seaboard.

Gross domestic product (GDP) rose by 1.2 per cent in the June quarter after a downwardly revised 0.9 per cent fall in the March quarter. Economists had tipped a 1 per cent increase for the April-June period.

The Australian dollar climbed on the news of the quicker-than-expected expansion, jumping from $US1.0539 to $US1.058, as investors bet that the growth spurt would reduce the chance of an early interest rate cut by the Reserve Bank.

The quarterly increase came mostly from a jump in inventories, which added 0.8 percentage points to the growth tally. Consumption also rose, adding 0.7 percentage points and helping to counter the half-percentage point cut delivered by Australia's weaker-than-expected trade performance for the quarter.

The year-on-year increase for the quarter came in at 1.4 per cent, accelerating from the 1 per cent pace in the March quarter and also doubling economists' estimates of a 0.7 per cent expansion.

For the whole of the 2010-2011 financial year, the economy grew 1.8 per cent, the ABS said. That pace will affect the federal budget, falling short of the 2.25 per cent forecast by Treasury - with 4 per cent growth predicted for the current fiscal year. The expansion was also less than the previous year's 2.3 per cent.

Moody’s Economy.com analyst Katrina Ell said the link between economic growth and tax revenues mean tax inflows for 2010-11 may fall short of government estimates.

“With the global uncertainty there is a risk that slower global growth then is going to filter through to slower domestic growth which is going to impact tax revenues," she said. "So there is definitely that risk there.”

Queensland leads recovery

By state, final demand soared 3.5 per cent in Queensland for the quarter, seasonally adjusted. Final demand increased 0.2 per cent in New South Wales and 0.6 per cent in Victoria.
 
In South Australia it rose 2 per cent, while in Western Australia it increased 1 per cent in the quarter. In Tasmania, demand fell 0.5 per cent in the quarter, while it contracted 0.7 per cent in the Australian Capital Territory.

Consumers spend up

National Australia Bank senior markets economist Spiros Papadodoulos said the rise "was a bit stronger than expected".

‘‘The most surprising aspect was the strength of household consumption,’’ he said. Household consumption rose 1 per cent in the quarter and was up 3.2 per cent over the year to June, adjusted for seasonal variations.

But Mr Papadodoulos said the 0.1 per cent fall in dwelling investment was the biggest disappointment.

‘‘Encouragingly, for the outlook business investment is strong and that’s where we'd expect most of the growth to come from in the next year.’’

Machinery and equipment investment were up 4.9 per cent in the quarter. Total investment in dwellings fell 0.1 per cent in the quarter, adjusted, to be up 0.7 per cent in the year to June. Total gross fixed capital formation fell 3.8 per cent in the quarter and was down 4.6 per cent over the year, adjusted.

Other economic data out today also pointed to weakness in the constuction industry extending into the current September quarter.

Construction activity fell to its lowest level in almost two and a half years in August, the Australian Industry Group-Housing Industry Association reported today.

Treasurer's view

Treasurer Wayne Swan said the recovery was due to the underlying strength of the national economy following last summer’s natural disasters.

‘‘They’re encouraging figures, especially when you consider the challenges we see abroad,’’ Mr Swan told reporters in Canberra.

‘‘We have an economy with strong investment, rising incomes, sustainable consumption and low unemployment and these are the building blocks of a strong economy.’’

Inventory concerns

RBC Capital Markets economist Michael Turner said the only area of concern from today's national accounts was the rise in inventories that helped drive the quarterly growth in GDP.

‘‘Typically when you get a big run-up in inventories and there’s a little bit of uncertainty, businesses' first preference is to run down inventories rather than producing more," Mr Turner said, referring to the stocks held by companies in anticipation of future demand.

The last time Australia had an increase of inventories like the second quarter of 2011 rise was in the September quarter of  2008, with GDP contracting in the following three months, he said.

Investment

TD Securities economist Annette Beacher said the result confirmed the good news contained in the 4.9 per cent rise in second-quarter capital expenditure reported by the ABS last week.

"The surprise is the consumption figure, meaning that retail sales surveys are woefully underestimating the strength of the consumer," she said.

Despite the first-quarter contraction caused by the disruption of resource exports after the Queensland floods, Australia’s economy has remained relatively resilient. Demand from Asia for commodities and investment inflows into the mining sector remain strong.

Consumer confidence, on the other hand, has been weaker with caution weighing on retail sales and the housing sector, where house prices have declined.

Uncertainty about interest rates has also been a near constant throughout 2011, with bets swinging from the likelihood of higher interest rates to as many as 75 basis-points in cuts by December. Even today, investors are tipping a three-in-four chance of a rate cut in October - down from nearly a 100 per cent chance just prior to today's GDP release.

The Reserve Bank kept interest rates on hold at 4.75 per cent for a ninth consecutive monthly meeting yesterday, pointing to a mixed outlook the economy and inflation.

czappone@theage.com.au

With AAP

twitter This reporter is on Twitter: @chrizap

twitter Follow BusinessDay on Twitter