During September there were more indications that global economic growth has increased pace this year. Q2 GDP growth reports and revisions from the US, China, Japan and Europe confirm a marked improvement in economic activity in the first half of 2017. Leading indicators of economic activity point to further improvement in Q3. Growth may slip briefly in the US and China from the impact of natural disasters in the case of the former and earlier policy initiatives in the latter, but there is building momentum in the global economic recovery that is unlikely to be restrained until economic policy settings are tightened. So far, persistently low inflation has allowed central banks either to maintain very easy policy settings or to only slowly start normalising policy settings. If global growth continues to gain momentum as seems increasingly likely the risk builds that inflation will lift and that more central banks, including the RBA, will move towards lifting interest rates.
US Q2 GDP was revised upwards to 3.0% annualised pace from an initial reading of 2.6% and with strong support from household consumption and business investment spending. July and August economic readings are mixed-strength although business and consumer sentiment reports remain very strong. The first batch of regional manufacturing purchasing manager reports for September are strong with the Empire (New York) State report at +24.4 from +25.2 in August, both very high readings for this survey, and the Philadelphia Fed survey showing an unexpected increase in September to +23.8 from +18.9 in August. The two huge hurricanes that impacted the US in the month – Harvey cutting Gulf of Mexico oil production and flooding parts of Texas and Irma hitting parts of Florida – will dent US GDP growth in Q3 but the impact looks set to be brief.
All told, the US economy continues to perform well and one potential threat to its well-being – a shutting down of parts of Government while President Trump and Congress wrangle over the government debt ceiling and budget issues – came to a surprising resolution with the President dealing with opposition Democrats to help promote his policies. The Federal Reserve (Fed) has had a lot to weigh up in its policy thinking but its September policy meeting showed that it still expects solid economic growth over the next two years and in time a lift in inflation in 2019. Essentially the Fed has not changed its view of likely interest rate moves still looking to deliver another 25bps funds rate hike to 1.50% late this year plus another three 25bps hikes in 2018 and another three in 2019. The Fed also announced that it would start winding down its $US4.5 trillion balance-sheet in October, initially capping Treasury sales at $US6 billion a month with $US4 billion of mortgage-backed paper sales. Every three months the Fed plans to escalate total monthly sales by $US6 billion until sales reach $US30billion of Treasury bonds and $US20billion of mortgage-backed securities. The improving US economy plus the Fed’s policy plans make it highly likely that US bond yields will rise over coming months.
In China, the world’s second biggest economy after the United States, Q2 GDP was stronger than expected at 6.9% y-o-y matching annual growth in Q1. There are signs that growth may slip slightly in Q3. Indicators of economic activity released for August were mostly softer than expected while interestingly inflation readings were higher than expected. Export growth slipped to 5.5% y-o-y from 7.2% in July. August industrial production (+6.0% y-o-y from +6.4% in July); urban fixed asset investment (+7.8% from +8.3%); and retail sales (+10.1% from +10.4%) were all softer and at this stage GDP growth is tracking around 6.5% y-o-y in Q3. The tighter policies imposed by the Peoples’ Bank of China late last year and early this year to deal with too rapid lending and the over-heating residential property market were always likely to moderate growth. There is some evidence that those tighter policies have worked capping speculation in residential property. China’s house price growth decelerated again in August down to 8.3% y-o-y from 9.7% in July. Other prices, however, are showing signs of accelerating. Annual CPI inflation increased to 1.8% y-o-y in August from 1.4% y-o-y in July, while annual producer price inflation showed an unexpectedly sharp increase to 6.3% y-o-y from 5.5% in July. Rising factory gate prices in China are sounding a little heeded warning that inflation could return globally.
Europe continues to show signs of improvement. Q2 GDP growth initially reported at 2.1% y-o-y was subsequently revised up to 2.2% and recent monthly economic indicators point to GDP growth improving again in Q3. Consumer confidence in Europe is the highest it has been since 2001, while the manufacturing sector’s purchasing managers are the most confident they have been in more than six years. The final big national election in Europe for 2017 in Germany returned pro-Europe stalwart Angela Merkel to power for a fourth term. One small cloud is that the far-right AfD party polled well and will be represented for the first time in the German Parliament. All told, the European economy is gaining strength, cutting down the unemployment rate (9.1% in July) and lifting inflation (1.5% y-o-y in August). The ECB is still holding steady its very growth accommodating monetary policy setting. The improvement in European economic conditions make it highly likely that the ECB will announce a further reduction in its monthly purchases of bonds before the end of this year.
The Australian economy rebounded in Q2 with GDP growing 0.8% q-o-q after the soft 0.3% q-o-q reading in Q1. Even though quarterly GDP growth was much better in Q2 annual GDP growth was 1.8% y-o-y, the same as it was in Q1. Growth in Q2 was supported mostly be reasonably good contributions to growth from household consumption spending, government spending and exports. Australia’s growth outlook is still a mixed bag. Further growth in household consumption will be essential if GDP growth is to lift. In Q2 households lifted spending mostly by running down the household savings ratio. Whether the savings ratio can fall much further is a moot point given that household debt is exceptionally high and wages growth is still very low. One saving grace is that employment growth has lifted sharply through 2017 and the improvement is continuing (total employment up 54,200 in August after lifting 29,200 in July).
Strong employment growth will contribute to growth in household disposable income in Q3 and there is some chance that wages growth will be a little stronger too as the 3.3% minimum wage determination starts to flow through. At this stage, households would seem to be able to spend relatively freely. Business surveys are also indicating the beginnings of a lift in business investment spending before long. Prospects for government spending and exports are erratic quarter-to-quarter. According to the latest economic forecasts from the RBA contained in its early August quarterly Monetary Policy Statement, GDP growth will slowly rise to above potential pace in 2019 and inflation will work its way higher too to middle of the RBA’s target band in 2019. On balance, these forecasts look more realistic based on economic developments through September.
The RBA left the cash rate unchanged at 1.50% at its early September policy meeting and in various commentaries has indicated that it is in no hurry to move the cash rate but that eventually the next move is more likely to be upwards. Our view remains that a strengthening economy could encourage the household sector to increase its already very high borrowings. Still unusually low borrowing interest rates combined with additional incentive to borrow as the economy improves could lay in store unacceptable risks to the economy and financial stability down the track. It is this factor that will probably lead the RBA to start hiking the cash rate well ahead of any indication that inflation may lift. Our view remains that the RBA will start hiking the cash rate early in 2018 with an initial move of 25bps to 1.75% and that by early 2019 the cash rate will need to be nearer to 2.50%.