Firmer than expected global economic growth in January, slowing progress reducing inflation and still tight labour market conditions are causing central banks to try and hose down market expectations concerning how soon and how much official interest rates can be cut in 2024. In Australia, based mostly on quite firm economic data over the past month or so, the RBA may still need to hike the cash rate and hold it at the peak for several months before there is any real possibility of cutting the cash rate. Increasing geopolitical tension, notably in the Middle East, presents a renewed threat to global trade and supply chains that may resurrect goods price inflation, further delaying when central banks can start cutting interest rates.
In our first economic report for 2024 in mid-January, we noted that data released since the beginning of December show an economy still growing relatively strongly with a tight labour market and progress reducing inflation starting to flatline well north of the Federal Reserve’s 2% target. Advance Q4 2023 GDP, released last week, saw annualised real growth at 3.3% (market expectation 2.0%) and supported by firm growth in consumer spending, 2.7% annualised growth. US consumers were spending more freely late in the quarter with December personal spending rising 0.7% m-o-m after increasing 0.4% in November. Surveys of consumer sentiment and confidence both showed a strong improvement in both November and December.
Other US leading indicators are also firming. The January manufacturing and non-manufacturing purchasing managers’ indices released last week showed unexpected increases to 50.3 from 47.9 in December for the manufacturing PMI and 52.9 from 51.4 for the non-manufacturing PMI. Housing indicators have firmed mostly too with December new home sales up 8.0% m-o-m and pending home sales up 8.3% m-o-m.
US labour market conditions continue to look tight and support annual wage growth running above 4% y-o-y, too high to allow inflation to come down to the Federal Reserve’s 2% target. The December Non-farm payrolls report showed strong employment growth, up 216,000 and firm wage growth with average hourly earnings up 0.4% m-o-m, 4.1% y-o-y (November +0.4% m-o-m, +4.0% y-o-y). The unemployment rate was low and steady in December at 3.7%. US CPI inflation in December was higher than expected, up 0.3% m-o-m taking annual inflation up to 3.4% y-o-y from 3.1% in November.
When the Federal Reserve meets on Wednesday it is likely to leave the funds rate unchanged at 5.50% but with a stronger warning that firm economic conditions in the US will not permit the Federal Reserve to cut rates for many months.
In China, economic conditions remain soft with the downturn in the property sector continuing and dampening the spirits of Chinese consumers. Q4 GDP rose 1.0% q-o-q down from 1.5% in Q3 but lifting annual growth to 5.3% y-o-y from 4.9% in Q3. December monthly economic readings remain comparatively soft with fixed asset spending up 2.9% y-o-y (2.9% in November); industrial production up 6.8% y-o-y (6.6% in November) and retail sales up 7.4% y-o-y (10.1% in November). Annual growth in consumer and producer prices remained sub-zero in January at respectively -0.3% y-o-y and -2.7% y-o-y reflecting an economy with substantial excess capacity. The authorities continue to struggle to develop initiatives that can reverse over-supply in residential property and cauterize the deterioration in the balance sheets of big property developers, their customers and their financiers. GDP growth will struggle to make 1.0% q-o-q in Q1 2024, and inevitably annual growth (y-o-y) will slide below 5%, the order of growth necessary to stem destabilising over-supply conditions in China.
In Europe, Q4 2023 GDP out later this week is expected to show another small fall (-0.1% q-o-q) leaving annual growth around 0.0% y-o-y. Europe is in mild recession that is most pronounced in its biggest economy, Germany. The European Central Bank (ECB) remains unable to respond to deteriorating economic conditions by cutting interest rates because tight labour market conditions (the unemployment rate fell to a quarter-century low 6.4% in November) are still fostering high wage growth. Although annual CPI inflation fell to 2.9% y-o-y in December, progress is likely to falter in coming months. The ECB left its deposit rate unchanged at 4.00% at its policy meeting last week and is showing little sign of being able to cut rates soon.
In Australia, economic indicators released in January paint a mixed picture. At the leading-edge housing activity appears to have strengthened. Home building approvals in November were up 1.6% m-o-m, after rising 7.2% in October and the value of new home loans was up 0.5% m-o-m after rising 5.6% in October.
Retail spending, a key coincident indicator of economic activity, rose by 2.0% m-o-m in November to a record high, boosted by the run of sales promotions in the month. December retail sales are due this week and any rise in the month would indicate quite strong spending through late 2023.
Employment growth faltered in December, falling 65,100, but after an upwardly revised 72,600 increase in November. Abnormal weather conditions may have played a part in the December employment fall that went hand-in-hand with a sharp fall in the labour force participation rate to 66.8% in December from 67.3% in November. The unemployment rate was unchanged at 3.9% in December still indicating relatively tight labour market conditions.
Monthly CPI inflation fell a little more than expected in November to 4.3% y-o-y from 4.9% in October helped by lower petrol prices and moderating goods price inflation. The reduction in inflation will likely continue to show in the December (market expectation +3.7% y-o-y) and Q4 CPI reports out this week (market expectation +0.8% q-o-q, +4.3% y-o-y, down from +1.2% q-o-q, +5.4% y-o-y).
The key inflation readings this week will determine whether the RBA keeps the cash rate on hold at 4.35% at the 6th February interest rate meeting, or needs to tweak the cash rate higher. Any upside surprise in the inflation readings this week or sign that service price inflation is staying high could tip the balance towards another interest rate hike, given the resilience of demand in the Australian economy.