Q2 GDP reports will soon start to roll in from the world’s bigger economies starting with China next week, the United States in late July and most other economies not long after, including Europe and Japan. Australia takes its time getting out GDP data, but the Q2 report will be issued early in September. Most of these GDP reports are looking at least as firm as they were in Q1 and in the US and probably Australia noticeably stronger. Over the next seven weeks or so it is likely to become evident that the pace of global economic growth stepped up in Q2 and the improvement was quite widely shared. Stronger growth is likely to reinforce a message from many of the world’s central banks that the age of emergency-low interest rates is over. Much of the world now needs more “normal” interest rates.
Returning to the approaching Q2 GDP reports, first cab off the rank is China early next week. Despite a mild tightening of monetary policy by the Peoples’ Bank of China early in the year Q1 GDP growth came in stronger-than-expected at 6.9% y-o-y and Q2 is shaping up based on monthly data received to date around a similar growth rate. The real surprises in China’s monthly economic data have been better than expected growth in urban fixed asset investment, up 8.8% y-o-y in May as well as industrial production, up 6.5% y-o-y and especially exports, up 8.7% y-o-y. Strong growth in exports has not been confined to China but has featured in East and South East Asia generally a sign of better growth in global trade itself a signpost to stronger global economic growth.
US Q2 GDP based on tracking monthly economic readings is shaping up around 2.4% annualised pace, up a percentage point on 1.4% recorded in Q1 and running about three quarters of a percentage point above the US potential growth rate (the combination of productivity change and labour force change). Growth at 2.4% annual pace in the US is fast enough to generate a falling unemployment rate (already down at 4.4% in June) placing upward pressure on wages and eventually inflation. This is the main reason why the US Federal Reserve is lifting its funds rate when the opportunity arises and from the current rate of 1.25% has 1.50% in its sights for the end of 2017, 2.25% planned for end 2018 and conditions still permitting 3.00% for end 2019.
Europe, the laggard in the global economic recovery because of sovereign and banking debt problems has been resolving some of its more pressing debt issues over the past year or so and in the process economic growth has lifted and by more than widely considered likely early in the year. In Q1 GDP growth was a firm 0.6% q-o-q, 1.9% y-o-y, and Q2 is shaping up a touch firmer. The order of economic improvement in Europe is such that the European Central Bank (ECB) has indicated that it no longer sees need for easier monetary conditions in the future. The ECB is still a long way from declaring that it sees a need to start normalising ultra-low interest rates, but eventually that is likely to be its next move.
In Australia Q1 GDP was soft at 0.3% q-o-q, 1.7% y-o-y and at the time the data was released in early June it is fair to say that most analysts, including ourselves, were struggling to see where better growth might come from. The problem was that a developing housing downturn looked set to really challenge an over-indebted household sector struggling with record low wages growth. The biggest part of GDP, household consumption spending looked set for a period of soft growth.
Two big surprises look set to generate better Australian GDP growth in Q2. Retail trade has picked up sharply in April, +1.0% m-o-m, and May +0.6%. New car sales have been strong through Q2 as well. At this stage it looks as if household consumption expenditure lifted around 1.0% q-o-q in Q2, double the pace of Q1. What seems to have enabled the likely strong Q2 lift in household consumption spending was the second big surprise a sharp lift in employment over recent months causing a big fall in Australia’s unemployment rate from 5.9% early in the year to 5.5% in the latest reading for May.
In just the three months ending May employment rose by 141,100 with full-time positions comprising 112,800 of total employment growth. Placing these numbers in context and showing how extraordinary the change in the last few months has been, in the previous nine months employment rose by 91,700 (an average of around 30,000 every three months) and full-time rose by only 35,200 (an average of around 12,000 every three months).
The sharp lift in employment over the most recent three-month period helps to boost growth in household disposable income even with wages growth still very weak. It also makes it more likely that households can continue to service their heavy debt burden and more likely that the slowdown in housing is at the gentler end of the spectrum of possibilities.
Another factor likely to reinforce the GDP growth priming influence from the household sector in Q2 is a stronger turn in the volume of Australian exports, partly a catch-up from coal exports with the speedy repair in April of cyclone-damaged railway links from Queensland’s mines to the coast. Net exports were the biggest detractor from GDP growth in Q1, but should make a positive contribution in Q2.
Whether the improvement in Q2 GDP globally and in Australia is a sign of stronger growth persisting through the second half of 2017 is a little hard to judge, but we suspect that the risk has migrated towards stronger rather than weaker growth. What is evident is that even though government bond yields around the world have started to rise over the past month, they are way too low for a world where growth is above 2% and inflation is at least 1% and migrating higher and a growing number of central banks beyond the US Federal Reserve are indicating that their next rate move is likely to be a hike and probably soon.
The way that Q2 GDP data is shaping up plus the more hawkish comments from several central banks highlight the risk of quite a sharp move up in global bond yields with US 10-year and Australian 10-year government bond yields both set to move above 3.00% in our view over the next few months.