Global economic growth has lost momentum in the early months of 2018 although coming off the strongest year for global growth in a decade in 2017. Even though global growth is less robust than it was it is still running close to long term trend and seems on balance likely to regain pace through the northern hemisphere summer months. One major downside risk to global growth remains a broadening trade war, but there are few signs that the early skirmish between the US and China is escalating. Global bond yields after rising in April seemed to peak and retreat a little in May although a slow build up of inflationary pressure in the US is setting the scene for more Fed rate hikes and higher bond yields over the next few months.
Looking at the US economy, annualised GDP growth slowed from 2.9% in Q4 2017 to 2.3% in Q1 2018 but most April and May economic readings and surveys point to US economic growth accelerating in Q2. Most indicators of housing activity were weaker in April, but retail sales were firm in March and April and so too was industrial production in both months. Non-farm payrolls rose in April by 164,000 an increase strong enough to reduce the unemployment rate below 4% (3.9%) for the first time since 2000. Inflation in the US remained elevated in April with the CPI up 2.5% y-o-y although the core CPI excluding food and energy prices was 2.1% y-o-y. Higher energy prices are driving some of the lift in the CPI and signs in late May that global crude oil supply will be boosted by an agreement to lift Saudi and Russian oil output could take some pressure off the CPI over coming months although with building capacity constraints in the US economy working in the opposite direction.
Recent developments in the US economy remain consistent with the Federal Reserve’s public view that robust US economic growth through 2018 and 2019 will lift annual inflation consistently above its 2% target and require continuing slow-paced increases in the Funds rate to a neutral setting around 3.25% by early 2020. The minutes of the Fed’s latest policy meeting imply that it will hike the Funds rate by 25bps to 2.00% at the approaching June policy meeting and will continue to hike the Funds rate by 25bps roughly every three months thereafter. If inflation rises faster than the Fed expects then the pace of rate hikes would step up, but the likelihood of this occurring seems low. Nevertheless, the most likely scenario for hikes in the Fed Funds rate (the Fed’s current view) or the second most likely scenario (surprisingly high inflation causing the Fed to increase the pace of rate hikes) both imply US bond yields rising further over coming months.
China was an important exception to the moderating growth theme in early months of 2018. Q1 GDP growth held steady at 6.8% y-o-y and April economic readings point to GDP growth holding up around 6.8% in Q2 as well. April international trade readings were particularly strong with exports accelerating to +12.9% y-o-y from -2.7% in March while imports rose by 21.5% y-o-y from +14.4% in March. Other April readings were mixed-strength with urban fixed asset investment spending up 7.0% y-o-y (7.5% in March); industrial production up 7.0% y-o-y (6.0% in March); and retail sales 9.4% y-o-y (10.1% in March). On balance, these readings still imply robust economic growth in China, but they also imply that the rebalancing of economic growth drivers much more in favour of retail spending inside China is proving difficult to achieve. The authorities are still finding it hard to influence Chinese households to spend more freely and save a smaller proportion of their income. A still poor welfare safety net in China still encourages unusually high household saving in China and this area needs to be addressed if China’s consumers are to make the order of contribution to GDP growth that the authorities would like to see over time.
In Europe, Q1 GDP growth moderated to +0.4% q-o-q, +2.5% y-o-y from +0.6% q-o-q, +2.7% y-o-y in Q4 2017. The three big euro-area economies, Germany, France and Italy all recorded only +0.3% q-o-q growth in Q1. This slowing in the pace of European economic growth is not expected to persist but together with some moderation in European inflation it is strengthening the position of the “doves” at the European Central Bank (including President Mario Draghi) who want to see very easy monetary policy maintained until at least the end of September. Easy monetary conditions plus the continuing edging down in unemployment in Europe still make it likely the European economic growth will rebound through the summer months and possibly quite strongly.
Australian economic growth is slowly improving but economic prospects are still challenging with uncertainty surrounding spending by the heavily-indebted household sector compounded by a softer outlook for housing activity and still soft wages growth. Q1 GDP growth will be published in early June and at this stage looks reasonably strong, up around 0.6% q-o-q and lifting annual GDP growth to around 2.6% y-o-y from 2.4% in Q4 2017. Exports and business investment spending look set to make noticeably stronger contributions to GDP growth than they did in Q4 2017 with a part offset from perhaps softer growth in household consumption spending. The May Budget promised small income tax cuts that may part compensate for slow wages growth and help to lift household spending later in 2018 and in 2019. At this stage the forecasts of both Commonwealth Treasury and the RBA that Australian economic growth will accelerate to 3% or more over the next year seem realistic.
A slow and erratic pick up in the pace of Australian economic growth will eventually lift the pace of annual wages growth still languishing near 2% y-o-y. If the RBA is to ensure that lift in the cash rate over the course of the cycle is as modest as possible (a desirable objective given the household sector’s heavy debt burden) it will need to start hiking the cash rate ahead of evidence of any substantial lift in wages growth or inflation. This remains the main reason why we still expect the first RBA rate hike to occur over the next few months