The pace of global economic growth is slowing, according to initial reports of Q2 GDP, but the response of the world’s central banks either easing monetary policy or turning towards considering easier policy reduces the risk that slow growth turns to recession over the next year or so. Q2 GDP reports released so far from China and the US both show slower annual growth compared with Q1, but with comparatively strong growth in household spending helping to counter the damage to growth in key sectors in both economies. China is taking a hit to growth from weaker exports, whereas in the US disruption from the trade dispute is mostly via business supply lines, costs and margins and is starting to cut business investment spending. The promising signs in late June and early July that the US and China were resuming trade negotiations appear to be fading again. The saving grace is that policymakers, especially the central banks, are looking at ways of priming spending.
In the US, Q2 GDP growth at 2.1% annualised was better than expected although softer than 3.1% reported in Q1. One key strong element in the Q2 GDP report was consumer spending up 4.3%, the strongest lift since Q4 2017 and compared with 1.1% in Q1 2019. US household spending growth is likely to remain underpinned by strong employment growth (non-farm payrolls rose 224,000 in June), 3%+ annual wages growth and strongly rising household wealth. The prospect of more growth in household spending, the biggest single element of US GDP, make it unlikely that the US economy will suffer recession over the next year, even though the current US expansion is the longest in more than 160 years.
The weak part of US GDP growth is business investment spending down an annualised 5.5% in Q2, the worst outcome since Q4 2015. Although US businesses are benefitting from strong growth in sales to the US household and government sectors (government spending rose at 5% annualised pace in Q2) export sales are compromised by the trade war and supplies of imported goods from China are much higher priced after the various tariff increases imposed by President Trump.
The US Federal Reserve (Fed) meets later this week and comments from various senior Fed officials, including Chairman Powell indicate that although the Fed still expects the US economy to grow well, it is mindful of the downside risks to the growth outlook posed by the continuing trade war. The Fed has given a strong indication that it will cut the funds rate 25bps to 2.00-2.25% range at its end July meeting, but will balk at cutting rates as much as the unduly recession-risk obsessed interest-rate market is expecting.
In China, Q2 GDP growth slowed to 6.2% y-o-y from 6.4% in Q1. The monthly data for June tell a story of an economy weighed by weak international trade, exports fell 1.3% y-o-y, with imports down 7.3%, but with domestic sales and output holding up comparatively well. Fixed asset investment spending accelerated to 5.8% y-o-y from 5.6% in May while industrial production increased 6.3% y-o-y in June from 5.0% in May. Most encouragingly, retail sales growth accelerated to 9.8% y-o-y in June from 8.6% in May. These June readings seem to show that while the trade war is hurting the economy the moves by the authorities cautiously deploying more expansionary fiscal and monetary policy, may be assisting domestic spending to offset international trade weakness. China seems to stand more chance than was the case a month ago of keeping annual GDP growth at 6% or higher in the second half of 2019.
In Europe most leading economic indicators have stayed weak in July. The preliminary July manufacturing PMI slipped further below the 50 expansion/contraction line falling to 46.4 from 47.6 in June. July consumer confidence at -6.6, although better than -7.2 recorded in June remains weak. Q2 GDP is due later this week and is expected to show only 0.2% q-o-q growth reducing annual growth to 1.0% y-o-y from 1.2% in Q1. At its July policy meeting, the European Central Bank left policy interest rates unchanged but in the accompanying commentary focused on downside risks to European growth prospects and its readiness to adopt easier policy. In Britain, Boris Johnson won the leadership race for the conservative party and became the new Prime Minister promising to deliver Brexit on 31st October with or without a new agreement with the EU. The new Prime Minister’s plans will run the gauntlet of a deeply divided Parliament and country in the first instance and if he survives that an EU governing body deeply opposed to changing the deal offered for Brexit, especially the conditions related to Ireland. The chances still look very slim of avoiding a period of heightened economic uncertainty for Britain and the EU beyond the end of October.
In Australia, the signs of moderate-paced economic growth generating good growth in employment but little upward pressure on inflation continued in July. Despite international trade tensions prices for Australian exports have lifted very strongly over the past year (in Q1 2019 up 4.5% q-o-q, +15.3% y-o-y and likely to be up at least 15% y-o-y when Q2 export prices are released later this week) delivering a big, albeit narrowly-based, boost to national income. Nominal and real Q2 GDP due for release early in September should see best quarterly growth in a year boosted by strong net export contribution but also assisted by better contributions to growth from household consumption spending and business investment spending.
During July it became clearer that home-buying activity has based and that house prices have stopped falling. Lower home mortgage interest rates after back-to-back official cash rate cuts by the RBA in June and July; an easing of APRA home lending rules; and income tax cuts flowing with 2018-19 tax returns make it likely that the improvement in home buying activity will extend through Q3 and Q4 2019 extending to improvement in home building activity in 2020.
There are still downside risks to Australian economic growth prospects from the entrenched international trade war and high Australian household debt combined with slow household income growth, but immediate-term growth prospects look better than in the second half of 2018 and early 2019. The RBA’ two 25bps cash rate cuts to a record low 1.00% were not aimed at lifting an economy at risk of sliding into recession but rather at helping the economy to generate lower unemployment while lifting inflation over time back inside target band.
The RBA notes a significant change in the Australian economy over the last 18 months, an increased flexibility in the labour market allowing a strong increase in demand for labour to be met by an even stronger increase in supply. The labour force participation rate has moved up by more than a percentage point since mid-2017 to a record 66% and still appears to be increasing. Rising supply of labour is one factor sustaining relatively slow growth in wages which in turn is keeping inflation low. The RBA has delivered a sizeable rate and is likely to wait and judge the impact on employment growth, wages and inflation. Our view is that the upward impact on all three will be noticeable over coming months avoiding the need for more rate cuts. If we are wrong, however, the RBA has made it plain that it will not hesitate to cut the cash rate further.