The global economy continues to grow above trend, but potential downside risks remain from a broadening international trade war and pockets of weakness related to high US dollar denominated debt exposure in some emerging economies. The US economy remains one of the world’s strongest performing and looks set to continue growing above trend through the remainder of 2018 extending in to 2019 assisted by robust growth in household and business income and spending. China’s growth rate is still comparatively high and stable. Japan’s growth prospects are improving on the strongest wages’ growth in two decades. Europe’s GDP growth has moderated but remains above 2%. Australian economic growth is moving above trend and is showing signs of broad improvement that is unlikely to be dented by recent political change. Among the world’s central banks slow removal of monetary accommodation is likely to be a key policy theme with the US Federal Reserve well at the forefront and the RBA still following well in the rear.
The second reading of US Q2 GDP is due this week and is expected to show annualised GDP growth around the 4% mark (advance reading 4.1%) and with household and business investment spending still showing impressive annualised gains around respectively 4.0% and 7.3% recorded in the advance numbers. US businesses and households are exhibiting very strong momentum in their spending supported by very strong growth in company earnings, improving wages growth, low unemployment and rising household wealth driven by gains in US house prices and the share market. Corporate and personal income tax cuts are contributing too. In time, the pressure from rising US interest rates may slow growth, but it is worth keeping in mind that after seven Fed rate hikes since late 2015 the Funds rate is still only 1.75%, or 1.15 percentage points below the latest 2.9% y-o-y CPI inflation rate. US real interest rates are still well short of territory that might actively constrain growth.
The latest commentary from the US Fed contained in the minutes of its July policy meeting sees US growth prospects improving compared to their most recent full set of economic forecasts posted in June. The Fed remains on course to hike the Funds rate twice more in 2018 with 25bps lifts to 2.00% in September and 2.25% in December.
In China, GDP growth edged down to 6.7% y-o-y in Q2 from 6.8% in Q1 and leading indicators are pointing to further mild deceleration in Q3. The latest monthly economic readings are all consistent with mild growth deceleration with growth in industrial production holding steady at 6.0% y-o-y in July, but growth in urban fixed asset investment spending and retails both slipping respectively to 5.5% y-o-y (6.0% in June) and 8.8% (9.0% in June). Despite the first moves by the US increasing tariffs on Chinese goods in July, China’s international trade was better than expected in the month with exports up 12.2% y-o-y (June 11.2%) and imports up 27.3% (June 14.1%). The Chinese Government is better placed than most to respond to untoward softening in growth with capacity to use fiscal and monetary measures to boost growth in need. It is unlikely that the authorities will allow China’s GDP growth rate to slip below 6.5% y-o-y in 2018 or 2019.
In Europe, Q2 GDP was initially reported as slipping to 2.1% y from 2.5% in Q1 but has subsequently been revised up a touch to 2.2%. Growth is still above long-term trend and sufficient to keep Europe’s unemployment rate falling and in countries like Germany down to a very low level that is starting to prime higher wages growth and some inflationary pressure. European headline CPI inflation has lifted to 2.1% y-o-y in July with underlying inflation at 1.1% and the risk is that it will continue to drift higher. While the European Central Bank (ECB) accepts that European growth prospects are relatively firm it is still reluctant to act too quickly reducing monetary accommodation. At its latest policy meeting the ECB reaffirmed that it will finish its purchases of securities (quantitative easing) by the end of 2018 and will deliver a first interest rate hike in the late summer 2019.
In Australia evidence is building that that the pronounced rise in Q1 GDP (1.0% q-o-q, 3.1% y-o-y) could be reinforced in Q2. The volume of retail sales increased by 1.2% q-o-q in Q2 after lifting only 0.2% in Q1. Construction spending was also stronger than expected in Q2 lifting by 1.6% q-o-q. Other high points in recent Australian economic reports included the biggest quarterly lift in wages in four years, up 0.6% q-o-q, 2.1% y-o-y and in July the lowest unemployment rate in six years, 5.3%. Other positive surprises included a 6.4% m-o-m lift in home building approvals in June and a sharp lift in Australia’s international trade surplus to $A1,873 million in June from $A725 million in May and driven mostly by a 3% lift in exports in the month. All told, Australia seems to be heading for back-to-back quarterly rises in GDP of 1.0% q-o-q or more in Q1 and Q2 and the momentum for strong growth still appears to be in place for Q3.
RBA commentaries came thick and fast through August with the policy meeting at the beginning of the month (no rate change bringing to two years the period of stability at 1.50% for the official cash rate); the quarterly Monetary Policy Statement; the Governor’s parliamentary testimony; and several speeches from senior RBA officials. The theme in all of the commentaries is that Australian growth will move above trend in 2019 and inflation will eventually pick-up although it may dip in the immediate term because of one-off falls in some administered prices such as child care fees. The RBA continues to warn that the next move in interest will be upwards, but that it may still be some time before the move occurs.
The leadership challenge and change in the Federal Liberal party adds some measure of uncertainty to business and household plans. That lift in uncertainty, however, should be minimal given that it was the Treasurer stepping in to the Prime Minister’s role. Nevertheless, the Prime Ministerial change provides another reason for the RBA to provide cash rate stability for a few more months. We see the RBA waiting until February 2019 before hiking the cash rate 25bps to 1.75%.