Downside risks to global economic growth prospects are mounting notwithstanding economic indicators in the major economies that are mixed rather than consistently weakening. The clearest downside risk to global economic growth remains the escalating trade war between the United States and China. Other prominent downside risks include potential political and economic turmoil in Europe focused on the approaching Italian election and the high likelihood that Britain will crash out of the EU without a deal at the end of October. The democracy protests in Hong Kong are also a potential flashpoint for sudden political turmoil if China intervenes with force. Set against these downside risks to global growth, the world’s central banks stand ready to ease monetary conditions and the chances are increasing of a significant rise in government spending in one or more of the bigger economies.
In the US, Q2 GDP growth at 2.1% annualised was better than expected and the reports of economic activity early in Q3 are pointing to at least as strong growth again in Q3. Strong household spending growth (4.3% annualised) provided the biggest support for US GDP in Q2 and looks set to provide similar, or better, support to Q3 GDP on the basis of near record high consumer confidence plus a very strong rise in retail sales in July, up 0.7% m-o-m. Low unemployment, plentiful jobs including for low-skilled workers, strong wages growth including for the lower paid are all providing very strong support for household spending that is unlikely to diminish in the near-term.
The downside risks to US economic growth come from more hesitant business spending responding to the disruption to costs and supply lines caused by higher tariffs on imports from China and most recently President Trump’s calls for US companies not to trade with China. Weaker US business investment spending could erode US growth prospects over time potentially leading to recession although probably not until late 2020 or 2021. Also, the risk of US recession could diminish further if the Federal Reserve (Fed) eases monetary policy more aggressively and/ or government spending in the US rises more rapidly.
The Fed cut the funds rate 25bps to 2.00 to 2.25% range at its end-July policy meeting, but the cut was not as big as called for by many in the market and certainly not the large rate cut called for by President Trump to weaponise monetary policy in his escalating trade war with China. The Fed is caught between maintaining policy independence where it changes monetary conditions to reflect the needs of the US economy according to its own economic forecasts or bowing to political pressure in setting rates.
The modest late-July cut in the funds rate speaks of a Fed resisting political pressure. The funds rate may still be cut further, but only modestly as long as US economic growth holds up. Despite President Trump’s attempts to lay the blame at the feet of the Fed for any potential weakness in US growth, it is becoming more widely understood that the escalating trade war is the main cause of uncertainty about future US economic growth prospects. The blame is likely to sheet home to President Trump for increasing US economic uncertainty and as it does the President is likely to need to start deescalating as the 2020 Presidential election year draws closer.
In China, Q2 GDP growth slowed to 6.2% y-o-y from 6.4% in Q1 and the signs are that China’s economic growth rate is slowing further in Q3. In July, growth in industrial production eased to 4.8% y-o-y from 6.3% in June. The part of China’s economy that the authorities would like to see gain traction, retail sales, is losing momentum growing 7.6% y-o-y in July, down from 9.8% in June. International trade growth is soft. The trade war with the US is hurting. The democracy protests in Hong Kong are also tipping Hong Kong’s economy towards recession. If China intervenes in Hong Kong it risks fomenting far greater political and economic uncertainty. If it continues to sit on the sidelines, the escalating protests in Hong Kong threaten a deep recession in the territory extending into bordering parts of southern China. So far, the authorities in China have been cautiously deploying more expansionary fiscal and monetary policy to try and offset the negative impact of the trade war and the disturbance in Hong Kong. At some point it is likely that more aggressive stimulus measures will be adopted. Until that occurs, China’s growth prospects are sliding.
In Europe, while a prospective hard British Brexit in late October and the likelihood that the approaching Italian elections will result in an unstable anti-EU Government are threatening to weaken further European economic growth prospects, recent economic indicators have mostly been a touch better than expected. Annual GDP growth moderated less than expected in Q2 to 1.1% y-o-y. The preliminary August manufacturing PMI was better than expected lifting to 47.0 from 46.5 in July although still sitting below the 50 expansion/contraction line. The August preliminary services sector PMI, against expectations of deterioration, improved to 53.4 from 53.2 in July. Europe’s unemployment fell to a decade low 7.5% in July. Understandably, the European Central Bank remains focused on downside risks to Europe’s soft economic outlook and is actively examining other unconventional measures of monetary easing it may be able to deploy in need.
In Australia, the signs of moderate-paced economic growth generating good growth in employment but no reduction in the unemployment rate and no upward pressure on inflation continued in August. Q2 GDP is due to be released next week and although quarter-on-quarter growth seems likely to be the best in a year (around 0.6% q-o-q) annual GDP growth is still likely to slide to around 1.5% y-o-y. Strong contribution to GDP growth from net exports and government spending, plus a weak contribution from household consumption spending are more than offsetting weakness in private capital expenditure preventing the economy from sliding into recession. While the risk of recession is low, especially with evidence that a key leading indicator of economic growth, home sales and prices turned the corner several months ago and are rising, the prospects for GDP growth are modest at best.
Modest Australian GDP growth is likely to continue to generate employment growth but the supply of labour is likely to continue to rise just about as fast. Wages growth is lifting (+0.6% q-o-q in Q2, +2.3% y-o-y) but very slowly. A key question is whether reasonable employment growth combined with the slow improvement in wages will be sufficient to encourage household spending to grow at better pace. In the near-term, tax cuts and lower home mortgage interest rates may boost household spending growth briefly, in turn helping to generate stronger GDP growth in Q3 and Q4.
Australia’s economic growth outlook is quite promising near-term but in 2020 is precariously balanced. The two 25bps cash rate cuts by the RBA in June and July taking the cash rate down to a record low 1.00% were aimed at providing more support for economic growth. Most likely, the RBA will wait and judge the impact of those rate cuts and the tax cuts. The RBA is watching the unemployment rate and wages growth especially closely. Neither the Q2 wages report (steady annual wages growth at 2.3% y-o-y) or the July labour force report (employment up 41,400 with unemployment rate steady at 5.2%) point to a pressing need for the RBA to cut the cash rate again in the near-term. At this stage, the cash rate looks set for a reasonably lengthy stay at 1.00%.