The corona-virus outbreak will dent Q1 global economic growth, but the impact is likely to be “V-shaped” with growth reduction in Q1 and perhaps Q2 recovering in Q3 and Q4. Our “V-shaped” recovery view does not depend upon when the corona-virus outbreak is contained – health expects dealing with the outbreak seem to see it peaking in March or April – instead it is based on signs of improvement in global growth ahead of the outbreak and likely policy stimulus delivered in response to the outbreak, especially in China. Australian economic growth may suffer a bigger dip than most in Q1 because of the overwhelming importance of China in Australia’s trade in goods and services. The corollary is that the actions taken by China’s authorities to boost the economy as it recovers from the corona-virus outbreak are likely to boost Australian economic growth as well.
Returning to the theme of improving global growth ahead of the corona-virus outbreak the best example is the US economy. The latest US economic readings still point to strengthening economic activity supported by growth in household spending. January retail sales rose 0.3% m-o-m after a 0.2% gain in December. The major support for household spending continues to come from the buoyant US labour market. January non-farm payrolls rose by 225,000 after lifting 147,000 in December. Annual growth in average hourly earnings rose to a decade-high 3.1% y-o-y and the unemployment rate at 3.6% in January remains close to a 50-year low.
Most US housing indicators remain very strong too. The National Association of Home builders’ Index (74 in February) has been in very strong mid-70 territory since October. Home building permits unexpectedly rose by 9.2% m-o-m in January and housing starts running at a multi-decade high in December after rising 17.7% m-o-m, shed 3.6% in January – a much smaller pull-back than expected.
Apart from US housing activity and household spending the latest regional manufacturing surveys for February are surprisingly strong too. The February Empire (New York) survey pushed much further than expected into expansionary territory recording +12.9 compared with +4.8 in January. The lift in the Philadelphia Fed survey for February was even more pronounced to +36.7 from +17.0 in January. Meantime, the January Federal Reserve policy meeting left the Funds rate unchanged at 1.75% and with no prospect of untoward lift in inflation the Fed is providing guidance that rates may stay unchanged through late 2020 at least. Whatever dip occurs in US growth because of the corona-virus is likely to be small and with quick return to accelerating growth beyond.
In China, at the epicentre of the corona-virus outbreak, the near-term reduction in GDP growth is likely to be pronounced. Extreme quarantining restrictions have shut down factories and public gatherings. In the short-term the authorities have made corporate loan conditions easier and reduced interest rates. The initial handling of the corona-virus outbreak and its early spread wrong-footed the Beijing Government authorities. The authorities are now fighting to arrest growing public unease by showing that they are on the front-foot combating the outbreak – imposing severe quarantining restrictions unthinkable anywhere else in the world but at the same time ramping up corona-virus research and building a quarantine hospital in Wuhan in record time. The public unrest threat to the Beijing authorities from corona-virus, however, will not be alleviated unless they can deliver a quick return to economic growth and prosperity after the corona-virus outbreak has peaked. Almost certainly, the authorities will deliver whatever fiscal and monetary stimulus it takes to reset annual GDP growth near 6% y-o-y after a Q1 fall to near zero, or perhaps less.
In Europe, lack-luster annual economic growth moderated further to 0.9% y-o-y in Q4 2019 and the biggest economy, Germany, has all but stalled showing no growth in the quarter and annual growth of only 0.4% y-o-y. Surprisingly, the latest leading economic indicators out of Europe are mostly a touch stronger. February consumer confidence improved to -6.6 from -8.1 in January. The February manufacturing sector purchasing managers’ index rose unexpectedly to 49.1 from 47.9 while the services sector PMI rose to 52.8 from 52.5. The latest unemployment rate reading for January showing a reduction to a decade-low 7.4% from 7.5% in December also seems inconsistent with soft and moderating annual GDP growth. Certainly, the European Central Bank is well aware of the potential downside risks to European growth and new President, Christine Lagarde, emphasises continuing monetary policy growth support and also the need for those European governments that able to provide fiscal support to do so.
In Australia, the latest economic readings point to economic growth accelerating late in 2019 ahead of the dent that will occur in Q1 from the bush-fires and corona-virus outbreak. Interestingly, the recovery in home-buying and prices that started mid-2019 is showing signs of gathering pace on the latest weekend’s home auction reports showing around 80% clearance rates in both Sydney and Melbourne and on higher listings. At this stage, it seems that housing activity will continue to improve providing a springboard for more general improvement in the economy once the corona-virus outbreak is contained.
Returning to the latest economic readings December home building approvals slid 0.2% m-o-m after an out-sized 10.9% gain in November and the trend over the two months is improving pointing to the beginnings of recovery in home building activity mid-2020. December home loan commitments for owner-occupiers rose by 3.5% m-o-m and are up more than 17% y-o-y another sign of improving housing activity. December retail sales fell by 0.5% m-o-m after an upwardly revised 1.0% gain in November. In Q4 real retail sales were up 0.5% q-o-q, the best gain in a year, after falling 0.1% in Q3.
While there is evidence that spending in the Australian economy was improving in Q4 2019 keeping the momentum going depends upon the heavily-indebted household sector preferring to spend rather than save more at the margin. Higher house prices may work towards reducing household caution, but low growth in wages – flat-lining at 0.5% q-o-q, 2.2% y-o-y in Q1 – still militates towards caution. The key influence on household spending growth could be that measure of relative tightness (and likelihood of better wages growth) in the labour market, the unemployment rate. The unemployment rate edged lower in November and December to 5.1% but bounced up in January to 5.3%. The RBA has indicated that it is watching the unemployment rate to assess the need for any further reduction in the low 0.75% cash rate.
In early February the RBA left the cash rate unchanged at 0.75% and after discussion at the meeting of the likely negative impact of the corona-virus on Australian growth in the near-term. The RBA is also mindful of the strong recovery in home buying and house prices and the influence of very low home loan interest rates. At this stage, we doubt whether the RBA would use the February lift in the unemployment rate to drive a cash rate cut. We also doubt whether the unemployment rate will drift up much further to change the position over the next few months.
We continue to expect no change in the RBA’s 0.75% cash rate over the next few months although that call is contingent on the unemployment not pushing up to 5.5%. Beyond the next few months, post-corona-virus spending in China and at home the housing recovery plus bush fire recovery spending all reduce the need for any cash rate cuts this year.