Global economic growth continued to gather pace through February with most leading economic indicators pointing to even stronger growth ahead, especially in the United States. Inflation is also showing signs of starting to lift although there are still no signs that the lift will be more than a temporary phenomenon, other than perhaps in the United States where the economy is starting to run up against labour market capacity constraints. In Australia, GDP growth looks set to improve when the Q4 report is released this week and more recent monthly data and surveys point to better growth continuing in Q1 2017 too. Central banks continued to move through February towards heralding an end of monetary policy easing or even tightening policy in the cases of the US Federal Reserve and the Peoples’ Bank of China.
Returning to the US economy, most indicators of economic activity continued to strengthen through February especially leading indicators of consumer spending, the labour market and manufacturing activity. The February Empire (New York) State purchasing managers’ index lifted from +6.5 in January to +18.7, the highest reading since late 2014. Even more impressively the mid-Atlantic coast Philadelphia Fed’s manufacturing PMI rose from a strong reading of +23.6 in January to +43.3 in February, the highest reading since January 1984. Amid signs of strengthening US economic activity on a broadening front, the labour market continues to tighten – non-farm payrolls rose by 227,000 in January after lifting 157,000 in December and very low weekly initial jobless claims point to further strong readings ahead. Wages are rising erratically and inflation readings continued to lift in January with the headline CPI at 2.5% y-o-y and the core CPI excluding food and energy prices up 2.3% y-o-y, both running above the Fed’s target of 2.0%.
One important factor influencing the US economy, especially business and consumer sentiment, is the policy program of President Trump. President Trump’s attempts to speed along national security and economic on-shoring measures by executive orders are running in to legal road blocks. The most positive part of President Trump’s policy proposals for US businesses in general relate to tax changes. President Trump promised an early outline of tax proposals and then appeared to stall on some proposals. Confusion about what proposals may be achieved is also noted by the Fed that wants to wait-and-see before making any adjustments to monetary policy to counter a budgetary expansion that may cause the US economy operating near capacity to potentially overheat. The Fed is working as it has been for some time on what the US data are showing and that warranted leaving the funds rate unchanged at 0.75% at its January 31st/ February 1st policy meeting but with a dual warning that it is both prudent to lift interest rates slowly, but also that it would be unwise to delay the next instalment with inflation rising. There was a strong sense from various speeches and comments from senior Fed officials, including Fed Chairman Janet Yellen that the approaching mid-March policy meeting is likely to deliver a 25bps rate hike to 1.00%.
In China, the Lunar New-Year celebrations and holidays limited the number of economic releases. What official releases there were relating to January showed greater-than-expected improved in China’s international trade performance, exports +7.9% y-o-y in US dollar terms and imports +16.7% y-o-y; rising inflation, CPI +2.5% y-o-y and producer prices +6.9% y-o-y; but a slight deceleration in house price inflation to +12.2% y-o-y from +12.4% in December. The limited January data readings are consistent with the economy growing at about its Q4 2016 pace of 6.8% y-o-y in Q1, but still with policy challenges ahead for the authorities relating to rebalancing economic activity on to a sustainable path. Near-term, the authorities are showing signs of focusing more on economic reform and less on sustaining economic growth at all costs. Further moves were made in February to close the most inefficient State-owned enterprises, notably in steel production. The Peoples’ Bank of China also tweaked slightly higher some of its official lending interest rates by 10bps during the month attempting to both manage capital outflow and limit too fast growth in residential construction too. There are signs of a policy-induced slowing in the pace of economic grow developing around mid-year.
In Europe, both GDP growth and inflation are showing signs of starting to lift. Q4 GDP growth rose 0.4% q-o-q, 1.7% y-o-y. Inflation accelerated to 1.8% y-o-y in January and is expected to push up further to 2.0% y-o-y in the preliminary February reading due this week. While the European Central Bank’s official interest rates still have a negative sign on the front the ECB is starting to reduce its monthly asset purchases or QE. Political risks still abound in Europe with several elections due this year and tricky negotiations ahead with Britain over exiting the EU, but at least most of Europe is growing.
The Australian economy was an unusual odd-man-out back in December exhibiting signs of weaker growth. An unusual combination in Q3 2016 of falling housing activity, falling government investment spending and weakness in net exports led to a negative Q3 GDP reading, -0.5% q-o-q sharply reducing annual growth from a downwardly revised 3.1% y-o-y in Q2 to 1.8% in Q3. Q4 GDP is due this week and looks set to lift around 0.7% q-o-q, 1.9% y-o-y. The growth rebound is supported by significant improvement in real retail trade in Q4, +0.9% q-o-q, as well as rising residential construction, +1.1% q-o-q and a much smaller fall in private new capital expenditure in Q4 than occurred in Q3. More recent reports and surveys indicate that the improvement in GDP growth in Q4 should continue in Q1.
Average monthly employment growth has lifted to +22,000 in three months ending January, compared with -8,000 in the previous three-month period ending October 2016. Over the same two periods, paid hours worked lifted more than 2% over the most recent compared with -0.1% before. National income has been boosted sharply by rising export prices, up 12.4% q-o-q in Q4 after lifting 3.5% in Q3 and still rising early in 2017. The sharp rise in export prices lifted Australia’s international trade balance to a record surplus $A3.5 billion in December, a figure that will probably be exceeded when January trade data are released later this week. Home buying activity also appears to be strengthening again in Sydney and Melbourne although in the process is highlighting potential economic vulnerability down the track from excessive build-up of household debt and down-side risks to housing activity and household consumption spending if the household sector becomes more cautious.
For the first time in this cycle the RBA has become explicit warning that further reductions in interest rates are not in the national interest. While inflation continues to track below the RBA’s 2-3% target band and is expected to stay below for some time, this is no longer a good reason for the RBA to cut its cash rate. Instead the RBA seems to view an economy with prospects of accelerating above trend growth but with potential threats to financial stability from too rapid price growth in parts of the housing market as good reason to hold the cash rate unchanged even in the face of low inflation and a push upwards in some banks’ lending interest rates caused by rising funding costs. The growing risk is that the RBA may need to nudge along the process of rising bank lending interest rates with a cash rate hike if house prices continue to rise to fast. We are penciling in a 25bps RBA cash rate hike to 1.75% early in 2018.