Global economic growth continued to broaden through March with most key regions of the world showing signs of stronger economic growth. While doubts are starting to arise about whether the US Trump Administration will be able to generate its planned fiscal spending in whole or to schedule signs continue to proliferate that US growth is gathering pace without policy assistance and to the point where the Federal Reserve was able to deliver another small step towards normalizing US interest rates. China confirmed that it is aiming to sustain GDP growth of at least 6.5% over coming years. Australia’s GDP growth rate jumped up sharply in Q4 2016, although partly due to unwinding of statistical anomalies causing Q3 GDP to be unusually weak. Central banks have changed footing from pursuing very accommodating monetary policy stances to starting to tighten in the cases of the US Fed and China’s Peoples’ Bank or have stopped easy almost everywhere else amid signs that inflation is lifting or may soon lift.
Returning to the US economy, indicators of economic activity continue to improve, especially leading indicators of economic activity which are either at cycle high-points or close. New home building activity seems to be entering another very strong phase. New home sales rose in February by 6.1% m-o-m after gaining 5.3% in January. February housing starts were up 6.5% m-o-m and housing permits rose 3.1%. The National Association of Homebuilders’ index rose very strongly in March to 71 from 65 in February. Retail spending seems to be strengthening too showing a rise in core spending (excluding automobile sales) of 0.2% m-o-m in February consolidating an upwardly revised strong increase of 1.2% in January. US household spending in general remains well supported by rising household wealth, increasing income and very good growth in Jobs. Non-farm payrolls lifted by 235,000 in February after 238,000 gain in January.
One issue with the US economy operating closer to capacity is that inflation is lifting modestly. In February, the headline CPI lifted to 2.7% y-o-y while core inflation, excluding food and energy prices was 2.2% y-o-y. Both readings are above the Fed’s 2% target, but the Fed is showing signs that it is prepared to allow inflation to run above target for a period. The fed hiked its funds rate by 25bps to 1.00% at its mid-March policy meeting but indicated that its earlier plans are still current to hike another two times in 2017. The Fed is still watching data to determine the need for rate hikes and is watching the Trump Administration’s plans for boosting fiscal spending. The latest set-back to President Trump’s health care legislation point to potential challenges to his proposals for more government spending and tax cuts and the Fed is unlikely to feel pressure to change its economic forecasts on the basis of changing government fiscal position for some time. At this stage, the Fed looks set to hike its funds rate on a gradual path with 25bp hikes loosely penciled in for June and December.
In China, the People’s Congress meeting indicated that China will aim to achieve 6.5% economic growth or stronger if possible over the next few years. In the near-term the authorities continue to deal with a number of issues that may limit economic growth later in 2017 –winding out inefficient and polluting State-owned enterprises; taking the steam out of excessive residential construction and house price inflation; and reforming the banking and financial system. Recent economic readings have still been strong mostly and consistent with GDP growth around 6.8% y-o-y when the Q1 2017 data are released in mid-April. While CPI inflation came down in February to 0.8% y-o-y from 2.5% in January the sharp acceleration in factory gate prices continued in February lifting to 7.8% y-o-y from 6.9% in January. Sharply rising prices of goods manufactured in China are likely to lift consumer prices around the world. The Peoples’ Bank of China has moved from a very accommodative monetary policy stance lifting twice (albeit by only 10bps each time) a selection of its lending interest rates to banks. The main official interest rates are unchanged but it seems increasingly likely that a modest, formal tightening of monetary policy will occur in China before long.
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 2.0% y-o-y in February. Leading indicators of European economic activity point to a further improvement in European economic growth. 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. The results of the Dutch elections favouring the existing, pro-EU government point to some rejection of the populist forces that promoted Brexit in the UK and the election of President Trump in the US. Political risk in Europe seems a touch lower as a result although key challenges still lie ahead with Britain about to enter two-years of divorce negotiations with the EU, elections ahead in France and Germany, and potential difficulties looming again over Greek government debt negotiations.
Australian economic growth rebounded sharply in Q4 2016 up by 1.1% q-o-q and 2.4% y-o-y. Nominal economic growth was even stronger up 3.0% q-o-q and 6.1% y-o-y aided by a major boost to national income from much higher export commodity prices in the quarter. The jump in economic growth was partly due to reversal of statistical anomalies that caused Q3 GDP to be so weak, -0.5% q-o-q. Several of the big contributors to Q4 growth such as big increases in household consumption spending and housing activity look set to figure less prominently in Q1 2017 GDP due in early June. While consumer and business sentiment readings have been comparatively firm in January and February monthly economic readings have been mixed-strength. Retail trade lifted 0.4% m-o-m in January, but after falling by 0.1% in December. Employment fell unexpectedly by 6,400 in February and the unemployment rate rose to 5.9% from 5.7% in January.
One increasing concern is that the relative strength of Australian economic growth has become dependent mostly on the willingness of the income-constrained and very heavily indebted household sector to lift its spending. The household sector has built-up a record high ratio of debt outstanding to household income prodded on in part the long era of interest rates falling to unusually low levels by late last year. Fast rising house prices, especially in Melbourne and Sydney, have added to the incentive for households to borrow even more even in the face of a turn in the borrowing interest rate cycle and record low housing rental yields. As the minutes of the RBA’s early March policy meeting (a meeting that again delivered no change to the 1.50% official cash rate) note household debt continues to rise faster than household income constituting a risk to economic growth.
The RBA’s increasing concern that the boom in housing and associated boom in household debt could lead to forces generating a sharp downturn in economic growth down the track and one that could compromise the stability of the financial system complicates the outlook for monetary policy. Inflation pressures in Australia are still very low mostly because wages growth remains at record lows. The inflation outlook is providing no cause for the RBA to consider tightening monetary policy. However, lack of concern about inflation, may be over-ridden by increasing concern that households are continuing to lift their borrowings off an already very high base and at too fast a pace, especially relating to investment in housing. Most likely the RBA, in consultation with APRA, will look to tighten non-interest controls on lending growth. If these continue to show little sign of working the RBA may be forced to a position of starting to hike the cash rate. At this stage we still see the cash rate unchanged at 1.50% through 2017, but the risk case is that the housing market may force the RBA to start lifting the cash rate earlier.