Global economic expansion continued in May led by advanced industrial countries such as the United States (US) and notwithstanding the worsening pandemic in much of Asia. Rising demand is testing production supply bottlenecks resulting in higher producer prices extending to higher consumer prices in the US. The lift in inflation is judged temporary by most central banks and no cause to start tapering monetary policy support in the near term. Economic expansion looks set to continue primed by fiscal and monetary support and further aided by increasing vaccination rates making lockdowns less necessary to contain occasional Covid-19 flare-ups.
US economic statistics released in May were mixed strength but consistent with GDP growth likely to lift above 10% annualised pace in Q2 from 6.4% recorded in Q1. The lift out of deep recession is the speediest and sharpest on record primed by the biggest lift in government spending since World War II and very easy monetary conditions. The rapid pace of growth in government, household and business spending in the US is adding to pressures on production supply chains already challenged by pandemic restrictions.
Job vacancies in the US are running faster than growth in payrolls. The generosity of unemployment support payments lifted in the pandemic and extended through 2021 could be causing some to avoid taking up lower-paid employment opportunities. An anomaly showed in the April non-farm payrolls report with a much smaller than expected 226,000 increase in the month and in an economy growing fast enough to warrant a rise of a million or more.
US businesses are reporting increasing difficulty obtaining Labour incongruous with the unemployment rate at 6.1% in April well above the pre-pandemic level of 3.5%. It is not only labour that appears to be in short supply but materials too placing upward pressure on producer prices. In April, producer prices rose 0.6% m-o-m, 6.2% y-o-y after lifting 1.0% m-o-m, 4.2% y-o-y in March. Consumer prices also increased by more than the market expected in April, up 0.8% m-o-m, 4.2% y-o-y and with the core CPI up 0.9% m-o-m, 3.0% y-o-y.
The Federal Reserve is calling the burst of inflation temporary and expects annual inflation to subside to 2% y-o-y later this year. The risk is that the Fed is wrong, and that inflation is becoming entrenched. If this is the case, the Fed will want more proof and that will take several months. There is a growing likelihood that the Fed may change view and start to taper monetary accommodation early next year.
Unlike the US where GDP growth is likely to accelerate through 2021 China’s annual GDP growth may have peaked at 18.3% y-o-y in Q1 2021. Nevertheless, there are signs in China’s April economic readings that growth is still robust in Q2. International trade is holding up better than expected with exports lifting to 32.3% y-o-y in April from 30.6% in March while imports rose 43.1% y-o-y from 38.1% in March. In the domestic economy growth in fixed asset investment spending, +19.9% y-o-y in April from +25.6% in March, and industrial production, +9.8% y-o-y in April from +14.1% in March, are moderating but at lesser pace than expected. Growth moderation, however, is more pronounced than expected in retail sales, +17.7% y-o-y in April from +34.2% in March. China’s y-o-y GDP growth will slow in Q2 and through the second half of 2021 but looks set to beat Government estimates of 6% annual growth for 2021.
In Europe, the reduction of Covid-19 restrictions and rising vaccination rates reducing the likelihood of future return to restrictions will see acceleration in European GDP growth beyond Q1. Europe has suffered a double-dip recession because of repeated periods of shutdown. In Q1, GDP fell by 0.6% q-o-q and was down 1.8% y-o-y. As Europe has started to open leading European economic indicators are lifting. The May manufacturing and service sector purchasing manager indices at respectively 62.8 and 55.1 are both in expansionary territory. Household spending is improving with retail sales up 2.7% m-o-m in March. Europe’s unemployment rate was down to 8.1% in March. EU budgetary support and ECB monetary support remain strong particularly for the smaller member economies that suffered worst from Covid-19. Europe should see a sharp rebound in GDP growth starting in the current quarter.
In Australia, the Q1 GDP report due this week is expected to show that the economy has recovered above its level just before the Covid-19 recession. Annual GDP growth is expected to lift above 1% y-o-y on a 2%+ q-o-q GDP rise. Some of the strongest readings in the Q1 GDP report will relate to private sector investment spending. In the Q1 construction and private capital expenditure reports released last week residential building work rose by 5.1% q-o-q in real terms while business capital expenditure on plant and machinery rose by 9.1% q-o-q.
Beyond Q1, early Q2 economic readings continue to show the economic recovery broadening and strengthening. Preliminary April retail sales lifted 1.1% m-o-m. The April NAB business survey showed both the business conditions and business confidence readings lifting to record highs, respectively +32 and +26. The post-Job Keeper fall in employment was modest at 30,600 in April and the unemployment rate fell to 5.5% from 5.7% in March.
The 2021/22 Federal Budget released in early May kept stimulus spending rolling promising to spend all the dividend to government coffers from higher-than-expected growth. The RBA continued upgrading its growth and employment forecasts in its early May Monetary Policy Statement but reaffirmed guidance that it does not expect to lift official interest rates before full employment is achieved and that will not occur before 2024.
The current policy prescription bakes in robust Australian economic growth even allowing for the current growth reducing Covid restrictions in Victoria. If Victoria’s restrictions extend beyond the current proposal of 7 days, it is fair to say they are the last extensive restrictions that will be implemented in Australia as the rising Covid vaccination rate limits the need to impose restrictions in Covid outbreaks. What the Victorian restrictions take from growth in Q2 will be given back and more in rising business and household confidence to spend in an environment of no more extensive shutdowns.
At some point rapid growth will spill over to sustained inflation. The RBA expects annual inflation to spike above 3% y-o-y in Q2 before subsiding below 2% later in 2021 and then rising slowly through 2022 and 2023. Slow annual wage growth will prevent a sustained lift in inflation according to the RBA. While slow wage growth (still only 1.5% y-o-y in Q1) may continue through the remainder of 2021 the pace of economic growth leading to more labour shortages in more sectors of the economy may generate higher wage growth in 2022 earlier than the RBA is forecasting. We do not expect a quick change in the RBA’s views about wages, inflation, and interest rates, but we do expect rapid growth to force a change in 2022. We see the RBA abandoning the 2024 timeline for a rate hike in the first half of 2022 and delivering a first hike late 2022 or early 2023.