The pace of the global economic recovery eased in Q3 evident first in China’s Q3 GDP report and with more confirmation expected in GDP reports from the US and Europe over the next week or so. Inflation pressure has not peaked yet from elevated demand for goods outstripping limited supply. Energy supply has been subject to a range of unusual constraints in October affecting the US, China and Europe adding to upward pressure on inflation. Higher inflation is still regarded as temporary by most central banks although some have started to break ranks with the US Fed declaring it is closely monitoring price increases and likely to taper its bond buying soon, while others such as the Bank of Korea, Norge Bank and Reserve Bank of New Zealand have hiked official interest rates. In Australia, the RBA remains adamant that it can hold down official interest rates until 2024 at least because locally supply and wage pressures are not pressing in the near term.
A range of conflicting factors are influencing the outlook for global economic growth. In the US and Europe strong government spending support for growth remains in play – the social and physical infrastructure spending bills in the case of the US and European recovery support spending for weaker EU economies. These boosts to government spending, however, will not match the winding down of income support programs which means less overall fiscal support for growth. Slow removal of monetary support by some central banks may also lean against the recovery while others will maintain highly supportive monetary conditions. China, the world’s, second biggest economy, is losing growth pace and downside risks are growing near term because of President Xi’s “common prosperity” policy changes, pressure on property developers and energy shortages. Everywhere, around the world, less pandemic restrictions have boosted growth, but infection rates still simmer even in highly vaccinated countries presenting the risk of a return to restrictions.
In the US, the first look at Q3 GDP is due later this week and is expected to show that annualised growth moderated to around 2.8% from 6.7% in Q2. Household spending was not as robust in Q3 as it was in Q2 although the softness in Q3 was early in the quarter with most indicators later in the quarter starting to firm again. Retail sales, for example, fell 1.8% m-o-m in July, but then lifted 0.9% in August and 0.7% in September. Consumer sentiment in the US has been weighed over the past month or two by rising petrol prices, removal of special unemployment support payments as well as concerns about the Biden Administration’s difficulties dealing with issues surrounding its budget plans, debt ceiling and threat at one stage of government shutdown. On the positive side, household sector savings are still high providing a war chest to spend, wages are rising with average hourly earnings up 4.6% y-o-y in September and household wealth is high.
Most leading indicators of US business activity remain in historically high territory. The October National Association of Homebuilders’ index rose to 80 from 76 in September. The September ISM manufacturing purchasing managers’ index rose to 61.1 from 59.9 in August while the non-manufacturing or services ISM purchasing managers’ index rose to 61.9 from 61.7. US businesses report very strong demand but continue to experience supply issues and rising input prices. September producer prices rose by 0.5% m-o-m, 8.6% y-o-y and the CPI was up 0.4% m-o-m, 4.0% y-o-y. Higher energy prices and the rising cost of shelter in the US mean that upward inflation pressure is showing little sign of abating near term. The failure to return of many who dropped out of the US labour force in the pandemic shutdowns is adding to labour shortages and driving wages higher. The Fed has moved over the past two months from a relaxed view that inflation is temporary to close monitoring of price changes and firming up an imminent start to reducing QE. The risk is that Fed will soon guide the market to expect a rate hike before mid-2022.
China’s economy continued to lose growth momentum in Q3. GDP rose 4.9% y-o-y down from 7.9% in Q2 and the policy initiatives over recent months add to the risk of even softer growth in Q4. China’s environmental initiatives and attempts to contain excesses in the property development sector while potentially positive for China to grow sustainably longer term are at the expense of near-term economic growth. Two mainstays of past economic growth, fixed asset investment spending and industrial production continue to slide. In September, fixed asset investment spending rose 7.3% y-o-y, down from 8.9% in August. The continuing Government crackdown on speculation in property development will continue to reduce activity in the sector further weakening fixed asset investment spending. Industrial production is under pressure too from increasing environmental restrictions and energy shortages. In September industrial production was up only 3.1% y-o-y down from 5.3% in August. Retail sales growth accelerated to 4.4% y-o-y in September from 2.5% in August but still a comparatively soft result and unlikely to strengthen far with the uncertainty being generated for Chinese investors and home buyers caught up with the financial difficulties swirling around big property developers such as Evergrande.
Europe’s very strong 14.3% y-o-y Q2 GDP growth rate will step lower when Q3 GDP is released next week. Europe’s summer of freedom from covid restraints has morphed to an autumn of concern that restraints may return because of rising infection rates. An acute energy crisis caused by many factors is also adding to supply chain problems driving up prices fast in Europe. Producer prices were up 13.4% y-o-y in August while the CPI lifted to 3.3% y-o-y in September. European wage growth is accelerating, notably in Germany with claims for a 5% annual increase and more becoming more common. The European Central Bank continues to delay when it will need to react to higher inflation, but its –0.50% official deposit rate looks unsustainably low. Outside the EU Norway’s central bank has already hiked its cash rate from zero to 0.25% and the Bank of England is likely to follow suit in November.
In Australia, the inflation pressure points from supply chain issues and rising wages are not yet showing in higher inflation. The headline Q3 annual CPI inflation rate (out on Wednesday) is expected to be around 3.0% y-o-y, down from 3.8% in Q2. The two key underlying annual inflation readings, the trimmed mean and weighted median are both expected to come in around 1.8% y-o-y still below the RBA’s 2-3% target band. If the Q3 readings come in around market expectations the RBA will continue to proclaim the run of 3%+ headline annual CPI readings as being temporary and no cause to drive a lift in official interest rates in the near-term.
Another factor playing in favour of the RBA’s interest rate guidance is that the Q3 GDP growth rate due in early December will have a negative sign on the front of it reflecting the loss of spending and output due to the New South Wales and Victoria lockdowns. Those lockdowns set-back progress towards achieving full employment and higher wage growth although they also fostered more government spending and even greater commitment to support recovery from those lockdowns.
A key factor determining how much longer the RBA can maintain its interest rate guidance is how well the Australian economy rebounds in Q4 and the pressure placed on the labour market and wages. There are signs that spending is already starting to lift quickly in New South Wales and Victoria post lockdown and that many businesses are struggling to attract workers back. We expect a sharp recovery in employment in November and December and the national unemployment rate at 4.6% in September to fall to 4.0% or lower by March next year. If we are right, the quarterly wage price index will lift and average 0.8%+ each quarter during 2022. Apart from our employment and wage growth expectations we also see additional pressure on Australian inflation from overseas inflation and local persistently high house prices and rents.
For all of these reasons we do not think the RBA’s current guidance of no interest rate hikes before 2024 can last beyond the early months of 2022. We expect a first RBA rate hike in the second half of 2022 and at least two more hikes in 2023.