Global economic growth continued to show signs of improvement in April and to the point where international agencies such as the IMF are edging upwards their global growth forecasts. US economic growth indicators have settled back a touch although most survey reports of consumer and business activity remain strong. Growth in China in contrast firmed in Q1 and seems likely to be firmer in Europe. Geopolitical uncertainty remains elevated with the new US Administration taking a harder stance relating to Iran, Syria and North Korea and the first round of the French presidential election presenting a contest in the second round that is likely to determine the future of the European Union. Central banks continue to edge away from very easy monetary conditions. The US Federal Reserve has started to talk about running down its balance sheet in tandem with slowly raising its funds rate. The Peoples’ Bank of China continues to slowly raise key interest rates. The European Central Bank has just started buying less bonds from the market each month. The RBA is on extended cash rate hold, but its economic forecasts and comments imply that the next move eventually will be a rate hike.

Returning to the US economy, most indicators of economic activity released in April continued to show a split between still very strong survey readings of consumer and business activity and comparatively soft actual readings of employment growth; retail trade and business output and spending. Indeed, the approaching release of Q1 GDP due later this week is expected to show annualized growth around 1.1%, down from 2.1% in Q4 2016. Over recent years, the winter quarters have usually shown a dip in growth before improvement in the Q2 and Q3 readings. Often severe winter weather disruption is to blame and unusually severe storms and cold have featured this year, especially in March. Several March economic readings were unusually (very likely temporarily) soft. Non-farm payrolls rose by 98,000 well below expectations and 219,000 recorded in February. Retail sales fell by 0.2% m-o-m, after falling 0.3% in February. Housing starts fell in March by 6.8% m-o-m and manufacturing output fell by 0.1%. Most likely these indicators of economic activity have rebounded in April.

Apart from softer March readings of economic activity, inflation pressure in the US slipped back too. The March CPI unexpectedly fell by 0.3% m-o-m, reducing annual headline inflation to 2.4% y-o-y from 2.7% in February. More importantly for the Fed, core CPI annual inflation also slipped to 2.0% y-o-y from 2.2% in February. Various comments from senior Fed officials implied mostly that the Fed was on track to deliver slowly another two rate hikes in 2017. The minutes of the Fed’s mid-March policy meeting also revealed an active discussion about the end of reinvestment of the proceeds from maturing assets in the Fed’s portfolio implying that monetary policy tightening could become a combination of rising funds rate and reduction in the size of the Fed’s balance sheet. The next active Fed policy meeting is likely to be in June when the Fed still seems likely to deliver a 25bps hike in its funds rate to 1.00%, but in the mean-time it will not just be the economic data determining the likelihood of a mid-year rate hike, the unveiling of President Trump’s tax cutting program in the next week or so – its size relative to expectations and the likelihood of it being approved by Congress – is likely to play a part in whether the reflation trade in financial markets is still alive, in turn influencing whether another more general push upwards in global interest rates is on the cards.

In China, economic data relating to March and Q1 have surprised on the higher side of expectations and imply that the authorities are managing to sustain growth above 6.5% y-o-y for the time being, while also conducting reforms tempering excessive residential real estate development and house price speculation; improving bank lending practices; and running down the most polluting state-owned enterprises. Q1 GDP lifted to 6.9% y-o-y from 6.8% in Q4. March readings of exports, +16.4% y-o-y; imports, +20.3% y-o-y; urban fixed asset investment, +9.2% y-o-y; industrial production, +7.6% y-o-y; and retail sales, +10.9% all accelerated compared with February and all by more than the market expected. Interestingly, the improvement occurred despite the beginnings of a sharp fall in the iron ore price (not usually consistent with accelerating industrial production in China) and another small monetary policy tightening move by the Peoples’ Bank of China. It still seems likely to us that China’s growth rate will be a little softer later in 2017 as residential construction pulls back further. The recent data implies a shallower dip than we thought likely previously with GDP still growing close to 6.5% y-o-y later in the year.

In Europe, economic indicators continue to improve mostly and Europe’s unemployment rate, although still high at 9.5% in the latest February reading, is the lowest reading since May 2009. The improvement in European economic activity is being recognized increasingly by the European Central Bank in its commentaries although it is still wary of potential downside risks, a key reason why it will be very slow to move from less accommodating monetary policy – reducing the size of its monthly asset purchases – to starting to lift interest rates. One big area of uncertainty remains the stability of the European political union. The current first round French presidential election appears to be presenting non-mainstream party candidates for the second round one very pro-EU and the other determined to pull France out of the EU.

The Australian economy, while continuing to grow modestly is exhibiting erratic employment growth; a sticky unemployment rate and potential vulnerability to any weakness in demand in our biggest trading partner, China, or to a pull-back in spending by Australian households either frightened by a housing downturn or taking a prudent view that borrowings are excessive. For the time being and notwithstanding the big fall in the price of iron ore over the past month or so, China’s demand looks less fragile than Australian household demand. While Australian export demand looks robust, one complication is that weather events in Western Australia and Queensland have damaged transport infrastructure limiting supply. Temporarily, net exports could soften, although are likely to pick up later in the year.

Influences on household spending have become much more complicated. Stronger household consumption expenditure in Q4 2016 is starting to look temporary. Retail sales were disappointingly weak in February falling by 0.1% m-o-m, and monthly consumer sentiment has softened over recent months. The combination of still very weak wages growth combined with very high levels of household debt are squeezing the ability and willingness of households to spend more freely. There is a concern in the family of financial regulatory authorities (the RBA, APRA and ASIC) that some parts of the household sector have borrowed too much lured by escalating house prices in some cities as well as lending practices by some financial institutions that seem to have become imprudent. The problem the regulatory authorities face is that by acting to limit certain types of lending they may add to pressures forcing households to retrench their spending – if for example the housing market were tipped weaker.

The moves by APRA to tighten controls on certain types of lending and the RBA choosing to stand aside as banks repeatedly lift lending interest rates on certain of their home loan products is adding uncertainty in to a housing market already subject to increasing pockets of over-supply over the next year or so. The risk of a quite pronounced downturn in housing is growing and that in turn could promote noticeably weaker general household spending. Even in a world of improving global economic activity, Australia may struggle as a housing correction develops extending to a phase of weaker household spending.

In this evolving economic environment the RBA is increasingly caught between opposing forces. Improving global growth and the remnants of strong Australian housing activity point to a need to prepare the way for higher interest rates. Yet the still quite weak labour market, weak wages growth, low inflation and the risk of an overly-indebted household sector starting to retrench indicate a need for accommodating monetary policy. These opposing forces imply the RBA taking its time before having the information available that indicate which force is gaining the upper hand. We see the RBA leaving the cash rate unchanged at 1.50% through the remainder of this year and the risk in 2018 is also becoming more evenly balanced although we still pencil in the start of a mild rate hiking cycle.