Concern is building among analysts about a potential global economic growth slowdown even though recent data show many advanced economies are still growing strongly. High inflation, fueling rising government bond yields and the risk of aggressive reduction of monetary accommodation by central banks is a major growth crimping concern. Rising geopolitical risk with the Ukraine war stretching international alliances is adding to fear that global growth may falter. China’s hardline lockdown response dealing with Omicron is also providing evidence of one major economy facing imminent weakness.
Set against concerns about weaker global growth, the world’s biggest economy, the United States, continues to power ahead according to data released in April. Leading indicators, such as the ISM manufacturing and non-manufacturing purchasing manager index readings at respectively 57.1 and 58.3 in March point to continuing expansion. Coincident indicators such as March retail sales, up 0.5% m-o-m (+1.1% m-o-m for core retail sales) and March industrial production, +0.9% m-o-m matching a similar gain in February, remain firm.
Turning to the key lagging indicator of US economic activity such as employment growth, nonfarm payrolls lifted by 431,000 in March taking the unemployment rate down two notches to 3.6%, the lowest reading since the pandemic started in early 2020. The tight US labour market is driving up wages. In March, average hourly earnings rose by 0.4% m-o-m, 5.6% y-o-y and annual wage growth running above 5% ensures that even when the current high annual CPI inflation rate, 8.5% y-o-y in April, falls on less rapidly escalating manufactured goods prices and energy prices later this year, annual inflation may settle around 4%, well above the Fed’s 2% target.
The high US inflation outlook is driving up US bond yields and expectations of how high the Fed will need to lift the Funds rate, currently in 0.25-0.50% range after the initial 25bps hike at the March policy meeting. Fed officials are talking about the possibility of a bigger rate hike at the early May policy meeting as well as working up to delivering a Funds rate around 3.50% over the next two years.
It is worth noting that Fed tightening on current guidance will still leave real interest rates in negative territory throughout the forecast period and more likely to sustain rather than cut back US aggregate demand.
Turning to China, the data released for March and Q1 2022 point to an economy that continues to slow. While Q1 GDP accelerated to 4.8% y-o-y from 4.0% y-o-y in Q4 2021 it looks set to slide in Q2 because of broadening lockdowns to contain China’s Omicron outbreak. Annual change in fixed asset investment and industrial production moderated in March to respectively 9.3% y-o-y (12.2% in February) and 5.0% y-o-y (7.5% in February). The beginnings of city lockdowns in March hit retail sales relatively hard, down 3.5% y-o-y from +6.7% in February. The lockdown of China’s biggest city, Shanghai, in April and the threat of lockdown in Beijing implies much softer monthly economic readings for April and May and the possibility that Q2 GDP growth is negative. China’s imperfect Covid vaccination program is causing its zero-covid tolerance and strict lockdown policies. Lockdowns are proving a poor defence against the virulent Omicron variant. China is facing a protracted phase of slow economic growth unless the authorities make an uncharacteristic policy change abandoning strict lockdowns and moving towards living with covid, not an easy change anywhere but peculiarly difficult in China where less effective local vaccines and low coverage would spell high hospitalisation and death rates.
Europe’s economic figures continued to hold relatively firm in April. The preliminary April purchasing manager index readings for manufacturing (55.3 from 56.5 in March) and services (57.7 from 55.6 in March) remain firmly in expansionary territory above 50. Surveys reflecting sentiment, however, have been hurt by the Ukraine War. April Sentix investor confidence fell to –18.0 from –7.0 in March. The April ZEW economic sentiment survey registered a much greater collapse to –43 in April from +38.7 in March. The risk that much weaker sentiment will translate to weaker economic growth is keeping the European Central Bank on interest rate hold (ECB deposit rate –0.50%) even in the face of high inflation. Europe’s CPI lifted to 7.5% y-o-y in March with producer prices running above 31% y-o-y. Germany, one of the stronger economies in Europe and a key economy because of its size, faces special economic challenges from the war in Ukraine. The need to sanction Russian over the Ukraine invasion runs afoul of Germany’s dependence on energy supplied by Russia. Cutting off Russian energy supply would tip Germany into recession, but not cutting Russian energy is blunting international sanction efforts against Russia.
Australian economic figures released in April remained strong. February retail sales rose by 1.8% m-o-m after rising 1.6% in January. Home building approvals recovered the 27.1% fall recorded in January and more, rising by 43.5% in February. The labour market remained very tight in March with employment up 17,900 and the unemployment rate holding down at 4.0%. The latest monthly NAB business survey showed strong results with March business conditions lifting to +18 from +9 in February and business confidence lifting to +16 from +13.
The Federal Election was announced for Saturday 21st May but the policies announced so far by both major parties point to nothing to disrupt current strong growth momentum. Both major parties are committed to substantial spending programs and limited or no lift in taxes over the next parliamentary term. Strong growth continues to spill over to upward pressure on inflation likely to be seen this week with the release of the Q1 CPI. Headline CPI inflation according to market forecasts will lift 1.7% q-o-q, 4.6% y-o-y, up from 1.3% q-o-q, 3.5% y-o-y in Q4 2021, while underlying trimmed mean inflation is forecast to lift 1.2% q-o-q, 3.4% y-o-y from 1.0% q-o-q, 2.6% y-o-y in Q4 2021.
Inflation pushing above the RBA’s 2-3% target band on all measures and likely to stay above in the near term should prompt the RBA to hike the cash rate and possibly at the next policy meeting in early May. The RBA may still want to see the Q1 wage price index out in mid-May before committing to a rate hike. While wages are still rising comparatively slowly (below 3% y-o-y) we doubt whether the Q1 wage report can be benign enough to prevent the RBA from hiking. We see the RBA hiking the cash rate by 40bps to 0.50% either at the May or June policy meetings.