In May economic indicators point to moderating global economic growth and slow, bordering stalling progress containing high inflation. Central banks remained focused on bringing inflation down with some, including the US Federal Reserve, the European Central Bank and the RBA, hiking official interest further in the face of signs of slowing demand. Government bonds that rallied strongly in Q1 on hopes of central banks moving quickly to lower official interest rates later this year, gave up some gains in April and May amid growing concern that central banks may need to lift official interest higher and then keep them high for longer.

In the US, most economic reports released in May show signs that the pace of economic growth is slowing, but not yet to the point of recession. At times during the month, the risk of recession rose from an added credit crunch developing in the wake of recent regional bank failures and political turmoil dealing with the approach of the $US 30 trillion government debt ceiling and consequent shut-down of government payments if the ceiling is not raised. Towards month-end, the banking problems appear to be stabilising and President Biden and Republican House Speaker McCarthy reached an in-principal deal on the debt ceiling providing hope that recession risk from the banking and debt-ceiling issues is becoming less pronounced.

Nevertheless, the Federal Reserve’s campaign to reduce inflation to 2% target (it hiked the funds rate another 25bps to 5.25% at the early May policy meeting) has been causing weaker economic growth – Q1 2023 GDP down to 1.3% annualised growth from 2.6% in Q4 2022 – and continues to soften growth evident in most early Q2 economic data other than that relating to the labour market. Housing data have been bumpy month-to-month but the trend is weaker. Manufacturing leading economic indicators have been weak for several months with the latest April ISM purchasing Managers Index at 47.1, below the 50 expansion/contraction marker but not yet down in the low 40s that in the past has preceded recession.

US consumer spending was strong in Q1 (up 3.8% in real annualized terms) but is fading in Q2. Retail sales were up 0.4% m-o-m in April, but after falling 0.7% in March. After allowing for inflation, real consumer spending growth may turn negative in Q2 after the unusually strong rise in Q1 and that raises the possibility of a fall in Q2 GDP when it is reported in late July.

US inflation and its supporting hand maiden the strong labour market, however, are not giving up much ground. Headline April CPI inflation was up 0.4% m-o-m, 4.9% y-o-y (down one notch from 5.0% in March). Core inflation excluding food and energy prices rose in April by 0.4% m-o-m, 5.5% y-o-y (March 0.4%, 5.6% y-o-y), while the April core personal consumption expenditure deflator rose by 0.4% m-o-m, 4.7% y-o-y (March 0.4%, 4.6% y-o-y). April average hourly earnings rose by 0.5% m-o-m, 4.4% y-o-y with non-farm payrolls up 253,000 and the unemployment rate falling to 3.4%, a half-century low. All of these still high April inflation readings and strong labour market readings place the Fed’s 2% inflation target out of reach on at least a one-year time horizon meaning that the Fed may hike the funds rate more and then keep the funds rate high at least the remainder of this year.

In China, economic releases in May show continuing recovery, but led by retail spending this time rather than fixed investment spending and industrial production the drivers of growth in the past. In April, fixed asset investment spending rose 4.7% y-o-y, decelerating from 5.1% in March. Industrial production accelerated to 5.6% y-o-y in April from 3.9% in March, but the strongest lift in activity came in retail sales, up 18.4% y-o-y in April from 10.6% y-o-y in April. After the policy reversals away from restrictions late last year and early this year, China is likely to provide a growth engine for an otherwise slowing global economy in 2023. By the standards of growth recoveries in China over the past two decades, the lift in China’s economic growth rate will be modest – perhaps 4.5% in 2023 as opposed to growth nearer 10% in the first year of earlier recoveries.

In Europe, GDP growth slowed in Q1 2023 to 0.1% q-o-q, 1.3% y-o-y with the biggest economy, Germany, already in the early stages of recession. Anomalies remain between weak goods production and still strong services. Also, the labour market remains very tight with the EU unemployment rate down at a quarter century low point of 6.5% in March. European inflation remains high and sticky with the preliminary May CPI up 7.0% y-o-y. Inflation is especially problematic in the United Kingdom where CPI inflation stands at 8.7% y-o-y. Both the European Central Bank and the Bank of England remain most strident in their warnings about the need to reduce inflation, even in the face of the risk of recession. At their respective May monetary policy meetings, the European Central Bank hiked its deposit rate 25bps to 3.25% while the Bank of England lifted its Base Rate by 25bps to 4.50%. The only concession to a deteriorating economic growth outlook is that both central banks are moving official rates up in steps of 25bps rather than 50bps. Sticky and high European and British inflation mean that both central banks are likely to hike rates at least once more over coming months.

In Australia, there are signs of softening consumer spending in May and perhaps a first sign of softness in the labour market. April retail sales were flat after rising 0.4% in March. In Q1 2023, real retail sales were down 0.6% q-o-q after falling 0.3% in Q4 2022. If the softness in April nominal retail sales continues in May and June as seems likely, real retail sales will fall by more than 1.0% q-o-q in Q2 and provide the RBA with some evidence that rate hikes to date may be causing the deceleration in demand needed to keep pushing down inflation.

Slowing growth in retail sales may also be reinforced by a softening labour market. Employment unexpectedly fell in April by 4,300, but that came after two big increases in March, +61,600, and February, +51,600. Nevertheless, the fall in employment in April was sufficient to see the unemployment rate rise to 3.7% from 3.5% in March. If the softer labour market readings recorded in April are confirmed by relatively soft May and June readings, the RBA may draw some comfort that stronger housing demand and price readings over recent months plus evidence that wage growth is on the border of supporting continuing high inflation do not necessarily demand that it needs to hike the cash rate further.

When the RBA surprised many by hiking the cash rate by 25bps to 3.85% at its early-May policy meeting it was a line-ball decision. Although inflation was falling down to 7.0% y-o-y in Q1 and on the monthly CPI report down to 6.3% in March it remained too high. Signs of weakening consumer spending provided hope that inflation would continue to fall, but that hope was offset by early signs of revival in housing demand pushing up prices and rebounding wage growth against a back-drop of three years of no productivity growth that could prevent inflation returning to 2-3% target. After the May rate hike decision, the RBA received the Q1 wage price index release showing wages up 0.8% q-o-q, 3.7% y-o-y. Given poor productivity, that was too high for comfort. Also big wage rise decisions over recent months, particularly in the public sector and championed by government, are likely to push the wage price index well above 4% y-o-y later this year.

Looking ahead to the June RBA meeting, the Reserve Bank could justify another 25bps rate hike on the basis of risks of too high wage growth at a time of weak productivity growth. But there is a chance that Australia’s unemployment rate has started to rise and that could start to contain and slow the pace of wage claims. Also, the problematic return of strong demand to the housing market pushing up prices may soon be tempered by the approaching peak months of the fixed-rate rollover mortgage cliff and rising unemployment. It will be another line-ball decision for the RBA next week, but we see it falling just in favour of staying on pause at 3.85%. Whatever the relief that comes from the pause will be tempered by realisation that the fight to get inflation down to 2-3% target still has a long way to go and, in our view, means that the RBA will need to hold the cash rate at 3.85%, or higher, for many months extending in to 2024.