The pace of global economic growth continued to moderate according to most indicators of economic activity released in February. However, some key economic indicators, mostly relating to labour market conditions remain strong or very strong, especially in the United States and Australia. Strong labour market conditions provide hope that the current moderation in global growth will be temporary. The temporary growth moderation thesis is also helped by other developments in February, notably more signs that key central banks including the US Federal Reserve (Fed) are on monetary policy hold and what seem like positive discussions between the US and China aimed at preventing escalation of their trade war.
Turning to the US economy, most leading indicators of activity released in February have softened but to readings still consistent with strong business and household spending. The partial shutdown of the Federal Government agencies over funding of President Trump’s wall on the US border with Mexico ended and the damage to spending from Federal Government employees going without pay (since restituted in full) is likely to be temporary reducing Q1 2019 GDP growth but probably with a small boost to Q2 GDP growth. The report of Q4 2018 GDP remains a casualty of the Government shutdown but is due for belated release this week and is expected to show annualised growth slipping to 2.4% from 3.5% in Q3. When Q1 GDP is released in late April growth may slip even further to around 1.0% influenced by the negative one-time impacts of the government shutdown and some of the worst winter weather in 40 years.
Despite the slowing trend in US GDP growth there are signs of resilience in strong labour market conditions and strong business earnings still growing close to 20% y-o-y. Non-farm payrolls rose by 302,000 in January after gaining 222,000 in December. Average hourly earnings rose by 3.2% y-o-y in both January and December well above the 1.6% y-o-y increase in the CPI in January. Strong employment growth combined with a more than 1.5% y-o-y increase in real earnings point to resilient and possibly strengthening US household spending.
Meanwhile, the biggest threat to US growth prospects late in 2018 – the Fed raising interest rates too high – has receded early in 2019. Fed commentaries in January and February while recognizing the economy is strong have focused on potential downside risks and the need to take a patient approach to monetary policy. In short, the Fed rate outlook has shifted from one or two rate hikes in 2019 to no rate change. The Fed rate outlook can change again if the current growth slow patch returns to faster growth later in the year as we view most likely. Nevertheless, the data over the next few months are more likely to be quite soft and the current Fed monetary policy pause could last until late in the year.
In China, the main signs of weakness are in leading indicators such as manufacturing purchasing managers’ indexes down below 50 (the expansion/ contraction line) in December and again in January. The Lunar New-year celebrations limit data releases in February to January international trade and inflation reports. January international trade was stronger-than-expected with exports up 9.1% y-o-y after falling 4.4% in December and imports down 1.5% y-o-y less than the 7.6% fall recorded in December. Inflation receded in January with the CPI up 1.7% y-o-y compared with 1.9% y-o-y in December and producer prices up only 0.1% y-o-y in January compared with 0.9% y-o-y in December. The moderation in producer price inflation implies that CPI inflation could moderate further over the next few months increasing the likelihood of more monetary policy easing moves by the Peoples’ Bank of China. GDP growth in China continues to moderate in the near-term, but if an agreement can be reached with the US on international trade the outlook for China’s growth prospects could improve. China has plenty of monetary and budgetary policy flexibility to reinforce the impact of any positive news relating to a trade agreement.
The reduction in the pace of economic growth remains most pronounced in Europe. GDP growth in Europe was only 0.2% q-o-q in Q4 2018 slowing annual growth to 1.2% y-o-y. More disturbingly among the bigger European economies Italy has slipped in to recession with back-to-back negative quarterly GDP growth in Q3 and Q4 and growth in Germany was negligible in Q4 after falling in Q3. There are pockets of strength in Spain and parts of Eastern Europe but European growth is weakening and with downside risk from the closing stages of Brexit (almost certainly a hard Brexit without a transition deal with the EU) and no end in sight to Government protests in France. The ECB maintained steady monetary policy settings at its first policy meeting in 2019 but the accompanying minutes indicate that it is becoming less confident that the current slowing in European economic growth is temporary.
In Australia, December reports of retail sales -0.4% m-o-m; home building approvals, -8.4% m-o-m; and housing finance for owner-occupiers, -6.1% m-o-m were all disappointingly weak and undoubtedly contributed to the RBA downgrading slightly its forecasts of GDP growth for 2019 and 2020 and its guidance on the next cash rate move from likely up to a fifty-fifty call of up or down. At the heart of the change in the RBA’s economic and rate views are concerns about the future strength of household spending. In particular, the current slow pace of improvement in household income growth could lead households to retrench spending plans causing GDP growth to weaken.
Set against concerns about potentially weaker Australian economic growth exports remain very strong contributing to a record monthly international trade surplus in December of $A3.7 billion. The labour market remains strong as well with employment up 39,100 in January more than double market expectations and the unemployment rate holding down at a 7-year low 5.0%. Even the softest part of the Australian economy, housing, has shown some signs of life in February with weekend auction clearance rates holding close to 60% in Sydney and Melbourne. Interestingly the most recent readings of business and consumer sentiment have strengthened as well.
It is fair to say that Australia’s economic outlook will be subject to uncertainty for some time, especially with a Federal election approaching in May. Almost certainly the RBA will continue to keep the cash rate on hold for the next few months at least. Our view remains that the stronger parts of the Australian economy will drag the weaker parts higher over time. Our view remains that the next rate move by the RBA will be a hike, but not before mid-2020.