Economic data released in July showed that while global economic growth is moderating, the damage so far is not as much as feared from the US policy turn towards imposing higher trade tariffs. Also, progress reducing inflation is stalling rather than reversing. Part of the reason for the better- than-expected economic outcomes so far is that the US Administration has delivered only part of the early-April Liberation Day tariff increases proposed allowing time for countries to negotiate with the US better trade deals. Nevertheless, effective US tariff protection rates have risen to their highest level in more than 80 years, and that still represents a brake on US and global growth prospects as well as a boost to US inflation with the damage likely to show through late this year and in 2026.
In the United States, the preliminary reading of Q2 GDP growth is due later this week and is expected to show that growth rebounded to +2.4% annualised pace compared with -0.5% in Q1. The GDP growth bounce will come mostly from international trade after a sharp rise in US imports in Q1 to build up stocks ahead of President Trump’s April ‘Liberation Day’ tariff announcements turned to a sharp pull-back in import growth in Q2. Consumer spending, the main driver of US economic growth through 2024, likely made only a soft contribution to US growth in Q2, even with some evidence in monthly US economic readings of improving US consumer sentiment and spending late in the quarter.
US retail sales rose by a greater-than-expected 0.6% m-o-m in June, but coming after small falls in the previous two months. The University of Michigan’s consumer sentiment survey lifted from 52.2 in May to 60.7 in June and a preliminary July reading of 61.8. While the consumer sentiment readings are still low historically, they are rising. Similarly, US purchasing manager reports, show slightly better sentiment among US businesses. The ISM June purchasing manager index rose to 49.0 in June from 48.5 in May, while the ISM non-manufacturing, or services, sector PMI rose to 50.8 in June from 49.9 in May.
US labour market conditions held relatively tight according to data released in July. Non-farm payrolls rose 147,000 in June after a 144,000 lift in May. Market expectations of a lift in the unemployment rate in June were confounded by the rate edging down to 4.1% in June from 4.2% in May. Wage growth remained firm with June average hourly earnings lifting by 0.2% m-o-m and 3.7% y-o-y. Meanwhile, inflation stopped falling in the US and appears to be basing above the Federal Reserve’s 2% target. Annual CPI inflation lifted to 2.7% y-o-y in June from 2.4% in May, while the core CPI rose to 2.9% y-o-y from 2.8% in May. The Federal Reserve remains concerned that loose fiscal policy in the wake of the passage of President Trump’s ‘Big Beautiful Bill’ in July together with tariff changes will keep inflation above its target 2% and for the time being is keeping the Federal Funds rate on hold at 4.50% and with little scope to cut the rate by much over the next year or so.
In China, Q2 GDP growth was firmer than expected, up by 1.1% q-o-q, 5.2% y-o-y from +1.2 q-o-q, +5.4% y-o-y in Q1. The June month data, however, was a mixed bag with exports, +5.8% y-o-y from +4.8% in May, and industrial production, +6.8% y-o-y from +5.8% in May, both firmer than expected, while fixed asset investment spending, +2.8% y-o-y from +3.7% in May, and retail sales, +4.8% y-o-y from +6.4% in May, were both soft. Rather than announcing any new measures to help boost spending by Chinese households, the authorities reached for the old playbook, announcing spending on a big dam. Spending on the new dam may lift growth in industrial production and China’s demand for construction materials but it will do little to counter the headwinds to China’s exports from the higher US import tariffs, or to encourage Chinese households to spend more. China’s inflation rate, -0.1% m-o-m, and only +0.1% y-o-y still tells a story of excess supply and limited demand in the Chinese economy, that the authorities are failing to address with appropriate policy changes.
In Europe, economic reports continue to show modest growth combined with lower inflation. The UK differs in that modest growth is running hand-in-hand with sticky inflation, causing the Bank of England to keep its base rate at a relatively high 4.25%. Returning to the EU, Q2 GDP is due later this week and is expected to show some settling (consensus forecast 0.0% q-o-q, +1.2% y-o-y) after Q1 GDP growth on final revision came in at a comparatively strong +0.6% q-o-q, +1.5% y-o-y. Headline CPI inflation lifted slightly in June to 2.0% y-o-y from 1.9% in May while core inflation was 2.3%, the same as in May. The European Central Bank has been cutting interest rates more aggressively than its peers, but that cutting stopped at its late July policy meeting when it held the deposit rate unchanged at 2.00%. The ECB has little leeway to cut rates any further with inflation hovering around the ECB’s 2% target.
In Australia, while economic releases during July were mixed-strength there some important brighter readings. Housing indicators were all stronger including house prices, home building approvals (+3.2% m-o-m, +8.0% y-o-y in May) and housing commencements (+11.7% q-o-q and +17.3% y-o-y in Q1). After weak household spending readings in March and April, May saw a substantial lift, up 0.9% m-o-m, +4.2% y-o-y. The stronger May household spending reading means that household consumption expenditure may make a substantial contribution to Q2 GDP growth when the report is released early in September.
On the softer side, employment grew by only 2,000 in June after falling by 1,100 in May and the unemployment rate lifted from 4.1% in May to 4.3% in June, the highest reading since November 2021. The softer labour market and a seemingly low May monthly CPI report, 2.1% y-o-y with underlying (trimmed mean) inflation down to 2.4% prompted most analysts to predict that the RBA would cut the cash rate by 25bps to 3.60% at its mid-July policy meeting. The RBA surprised by leaving the cash rate unchanged at 3.60%.
In the statement and Governor’s press conference accompanying the RBA’s July rate decision as well as in a more detailed speech later by RBA Governor, Michelle Bullock, it has become clearer that the RBA is unconvinced that current Australian economic conditions and progress reducing inflation warrant a move towards quickly and substantially cutting the cash rate. Instead, the RBA sees need to move cautiously and slowly.
The main reason for the RBA’s cautious approach to cutting rates is that it did not raise rates as much as its central bank peers in 2022 and 2023, and with less damage to show to maintaining full-employment as a result, the RBA does not need to move as aggressively as its peers bringing rates down. Also, the RBA believes that the downside risks to global economic growth from US tariffs are not as great as feared even a month ago. The RBA wants to see whether the reduction in Australian inflation in the limited-basket monthly CPI series is reflected in the comprehensive Q2 report (the RBA suspects inflation is not quite as low in Q2 as it forecast back in May).
What has become clearer is that the RBA is in no rush to cut interest rates. We still see a good chance that the RBA will cut the cash rate 25bps to 3.60% at its August policy meeting, but beyond that any further rate cuts will need to be forced by surprisingly low inflation and/or surprisingly weak economic growth.