Global economic growth slowed a touch in Q1 2018 according to national Q1 GDP reports released so far. The pace of global growth, even with the slowing in Q1, is still fast enough to continue eating away at excess capacity raising the likelihood of higher inflation down the track. Most leading economic indicators are still pointing to global growth picking up pace again in Q2 and Q3. One major downside risk to global growth is a broadening trade war, but that threat seems to have become contained over the past month to specific tit-for-tat increases in import tariffs between the US and China. What discussion has occurred among senior US Federal Reserve officials seems to be focused more on the potential inflationary effects of higher tariffs rather than their growth limiting impact. US and global economic events during April remain consistent with rising bond yields, notably in the US.

Looking at the US economy, annualised GDP growth slowed from 2.9% in Q4 2017 to 2.3% in Q1 2018 although the slowing was less than widely expected given earlier evidence of relatively soft growth in monthly retail sales. As it turned out consumer spending on services lifted strongly in Q1 helping to boost total consumer spending in the quarter. Business investment spending, exports and inventories all made strong contributions to Q1 GDP although housing contribution was flat. Most leading indicators of US economic activity remained comparatively strong in April including purchasing manager reports and consumer sentiment readings implying firmer spending and output in Q2. Employment growth was less robust in March with payrolls up 103,000, down from a 320,000 increase the month before, but leading employment indicators such as weekly initial jobless claims (a record low 209,000 for the most recent week) are very strong implying stronger payrolls’ reports ahead adding to the risk that a very tight labour market forces wages and inflation higher.

Recent developments in the US economy remain consistent with the Federal Reserve’s public view that robust US economic growth through 2018 and 2019 will lift annual inflation above its 2% target and require continuing slow-paced increases in the Funds rate to a neutral setting around 3.25% by early 2020. The key issue is whether the Fed will be forced to deviate from its plan – essentially another two 25bps rate hikes this year followed by another three in 2019. There is a material risk that inflation increases more strongly than the Fed expects, forcing a more aggressive program of interest rate hikes. The two main factors that could lift inflation faster than expected are higher wages push in the tightening US labour market and/or a marked lift in US production costs from higher import tariffs. The Fed is monitoring both areas closely and the US bond market is starting to watch the Fed more closely. Upward pressure on US bond yields continues to build.

One area of considerable strength in the global economy is China with GDP growth steady at 6.8% y-o-y in Q1 GDP and still running faster than the 6.5% target set by Government in its latest plan. In the latest monthly economic data for March there are signs that the drivers of growth continue to rebalance in favour of domestic retail sales along the lines promoted by government policy. Annual growth in retail sales was stronger than expected in March lifting to 10.1% y-o-y from 9.7% in February. Urban fixed asset investment continues to hold up well, +7.5% y-o-y in March and with relatively less emphasis on residential property development. Industrial production pulled back in March to +6.0% y-o-y from 7.2% in February and most noticeably in areas consistent with the official aim of reducing output in polluting industries. China’s response to the US imposition of higher import tariffs has been measured and at this stage with a focus on achieving compromise with the US rather than escalation. The trade dispute with the US is still threatens China’s growth prospects, but that threat seems less pronounced because of China’s measured response.

In Europe, Q1 GDP is due this week and seems set to show growth slowing to around +0.4% q-o-q, +2.5% y-o-y from +0.6% q-o-q, +2.7% y-o-y in Q4 2017. Some European countries have already released Q1 GDP and the results have been disappointingly soft, +0.1% q-o-q for the United Kingdom and +0.3% q-o-q for France. Monthly European indicators have turned mixed-strength, a softer tone to retail spending although employment growth remains firm reducing the European unemployment rate to 8.5%. The late-April ECB policy meeting unsurprisingly left policy settings unchanged and the statement after the meeting implied no changes to the policy outlook too. Monthly quantitative easing bond purchases will continue until at least the end of September and there is no likelihood of an interest rate change before that time too. The ECB’s monetary policy setting remains extremely growth accommodative one reason to expect that the current slowing in the pace of European economic growth will be temporary.

Australian economic growth is slowly improving but economic prospects are still challenging with uncertainty surrounding spending by the heavily-indebted household sector compounded by a softer outlook for housing activity and still soft wages growth. There are strong points in the economy too. Commodity prices have mostly been firmer than expected improving incomes for the farming and mining sectors. Business investment spending is starting to rise and government infrastructure spending is lifting. Jobs growth has been very strong, (albeit with a recent soft patch in February and March) providing a boost to household disposable income even while wages growth has languished. Most recently, there is just a hint of slightly better wages growth up to 2.1% y-o-y in Q4 2017 from 2.0% in Q3. Most likely the tight labour market will see wages lift a little more through 2018. The Federal Government is expected to deliver income tax cuts in the May Budget that will further boost household disposable income.

Annual GDP growth in Q4 2017 (Australian Q1 GDP will be published in June) reduced to 2.4% y-o-y from an upwardly revised 2.9% y-o-y registered in Q3. Contributions to Australian growth are proving volatile quarter-to-quarter. Government spending and household consumption spending contributed strongly to GDP growth in Q4 while international trade detracted from growth. Household spending seems likely to make another positive contribution in Q1 based on firmer retail sales so far in the quarter. International trade should contribute positively given better exports so far in the quarter. On balance, our forecast of a patchy rise in GDP growth through 2018 is still intact, although developments around international trading conditions bare watching. Without strong growth in international trade Australia’s growth prospects would look much weaker.

For the time being it seems that the RBA’s economic forecasts remain slow pick up in GDP growth and inflation eventually too. Those forecasts imply no change in the 1.50% cash rate for next few months at least. Our view remains that it will probably be August (after the Q2 CPI release in late July) before the RBA starts lifting its inflation forecasts and sees a need to start hiking the cash rate. We continue to pencil in a first 25bps rate hike in August followed by a second in November.