Signs of global economic activity were mixed-strength in August but still consistent with a lift in the pace of growth since the beginning of the year. A noticeable benefit of stronger global growth is that unemployment rates in many countries continue to fall and in some cases, such as Germany and the United States, to levels that in the past have been consistent with rising wages and inflation. However, inflation remains very low in most countries. The world’s major central banks are caught between a desire to remove extraordinary and increasingly unnecessarily easy monetary conditions and persistently low inflation implying no need to tighten monetary policy. Most likely so long as global economic growth continues to gather momentum, central banks will continue to edge away from easy monetary conditions whether that be slowly hiking official interest rates following the lead of the US Federal Reserve (Fed); talking about the next move being a hike, the camp that the RBA is joining; or reducing the size of regular bond purchases in the case of the European Central Bank (ECB).
US economic readings released in August were mostly quite firm and imply that the first report of Q2 GDP showing 2.6% annualised growth will probably be revised higher. It is also likely that Q3 GDP growth will come in close to 2.5% annualised pace. US household spending appears to be in good shape supported by strong employment growth – nonfarm payrolls rose by over 200,000 in both June and July, reasonable wages growth, elevated consumer sentiment reports and strong growth in household wealth. Retail sales took a stronger-than-expected turn in July, up 0.6% m-o-m. Q2 company earnings reports were mostly quite strong and regional purchasing manager reports were also mostly stronger than expected. One soft spot in the US economy in July was housing activity. Housing starts fell 4.8% m-o-m, housing permits were down by 4.1%, new home sales fell 9.4% and existing home sales fell by 1.3%. Housing figures tend to be erratic month-to-month cautioning against reading too much in to one poor month.
All told, the US economy is performing well even in the face of increasingly dysfunctional operation of government policies as the wide rift between President Trump, Congress and the bureaucracy in Washington remains. As far as the Fed is concerned it is the risk that the economy operating close to capacity eventually primes inflation that is still leading it to slowly lift its funds rate and will also allow it to soon to start running down its large holdings of government bonds and mortgage-backed bonds as well. If something were to tangibly threaten a reduction in US economic growth such as a prolonged shut-down in government services caused by an impasse between the President and Congress legislating funding for the new financial year starting 1 October, that might halt the Fed’s monetary policy tightening plans. Barring such a growth-reducing event, it is reasonable to expect another 25bps Fed rate hike to 1.50% before the end of 2017 combined with the beginnings of Fed balance sheet reduction both implying US government bond yields rising over coming months.
In China, the world’s second biggest economy after the United States, Q2 GDP was stronger than expected at 6.9% y-o-y matching annual growth in Q1. There are signs that growth may slip slightly in Q3. Indicators of economic activity released for July were almost all softer than expected and down from June. Export growth slipped to 7.2% y-o-y from 11.3% in June and import growth at 11.0% y-o-y was down from 17.2% in June. The story of growth stepping down was also clear in urban fixed asset investment, 8.3% y-o-y from 8.6% in June; industrial production, 6.4% from 7.6% in June; and retail sales, 10.4% from 11.0% in June. The order of slowdown in these areas is consistent with the policy efforts of the authorities to reduce problems such as excessive credit growth and too much investment in residential construction and at this stage implies GDP growth slipping to around 6.5% y-o-y in Q3.
Europe continues to show signs of improvement. Q2 GDP growth initially reported at 2.1% y-o-y was subsequently revised up to 2.2% and recent monthly economic indicators point to GDP growth improving again in Q3. Stronger growth is generating strong employment growth and falling unemployment rate, down at 9.1% in June. Inflation in Europe is slowly lifting to 1.3% y-o-y in July but would need to rise much further to cause the ECB to start lifting its -0.4% official lending rate. It is possible over coming months that the ECB may reduce further its monthly purchases of bonds, but any rise in official interest rates is still a long way off, 2019 at earliest and dependent upon the European economy continuing to recover in the meantime.
The Australian economy, after slowing quite sharply in Q1 registering GDP growth of only +0.3% q-o-q, +1.7% y-o-y, probably rebounded and strongly in Q2. Employment growth has been very impressive over recent months causing the unemployment rate to fall to a 4-year low 5.6% in July. Job vacancies continue to rise strongly implying further growth in employment over coming months. The strength of employment growth indicates a pronounced lift in household disposable income in the quarter which in turn helps to explain a sharp lift in the volume of retail sales in Q2, up 1.5% q-o-q, compared with a revised 0.2% q-o-q increase in Q1 and implying a very strong contribution to Q2 GDP (due early September) from household consumption spending. Net exports and government spending also look set to contribute more strongly to growth in Q2 than they did in Q1.
There are weak patches in the Australian economy. The prolonged downturn in mining investment may be all but over, but the downturn in residential construction is only just starting. Household debt levels are extremely high and wages growth remains very weak, only 1.9% y-o-y in Q2 (although that may start to rise in Q3 after the 3.3% minimum wage determination). According to the latest economic forecasts from the RBA contained in its early August quarterly Monetary Policy Statement, GDP growth will slowly rise to above potential pace in 2019 and inflation will work its way higher too to middle of the RBA’s target band in 2019.
The RBA left the cash rate unchanged at 1.50% at its early August policy meeting and in various commentaries has indicated that it is in no hurry to move the cash rate but that eventually the next move is more likely to be upwards. Our view remains that a strengthening economy could encourage the household sector to increase its already very high borrowings. Still unusually low borrowing interest rates combined with additional incentive to borrow as the economy improves could lay in store unacceptable risks to the economy and financial stability down the track. It is this factor that will probably lead the RBA to start hiking the cash rate well ahead of any indication that inflation may lift. Our view remains that the RBA will start hiking the cash rate early in 2018 with an initial move of 25bps to 1.75% and that by early 2019 the cash rate will need to be nearer to 2.50%.