According to Q4 GDP reports global economic growth in 2017 was the strongest in almost a decade and most leading economic indicators point to continuing strength through 2018. Inflation around the world is still relatively benign although there are the first signs of slightly higher wages growth and inflation in the US. Central banks are still showing no signs of hastening the process of monetary policy tightening. In Australia, the RBA is showing no signs of starting to lift its cash rate from the current record low 1.50% in the near term. Until central banks show more urgency tightening monetary policy global economic growth seems likely to gather greater momentum helping to lift the pace of Australian economic growth too.
The US economy has enjoyed one of the longer and stronger economic recoveries since the global financial crisis by international comparison. The economic recovery in the US has reached the point where it appears to be stretching productive capacity. The unemployment rate has been lodged at a 17-year low 4.1% over recent months while annual growth in average hourly earnings accelerated to a 6-year high 2.9% y-o-y in January. Q4 GDP growth at 2.6% annualised belied the strength of domestic spending in the US with consumer spending rising 3.8% annualised; residential investment spending up 11.6%; and business investment spending up 6.8%. The US economy looks set to grow at well above 3% pace in 2018 before taking account of additional stimulus from legislated tax cuts and a lift in government infrastructure spending that could push GDP growth up to 4% or more.
Strong US economic growth is showing signs of priming inflation. The underling CPI, excluding food and energy prices, rose by 0.3% m-o-m in both December 2017 and January 2018. While annual underlying inflation was still below 2% in January at 1.8% y-o-y it seems only a matter of time on recent monthly movements before it pushes above. Concern about higher US inflation and the Fed’s policy response has caused US bond yields to push up erratically. The risk is that bond yields push higher on what seems almost inevitable – more strong US economic readings and more signs that inflation is increasing. There is also a growing risk that in coming months the Fed hardens its guidance on the funds rate from another three 25bps rate hikes in 2018 to more than three. Until that occurs, the US economy and US financial markets seem able to advance on the current Fed plan of three well-spaced rate hikes this year.
One of the bigger beneficiaries of strong global growth and its attendant growth in international trade is China. GDP growth in China remained strong through 2017 in the face of widespread expectations that it would fade under pressure from extensive economic reforms. China’s international trade gathered momentum through 2017 helping to hold annual GDP growth around 6.8% y-o-y. China’s international trade still looks very strong early in 2018. In January exports rose by 11.1% y-o-y, up from 10.9% in December, while imports rose in January by 36.9% y-o-y (a sign of burgeoning growth in domestic spending), up from 4.5% y-o-y in December. Much of China’s economic data for January is held for combined release with February because of the lengthy Lunar New Year celebrations. At this stage, when January-February readings are released in mid-March they are likely to be consistent with GDP growth still holding above 6.5% y-o-y in Q1 2018.
The biggest upside surprise in growth through 2017 came not from the US or China – impressive though were their growth readings – but from Europe. In Q4 every economy in the euro-area posted positive GDP growth in the quarter. Several posted GDP growth above 1.0% q-o-q. Annual GDP growth in Europe lifted to 2.7% y-o-y in Q4 and the falling number of Europeans unemployed – declining more than 130,000 in November and December is helping to boost spending generating even more GDP growth. European factories are performing particularly well and industrial production lifted by 5.2% y-o-y the strongest growth in more than six years. The European Central Bank is still very cautious indicating that exceptionally easy monetary conditions will persist through to at least the end of September. At some point, if European GDP growth remains robust as seems increasingly likely, the ECB will need to herald tighter monetary policy. Until that change in guidance from the ECB occurs, Europe’s economic growth prospects remain very bright.
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 with more than 400,000 jobs added in 2017, 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 also hinting at income tax cuts in the May Budget.
On balance, annual GDP growth in Q4 (due for release next week) should be similar to the 2.8% y-o-y registered in Q3. Looking beyond, improving business investment spending, plus strong employment growth and strong global growth boosting Australia’s export income should be enough to outweigh negative factors allowing economic growth to push above 3%.
One important factor supporting this improving growth forecast is that the RBA seems likely to leave the cash rate unchanged at 1.50% for several more months. While wages growth may lift, they are unlikely to lift enough to constitute a threat of higher inflation for some time. Meanwhile, annual inflation remains lodged below or at the bottom of the RBA’s 2-3% target band. Our view remains that it will be around six months at least 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.