Returning to the US, Q4 GDP growth at 2.6% was not as strong as 3.2% reported in Q3, but the domestic spending part of Q4 GDP was noticeably stronger than in Q3. Real Q4 consumer spending was up an annualised 3.8%; residential investment spending was up 11.6% and business investment spending was up 6.8%. What softness there was in the US economy in Q4 related to a widening trade deficit and falling inventories. Most indicators of how the US economy is travelling early in 2018 remain very strong. December ISM purchasing managers’ reports for the manufacturing (59.7) and non-manufacturing (55.9) sectors remain strongly in expansionary territory and crucially the business and household sectors remain able to spend confidently. US businesses are experiencing strong profit growth while US households are increasingly fully employed and with wages growth running ahead of inflation. Core CPI (CPI less food and energy prices) inflation remains below 2% y-o-y allowing the Federal Reserve to continue a slow, well-heralded pattern of interest hikes that will not return the Federal Funds rate – still a growth accommodating 1.50% even after five hikes – to a neutral setting around 3% until late 2019 on current Fed projections.
China has been an important part of the broadening and strengthening global economic growth theme too. China finished 2017 with GDP growth of 6.8% y-o-y in Q4, much higher than most analysts forecast at the beginning of the year. China increased its economic reform efforts in 2017, a process considered beneficial for China’s medium-to-long term growth prospects but likely to come at a cost of lower economic growth in the near-term. As it has turned out China enjoyed the economic equivalent of having its cake and eating it through 2017. Reforms occurred in banking; environmentally-sensitive industries; public administration and in residential real estate development and investment, but growth held up. Stronger global economic growth certainly helped to keep China’s growth rate stronger as China’s latest export data for December attest, up 10.9% y-o-y. Urban fixed asset investment spending, up 7.2% y-o-y in December, and industrial production, up 6.2% y-o-y, have also mostly stayed stronger than widely expected. At this stage, even though more economic reform is in prospect in 2018, it seems likely that GDP growth in China will manage 6.5% y-o-y or better, again making a strong contribution to global economic growth.
Europe provided the biggest positive surprise through 2017 and although there is some concern among analysts that GDP growth momentum will fade in 2018, there are very few signs that any fade is on the cards in the near term. Q4 GDP is due for release this week and is expected to show annual growth lifting to 2.7% y-o-y from 2.6% in Q3. Most indicators of European economic activity released in December January were stronger than expected, especially surveys of European businesses and consumers. European inflation remains very well contained, 1.4% y-o-y in December with the core reading steady at 0.9% y-o-y. Low inflation and a touch of uncertainty about Europe’s growth outlook continues to sideline the European Central Bank. At its January meeting it left policy unchanged and the accompanying statement from ECB President Draghi provided guidance on the interest rate outlook and asset sale program essentially unchanged from December. In short, unless European growth and inflation provide major upside surprise over coming months ECB asset purchases will continue until at least the end of September and the -0.40% ECB deposit rate will stay in place throughout 2018.
In Australia, signs are increasing that annual GDP growth in Q4 2017 (not due for release until early March) will be at least as strong as the 2.8% y-o-y reported for Q3. Moreover, there are also signs that GDP growth could accelerate above 3% y-o-y in 2018. Even though there is evidence that housing activity has topped out and may make little contribution to growth in household wealth or GDP in 2018, the household sector seems to be on the verge of spending more freely mostly because of greater optimism about labour market conditions and a greater sense of financial security helped by the plateauing of household debt, albeit still at a disturbingly high level. Consumer sentiment continued to rise in January to a 4-year high. Retail sales were surprisingly strong in November, up 1.2% m-o-m, and after lifting 0.5% in October. Household consumption spending probably lifted strongly in Q4 after an unusually weak showing in Q3.
The strongest support for household spending continues to come from near-booming growth in jobs, up another 34,700 in December after lifting 63,600 in November and bringing total jobs growth in 2017 to more than 400,000, up 3.3% y-o-y, the strongest growth in more than 20 years. More importantly there is ample evidence in various job vacancy surveys that Australian businesses need to employ many more workers over coming months helping to improve a sense of better job security in the household sector while at the same time starting to build expectations that the long phase of very low wages growth may be coming to an end. The Federal Government is also indicating the likelihood that personal income tax cuts will be announced in the May Budget.
The RBA expects economic growth to quicken in 2018, but is waiting for hard evidence that growth is stronger and is priming higher inflation before it considers changing monetary policy. Inflation remains low and the reading due this week for Q4 is still likely to show all measures of inflation at, or below, the bottom of the RBA’s 2-3% inflation target band. In this low inflation environment, the RBA still seems comfortable leaving the cash rate unchanged at 1.50% for several more months. Ultimately, we see the first signs of higher wages growth and higher inflation prompting the RBA to start lifting its cash rate. We suspect that wages and inflation will move higher around mid-2018 and could be the deciding factor helping to shift the RBA towards hiking rates with a first 25bps cash rate hike to 1.75% probably in August or September 2018 and a second 25bps hike to 2.00% probably occurring in November.