Signs that that global economic growth has taken a stronger turn continued to show through in July prompting analysts to revise higher mostly their forecasts of global growth over the next year. Annual GDP growth readings in the United States and China for Q2 were firmer than expected and GDP growth reports elsewhere for Q2 about to be released in August and September are expected to be firm too, including in Australia. Inflation readings in most countries remain comparatively low, but more consistent strength in global growth is causing more central banks to step back from very easy monetary policy settings led by the US Federal Reserve (Fed). In the case of the RBA that never pushed its official cash rate as low as many of its peers, the pressure to start hiking its cash rate is less, but could become more pronounced later in the year. In any event, global bond yields that still reflect a world of stagnant growth are likely to respond to stronger global economic growth in our view by rising over coming months.
Turning to the US first, the advance reading of Q2 GDP showed a pronounced lift to 2.6% annualised growth from 1.2% in Q1. Encouragingly, consumption spending provided good support for growth by rising in Q2 at 2.8% annualised pace from 1.9% in Q1. Early indications of Q3 growth have been mixed, but the key elements that point to US households and businesses spending comparatively freely – strong employment growth; low unemployment rate; modestly rising real wages but with strongly rising household wealth and company earnings – are all consistent with stronger economic growth.
There are negatives too. The Trump Administration has become more dysfunctional and to the point where it cannot negotiate a path through Congress for key legislation. Plans to overhaul health care have failed and hope is fading rapidly for President Trump’s plans for budget spending and tax cuts. The Fed has also been removing monetary stimulus and while its official comments recently recognise that US economic readings are mixed-strength it remains adamant that it will continue slowly hiking its funds rate (now at 1.25% after four well-spaced 25bps rate hikes) and will soon start reducing the size of its holdings of US bonds and mortgage-backed securities. Notwithstanding the now strong likelihood that the Trump budget stimulus will not happen but that the Fed will continue to slowly tighten monetary policy the momentum in US economic looks set to carry through the rest of 2017 and in to 2018.
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. Economic readings for the month of June mostly beat analysts’ expectations too. Export growth was especially impressive, up 11.3% y-o-y accelerating from 8.7% in May. One feature supporting the notion that global growth has been accelerating has been a noticeable improvement in export growth in many key Asian economies, including China. Domestic demand within China continues to grow well too with annual growth in urban fixed asset investment spending and retail sales both strong in June at respectively 8.6% y-o-y and 11.0%. China’s authorities still face a difficult balancing act in maintaining 6.5% annual GDP growth while at the same time recalibrating key growth drivers and conducting necessary economic reforms. At this stage, the difficult economic policy balancing act is being achieved and China is unlikely to compromise global economic growth prospects in 2017 as many forecasters feared at the beginning of the year. Indeed, at this stage China is showing signs of growing more strongly later in 2017 adding momentum to global economic growth.
Europe continues to show impressive signs of improvement. Q2 GDP growth is due for release later this week and it seems likely that the relatively strong 0.6% q-o-q growth recorded in Q1 will be repeated which would lift annual growth to 2.4% y-o-y from 1.9% in Q1. Recent leading economic indicators out of Europe – business and consumer sentiment – have been consistently strong and imply that the marked lift in European economic growth will continue through Q3. While the number of people unemployed in Europe is rapidly declining month-by-month, the unemployment rate is still high at 9.3% indicating still considerable excess capacity. The recovery in Europe can be allowed to run on by the European Central Bank with plenty of excess capacity limiting risk of higher inflation.
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 rose sharply in the three months ending June, up by 101,200 and with full-time employment up by an even greater 111,400. The strength of employment growth indicates a pronounced lift in household disposable income in the quarter which in turn may help to explain a sharp lift in retail sales in April, up 1.0% m-o-m, and May 0.6%. June retail sales are due later this week and another small gain would see real retail sales in Q2 up by more than 1.0% far stronger than the 0.1% fall recorded in Q1 and an indication that household consumption spending will make a much bigger contribution to GDP growth than it did in Q1. Net exports and government spending also look set to contribute more strongly to growth in Q2.
There are weak patches in the Australian economy. The prolonged downturn in mining investment may be all but over, but the down turn in residential construction is only just starting. The Australian economy is a mixed bag, but one that on balance appears to be taking an improving turn. If the economy continues to pick up pace through the remainder of 2017, as seems more likely now, there is still relatively little pressure on inflation just yet. The Q2 CPI was lower -than-expected at 0.2% q-o-q, 1.9% y-o-y and although there are some inflation pressure points developing in higher utility prices and housing rent, wages growth remains very low.
The RBA is still unlikely to move its 1.50% cash rate in the near-term, but the pressure to start lifting the cash rate is beginning to build. 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