Global economic growth signals took a stronger turn on balance in June with hints that US GDP growth will be firmer in Q2 than in Q1, quite pronounced improvement in Europe plus signs that growth is holding up quite well through much of Asia, including China. Against these signs of improving global economic activity, economic growth in Australia has weakened, although there are tentative signs of improvement in Q2 with employment growth and retail spending both taking a stronger turn in April and continuing in May in the case of employment. Most economies still have considerable spare capacity and can grow without exerting untoward pressure on inflation. A notable exception is the United States where unemployment has fallen to a 16-year low point prompting concern at the Federal Reserve (Fed) that the economy is operating close to full capacity. Even though US inflation has settled back the Fed expects it to rise later this year and is taking the opportunity to slowly tighten monetary policy. The latest Fed rate hike was at its mid-June policy meeting where it also outlined a plan to start reducing its holdings of government bonds and mortgage-backed bonds – starting to reverse quantitative easing. The risk is rising of a renewed lift in global bond yields.
Looking in a little more detail at the US economy the weaker growth patch in Q1 evident in annualised GDP growth slipping to 1.2% from 2.1% in Q4 2016 may be on the brink of a renewed push stronger in Q2. Housing activity, at the leading edge of economic growth, seemed to take a turn for the better in May, at least in terms of existing home sales, up 1.1% m-o-m and new home sales, up 2.9%. An impressive feature of the new home sales data was a sharp lift in prices with the median price lifting by 11.5% m-o-m, 16.8% y-o-y. Regional manufacturing purchasing manager reports also appear to have taken a much stronger turn in June, with the New York State index soaring back in to expansionary territory at +19.8 from -1.0 in May while the Philadelphia Fed reading in June remained strong at +27.6 from +38.8 in May. Despite these signs of improving economic activity growth in non-farm payrolls has been comparatively soft, up 138,000 in May after a 174,000 increase in April. Retail sales remain lack-luster too with the core reading, excluding automobile sales, flat in May after rising 0.3% m-o-m in April.
The outlook for President Trump achieving promised tax cuts and budget spending increases is no clearer than a month ago. The President’s ability or even inclination to deal with the holders of the fiscal purse strings in Congress or the Washington bureaucracy who help shape and enable legislation remains suspect. Even without the promised fiscal stimulus, the US economy has substantially recovered and continues to grow towards potentially placing more upward pressure on wages and inflation. The path of least regret for the Fed still seems to be to lift slowly its funds rate. The June instalment took the funds rate up 25bps to 1.25% and the Fed is still indicating another 25bps hike to 1.50% before the end of 2017 and another three 25bps hikes in 2018. The Fed has also indicated that it intends to start managing down its $US4.2 trillion balance sheet built up through quantitative easing purchases of bonds and mortgage-backed paper. The Fed will avoid unsettling markets if it can but plans to start running down its holdings in September, escalating the amount of sales every three months in the following year. The Fed’s policy-tightening is likely to become more noticeable and one impact is likely to be higher US and global bond yields.
In China, May economic readings were mostly quite firm and consistent with Q2 GDP holding up above 6.5% y-o-y. In May export growth showed a surprise acceleration to 8.7% y-o-y as did imports to 14.8% with the latter a sign of firm domestic spending. Growth in urban fixed asset investment spending slipped only slightly to 8.8% y-o-y while industrial production and retail sales were both steady at respectively 6.5% y-o-y and 10.7% y-o-y. 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.
Europe continues to show impressive signs of improvement. Q1 GDP growth was impressive at +0.6% q-o-q, +1.9% y-o-y and most indicators point to strong growth being sustained in Q2. The unemployment rate is down to a decade low of 9.3% and between 100,000 and 200,000 Europeans a month are moving from the ranks of the unemployed to the ranks of the employed. Consumer confidence in Europe is the strongest it has been in a decade. A potential Trump-like shift in continental European politics widely feared early in the year in key elections in Holland and France has not occurred and in France has produced a stunning shift to pro-reform, pro-Europe centrism. The approaching German election looks increasingly favourable for Chancellor Merkel. The recovery in Europe can also be allowed to run on by the European Central Bank with plenty of excess capacity limiting risk of higher inflation. While the EU strengthens, the brexiting UK looks more vulnerable, especially in the wake of the Government’s June election debacle that turned hope of a bigger parliamentary majority to minority government at best and a weak negotiating position in approaching Brexit talks.
The Australian economy slowed quite sharply in Q1 registering GDP growth of only +0.3% q-o-q, +1.7% y-o-y. A sharp downturn in spending on housing and weaker exports were the main culprits for the weak growth rate. Exports were hit by weather damage to transport infrastructure in Q1 and with repairs in April will start to recover in Q2. In contrast, the down-turn in spending on housing is only just beginning and the efforts of banking authorities to contain excessive lending for investment housing, a rapid cooling of overseas investment interest in Australian housing, falling home building approvals and home building work in progress all point to a negative drag on economic growth most quarters over the next year or two. Weaker housing activity typically spills over to less robust growth in household consumption spending too. The issue is what will take up the slack as housing cools? At this stage, there are promising signs for government spending on infrastructure and exports, including exports of a wide range of services. There is also reasonable hope that after a year of very strong Australian company profit growth business investment spending will no longer be falling.
Although Australia’s economic outlook is finely balanced there are some encouraging near-term signs that growth could improve in Q2. Retail sales lifted strongly by 1.0% m-o-m in April breaking a run of very soft monthly readings. Employment growth has taken a much stronger turn over recent months lifting by 42,000 in May after a 46,200 gain in April. The unemployment rate has fallen from 5.9% earlier in the year to 5.5% in May. The brighter labour market readings could lift languishing consumer sentiment and provide offset to factors militating against freer household spending such as very weak wages growth and record high household debt as a proportion of income.
For the time being the RBA is still inclined to see positive economic growth factors winning out, although it recognises that there are downside risks too. If the economy slowly picks up pace, at some point wages and inflation will rise and the RBA will lift interest rates. If, however, the negative economic growth forces win out, the RBA will lower its growth forecasts and it could cut the cash rate further. At this point the data to hand are far from sufficient to prove the case for either the stronger or weaker economic growth forecasts which implies the RBA holding the cash rate unchanged at 1.50% for several more months to come. Our forecast remains that the RBA will lift the cash rate eventually in Q1 2018 by 25bps to 1.75%.