Conflicting signs of strength and weakness are showing in the global economy. On the strong side of the global economic growth ledger US GDP growth looks much stronger in Q2 than in Q1. US household spending seems to have lifted quite sharply in April and May. European economic growth also looks firmer in Q2 than in Q1, while Australian GDP growth was noticeably stronger in Q1 and seems to be maintaining strength in Q2. In Contrast, GDP growth in China looks less robust in Q2 than in Q1 and several bigger emerging economies are showing signs of weaker growth struggling with higher borrowing costs on US dollar denominated debt. A growing threat to the global economic growth outlook is the escalating international trade war driven primarily by rounds of higher import tariffs on an increasing range of US imports from China, Europe and Canada and prompting retaliatory increases in tariffs against US goods. Another complicating factor is that the US Federal Reserve and an increasing number of other central banks are withdrawing monetary stimulus to guard against the return of unacceptably high inflation.

The long US economic recovery is showing increasing evidence of being late-stage with little spare capacity and moving close to the point where the cost of resources, especially labour resources, are bid higher leading to higher inflation. The US unemployment rate was down to an 18-year low 3.8% in May with average hourly earnings up 2.7% y-o-y and showing signs of pushing up well above 3% over the next few months. The headline CPI rose to 2.8% y-o-y in May with the core CPI (excluding food and energy prices) up 2.2% y-o-y – above the Fed’s 2% target. Large tax cuts are coming in to play at a time when household spending is gathering pace. Retail sales rose in May by 0.8% m-o-m, after increasing by 0.4% in April. Consumption is likely to make a much bigger contribution to Q2 GDP than in Q1 and at this stage the advance reading of Q2 GDP due in late July seems likely to show annualised US GDP growth doubling to more than 4% from 2.2% in Q1.

Strained US economic capacity looks set to become even more strained. The unsurprising 25bps hike in the Fed funds rate to 2.00% in June reflects that inflationary pressure is likely to build in the US economy later this year and in 2019. The Fed also knows that US interest rates are not close to high enough to arrest the prospective inflationary threat and indicated in its forecasts released at the June policy meeting that two more 25bps rate hikes are likely this year with another three in 2019. No monetary policy related influences prospective US economic related are mixed – increased government budget spending will add to growth (and inflation) but the international trade war could weigh on US economic growth eventually although in the nearer term higher tariffs on imported goods will add to inflation. The risk of higher US inflation looks greater than the risk of a material set-back to US economic growth prospects. As a result, there is a greater chance the remainder of this year and early next year that the Fed becomes more aggressive hiking rates than it is currently indicating.

Consequently, there is also a high risk of occasional sharp corrections upwards in US bond yields especially with potentially more aggressive monetary policy tightening coinciding with a very large and growing US government bond selling program based on the funding requirements of a big budget deficit plus large scale maturing government debt needing to be refinanced and the Fed trying to wind down its holdings of government bonds too.

While US GDP growth looks set to accelerate in Q2, the same is not true in the world’s second biggest economy, China. There were some upside surprises in the data for May but confined to international trade data (exports up 12.6% y-o-y and imports up 26.0% y-o-y) and the surprising strength is unlikely to persist as US import tariff increases start to bite. May readings relating to domestic spending and production in China in contrast were all disappointing and the most disappointing was retail sales where annual growth in May slipped to 8.5% y-o-y from 9.4% in April. As remarked last month, the rebalancing of economic growth drivers in favour of retail spending inside China is proving difficult to achieve. The authorities are still finding it hard to influence Chinese households to spend more freely and save a smaller proportion of their income. A poor welfare safety net in China still encourages unusually high household saving in China and this area needs to be addressed if China’s consumers are to make the order of contribution to GDP growth that the authorities would like to see over time. In the near-term, when Q2 GDP is released in mid-July it seems likely that growth in China has slipped to 6.5% y-o-y, perhaps less, from 6.8% y-o-y in Q1.

In Europe, Q1 GDP growth moderated to +0.4% q-o-q, +2.5% y-o-y from +0.6% q-o-q, +2.7% y-o-y in Q4 2017 but is looking a touch better again in Q2. The European Central Bank, notwithstanding concern about the anti-European Government established in Italy, is becoming less concerned about potential downside risks to European growth prospects. At its June policy meeting the ECB announced that quantitative easing bond purchases would step down from 30 billion euro a month to 15 billion euro at the end of September and would finish at the end of September. The ECB has in effect set the clock ticking for its first interest rate hike, now much more likely to occur in 2019.

Australia in June has become an “odd-man-out” exhibiting one of the strongest GDP growth rates in the developing world in Q1 (1.0% q-o-q, 3.1% y-o-y), but a central bank keeping its official cash rate on hold at a record low 1.50% (a cash rate that is extraordinarily accommodating compared with inflation at 1.9% or nominal GDP growth running close to 5% y-o-y). The RBA continues to argue that with wages growth still low, inflation unlikely to lift towards the middle of its 2-3% target band in the near term and the risks to growth from potentially soft spending by the heavily indebted household sector it is unlikely to lift the cash rate in the near term.

Yet the signs from monthly Australian economic readings are pointing to the likelihood that GDP growth will be relatively strong again in Q2. Indeed, indications of household consumption spending are running noticeably firmer. Retail trade lifted more than expected in April, by 0.4% m-o-m. Jobs growth was still reasonably strong in May, +12,000, sufficient to take the national unemployment rate down to 5.4% and the unemployment rates in the two most populated states Victoria and New South Wales down to respectively 5.1% and 4.8%, close to what might be deemed full-employment unemployment rates.
Annual wages growth according to wage price index has only been edging upwards since mid-2018 but the increasing risk is that growth will accelerate shortly. While we accept that the RBA is reluctant to start hiking the cash rate, we doubt that reluctance can last long in the face of more relatively strong economic readings and probably some signs of higher inflation in the Q2 CPI release in late July. Our longstanding call for a first cash rate hike at the August RBA policy meeting is unlikely based on recent comments from the RBA, but we doubt whether the RBA will be able to hold out until 2019 before starting to hike the cash rate. Our latest forecast is a first cash rate hike in November and driven by firmer data on growth, wages and inflation between now and then