Most economic statistics released around the world in March still indicate strong global economic growth although there is a slightly softer edge to the data on balance indicating some moderation relative to the readings in January and February. The US Federal Reserve (Fed) lifted the funds rate by 25bps to 1.75% at its March policy meeting as widely expected but made few changes to its growth and inflation forecasts and left guidance on future interest rate hikes largely unchanged. In the US earlier optimism about growth prospects was dampened late in the month by President Trump’s announcement of a raft of import tariffs on goods from China. China retaliated promptly announcing tariffs on some US goods. If these moves restricting international trade by the US and China broaden in to an international trade war the consequences could extend to both weaker global growth prospects and higher inflation. Australia has been spared from direct trade restriction moves in the first skirmish but would inevitably suffer from more restricted and expensive international trade longer term. For the time being, the RBA continues to conduct monetary policy according to the needs of the domestic economy still warranting no change to the cash rate in the near term.
Looking at the US economy, economic readings and survey readings have become mixed-strength in March. Employment is still very strong with non-farm payrolls up by 313,000 in February with the unemployment rate stable and low at 4.1%. Wages growth, however, settled back a touch rising only 0.1% m-o-m in February and pulling down the annual change to mid-2% territory presenting less push for inflation. Most leading indicators of US economic activity remained strong in March including purchasing manager reports and consumer sentiment readings. On the softer side retail sales fell 0.1% m-o-m in both January and February. Most new housing indicators were softer too with February housing starts and permits down respectively by 7.0% m-o-m and 5.7% and February new home sales down by 0.6% m-o-m in February after falling by 4.7% in January.
The mixed-strength US data reports still imply the economy growing around 3% annualised pace in Q1 and a reasonable chance of sustaining that growth pace providing the tit-for-tat imposition of tariffs announced so far between the US and China do not escalate in to more areas of trade restriction with more countries. For the time being, the Fed is sticking with earlier views concerning the outlook for US growth and inflation. Those views encompass stronger GDP growth in 2018 and 2019 feeding higher inflation in time and warranting another two rate hikes this year and another three in 2019. Those views would change if a full scale international trade war occurs reducing the Fed’s growth forecasts while at the same time forcing a lift in inflation forecasts presenting an unfavourable scenario of more than previously heralded rate hikes at a time of softer than previously forecast GDP growth – a scenario that could potentially lead to a US recession developing later in 2019.
China’s economic readings remained promising in March and consistent with GDP growth of at least 6.5% y-o-y in Q1. Rather like the outlook for the US economy, the outlook for China is clouded by the trade war with the US. Stronger international trade has been a key force helping to lift GDP growth in China. February data was distorted by the influence of lunar new year celebrations so the incredible 44.5% y-o-y lift in China’s exports in February will fall back when March data are released. Nevertheless, there is little doubt that China’s international trade has been growing very well. That growth will run in to brisk headwinds caused by President Trump’s tariff moves. China’s industrial production up a better-than-expected 7.2% y-o-y in February is also likely to suffer over time. Prospects for retail sales and fixed asset investment spending, up in February respectively by 9.7% y-o-y and 7.9% are brighter and undoubtedly the authorities in China will use policy to compensate for set-backs to exports and industrial production by boosting urban investment spending and encouraging stronger retail spending. Nevertheless, China’s growth prospects are less assured with restrictions being imposed on its international trade.
In Europe, economic readings released through March also showed a touch less strength than evident in January and February. March purchasing managers’ reports for the manufacturing and services sectors moved from very strong readings around 57 and 58 in February to not quite so strong readings of 56.6 for the manufacturing sector in March and 55.0 for the services sector. European retail sales and industrial production in January both took a softer turn falling respectively 0.1% m-o-m and 1.0%. Europe’s economy is still generating good growth in jobs and GDP growth around 0.6% q-o-q in Q1. Also the European Central Bank at its latest policy meeting was confident enough about European growth prospects to tweak the wording in its commentary away from a bias to ease policy towards a more neutral stance. However, Europe’s growth prospects seem a little less strong and face threats from a new Italian Government with no stomach for continuing economic reform and an uneasy sense that European international trade may soon be threatened by US tariff restriction.
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 over the past 12 months, 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.
Annual GDP growth in Q4 reduced to 2.4% y-o-y from an upwardly revised 2.9% y-o-y registered in Q3. Contributions to Australian growth are proving volatile quarter-to-quarter. Government spending and household consumption spending contributed strongly to GDP growth in Q4 while international trade detracted from growth. Household spending seems likely to make a lesser contribution in Q1 based on soft retail sales so far in the quarter. International trade, however, may contribute positively given better exports so far in the quarter. On balance, our forecast of a patchy rise in GDP growth through 2018 is still intact, although developments around international trading conditions bare watching. Without strong growth in international trade Australia’s growth prospects would look much weaker.
For the time being it seems that the RBA’s economic forecasts remain slow pick up in GDP growth and inflation eventually too. Those forecasts imply no change in the 1.50% cash rate for next few months at least. Our view remains that it will probably be August (after the Q2 CPI release in late July) 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. Risks are quite evenly balanced on either side of our forecast. No extension in the international trade war if combined with a slower than expected lift in Australian growth and inflation could leave the RBA sidelined until 2019. In contrast a broad international trade war even if combined with softer growth would lift inflation more promptly and could cause the RBA to hike the cash rate earlier.