Evidence of continuing global economic recovery proliferated in November. At the same time major central banks continued to indicate only slow withdrawal of monetary accommodation. Low inflation is the main factor permitting the highly business-friendly combination of very low borrowing interest rates persisting at a time of above long-term trend global economic growth. There are the first signs in the form of rising global producer (factory gate) prices that inflation may not stay so low over the year ahead. At some point probably in 2018 central banks including the RBA are likely to either start the process of reducing monetary accommodation or lift the pace at which monetary accommodation is being reduced. Until that occurs, global economic growth may gather more pace increasing the likelihood of a lift in the pace of Australian economic growth too.
Returning to the US, the advance reading of Q3 GDP showed growth at 3.0% annualised from 3.1% in Q2. The Q3 reading is particularly impressive given severe hurricane damage in September. Consumption expenditure grew at 2.4% annualised pace in Q3 and non-residential investment spending at 3.9%. Both are key elements of domestic spending in the US and are growing very well. A wide range of US economic readings all point both to upward revision of Q3 GDP and a strong Q4 GDP reading as well. US housing activity is showing signs of lifting again – housing starts rose 13.7% m-o-m in October; housing permits were up 5.9% – retail sales are strong, up 0.2% m-o-m in October after a 1.9% gain September and importantly the labour market continues to strengthen. Non-farm payrolls rose by 252,000 in October and the unemployment rate fell to a new cycle low reading, 4.1% in October. At this stage inflation is still contained, 2.0% y-o-y for the headline CPI in October and 1.8% for the core CPI (excluding food and energy prices.
The combination of strong US economic growth and relatively low inflation is dividing opinion inside the Federal Reserve. The “hawks” on the FOMC foresee an increasingly capacity-constrained US economy lifting inflation and leaving the Fed looking tardy raising interest rates if it is not careful. The “doves” led by current Fed Chairman, Janet Yellen foresee only limited risk of inflation rising too quickly and prefer a slow interest rate normalisation process less likely to derail growth. The compromise position of the “hawks” and the “doves” is to continue watching incoming US economic data for signs of undue strength or inflation pressure to dictate change in rates. The strength of recent data readings point to another Fed rate hike (+25bps to 1.50%) at its next FOMC policy meeting in mid-December.
In China, the world’s second biggest economy after the United States, Q3 GDP held up well at 6.8% y-o-y from 6.9% in both Q2 and Q1. There are signs that annual GDP growth may be a touch softer in Q4. October economic readings were mostly a little less robust. Exports rose 6.9% y-o-y compared with 8.1% in September. October urban fixed asset investment spending, up 7.3% y-o-y was down a touch on 7.5% in September. Industrial production pulled back to 6.2% y-o-y from 6.6% in September and retail sales to 10.0% from 10.3%. These relatively minor pull backs are consistent with the authorities’ activities dealing with excessive growth in credit and reining in undesirable activities – polluting industries, business corruption and speculation in residential real estate.
In Europe annual GDP growth accelerated to 2.5% y-o-y in Q3. In another milestone for European economic recovery, every national economy reported positive q-o-q growth in Q3 and the big four European economies – Germany 0.8% q-o-q; France 0.6%; Italy 0.5% and Spain 0.8% – all reported strong GDP growth. Europe’s unemployment rate fell below 9% (8.9% in September) for the first time since the global financial crisis. The European Central Bank still appears cautious about Europe’s future economic growth. The minutes of its November policy meeting show disagreement, however, around the decision to cut the size of its monthly QE bond purchases from 60 billion euro to 30 billion, but imply that QE purchases will continue until at least September 2018. Some ECB members wanted a clearer signal that QE purchases would end in September 2018.
Australian economic growth is still looking patchy. Employment growth has been very strong through 2017 so far and the unemployment rate is down at a 4-year low 5.4%. Wages growth, however, remains very weak (0.5% q-o-q, 2.0% y-o-y in Q3) and the combination of low wages growth and very high household debt is resulting in subdued retail spending. Retail sales in volume terms rose by only 0.1% q-o-q in Q3. On the positive, business spending activity appears to be improving and public-sector infrastructure spending is lifting very strongly. Q3 construction work done rose in volume terms by 15.7% q-o-q driven by a 33% q-o-q lift in engineering work done. Export volumes are rising too including service exports -education and tourism. All told, annual GDP growth probably ran around 2.5% y-o-y in Q3 (data due early December), up from 1.8% y-o-y in Q2.
A combination of factors including very low wages growth and increasing competition in many Australian industries are helping to keep annual inflation below 2%. In time, the RBA expects inflation to lift, but it will probably be a slow process and in part dependent upon using up remaining spare capacity in the labour market. The RBA sees Australia’s full-employment unemployment rate effectively around 5.0% still some way below the current rate of 5.4%. While there is still some spare capacity in the labour market and wages growth remains low in turn supporting a low inflation rate the RBA is in no rush to start lifting interest rates.
The RBA left the cash rate unchanged at 1.50% at its early November policy meeting and the statement accompanying the decision; the minutes of the meeting and the quarterly Monetary Policy Statement all indicated no change in the cash rate is likely in the near term. In a recent speech, RBA Governor Lowe did make it clear however that economic conditions through 2017 have been changing in a fashion that question the need for such low interest rates. The next move in the official cash rate is much more likely to be a hike rather than a cut, but the timing of that change is still some way off while wages growth remains so low. Our view about the cash rate has changed over the past month. We no longer see the first cash rate hike occurring in February but instead around six months later in August or September 2018.