Further signs emerged in October that global economic growth is gathering momentum. The first Q3 GDP reports from China, 6.8% y-o-y, and the United States, 3.0% annualised showed growth in the world’s two biggest economies running above potential. More importantly, what signs are available for early Q4 indicate a continuation of robust economic growth. Q3 GDP reports from elsewhere are due over coming weeks and most are expected to tell a similar story of growth running at or above potential. Central banks had started to signal either tighter monetary policy or less accommodating monetary conditions although there seemed to be reluctance to force the pace of policy change in the decisions of central banks over the past month. If, however, global growth continues to gain momentum as seems increasingly likely the risk builds that inflation will lift and that central banks, including the RBA, will have to move towards lifting interest rates.
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. Most leading indicators are pointing towards stronger US growth and seem unaffected by the series of natural disasters impacting the US – hurricanes in the south and wildfires in California. Employment growth has taken what is expected to be a temporary hit – non-farm payrolls fell by 33,000 in September – but otherwise the US labour market continues to tighten with the unemployment rate down at a 16-year low of 4.2% while annual growth in average hourly earnings has accelerated to a cycle high of 2.9% y-o-y. Company earnings continue to grow very strongly.
On the US political front, the chances of the Trump Administration delivering tax cuts seemed to improve after the Budget for the current financial year was approved by Congress. The Federal Reserve remains committed to winding down the size of its balance sheet and delivering further rate hikes. Another FOMC meeting occurs this week, although it seems unlikely that the Fed will announce any policy change. The meeting after in mid-December may see a 25bps rate hike to 1.50%. Looking in to 2018 the outlook is clouded by the potential appointment of a new Federal Reserve Chairman in February. The power behind the current US economic recovery and the risk that US annual inflation will lift well above 2% in 2018 implies that the current Fed forecasts of three more 25bps rate hikes in 2018 is likely to be the least that they will do.
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. Signs continued to accumulate in October that the Chinese authorities are changing the drivers of economic growth – more infrastructure spending in the regions; less emphasis on residential construction and industrial production; more emphasis on consumer spending and delivery of services. These messages were all reinforced in President Xi’s address to the Party Conference marking the start of his second five-year term in office. China will continue to follow its own growth model in large part orchestrated by strong government direction with a strong leader a central feature of government. The message was one of growth on China’s terms with the rest of the world accommodating. It was not an entirely comfortable message for China’s trading partners, but it does imply that China will continue to grow comparatively strongly over the next few years.
Europe is expected to register Q3 GDP growth around 2.1% y-o-y and most leading indicators are pointing to similar growth or better in Q4. Consumer confidence in Europe is the highest it has been since 2001, while the manufacturing sector’s purchasing managers are the most confident they have been in more than six years. Europe’s unemployment rate was stable at 9.1% in August and inflation is running around 1.5% y-o-y. The European Central Bank still appears cautious about Europe’s future economic growth. At its policy meeting the ECB did propose another cut in the size of its monthly QE bond purchases from 60 billion euro to 30 billion, but not until January 2018. Also, the ECB is still implying that QE purchases will continue until at least September 2018 which implies that it will not lift its policy interest rates including the -0.40% deposit rate until late 2018 at earliest.
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 5.5%. Wages growth, however, remains very weak and the combination of low wages growth and very high household debt is resulting in subdued retail spending. Retail sales fell in August by 0.4% m-o-m after falling by 0.2% in July. At this stage, household consumption spending may make no contribution to Q3 GDP. Other parts of GDP spending look better. Business investment spending may have stopped falling. Government infrastructure spending is rising strongly in the eastern states. 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, up from 1.8% y-o-y in Q2.
At this stage annual inflation remains low, although mostly because of deflating import prices. The Q3 CPI rose by 0.6% q-o-q causing and annual inflation edged down to 1.8% y-o-y from 1.9% in Q2. Underlying annual inflation was stable around 1.8% y-o-y too. On the face of it there is no inflation smoking gun. However, inflation related to domestic sources (non-tradables) rose by 3.2% y-o-y in Q3, up from 2.7% in Q2. Inflation related to international sources (tradables) fell 0.9% y-o-y in Q3 from a 0.4% increase in Q2. Given the rising trend in factory gate prices overseas and the softer tone developing in the Australian dollar exchange rate it is doubtful whether weak prices of imported goods and services will persist. There is a risk that Australian annual inflation could mark up quite sharply over coming quarters.
The RBA left the cash rate unchanged at 1.50% at its early October policy meeting and in various commentaries has indicated that it is in no hurry to move the cash rate but that eventually the next move is more likely to be upwards. Our view remains that 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% and that by early 2019 the cash rate will need to be nearer to 2.50%.