Global economic growth showed signs of gaining momentum in January with economic readings from the US, China and Europe consistent with firmer GDP growth on balance. Signs also continued to show that the long period of very low inflation is turning and that slightly higher inflation may be in prospect. Australia was an odd-man-out both in the story of improving economic growth – real GDP in Q3 2016 fell 0.5% q-o-q – and rising inflation – annual inflation well below the RBA’s target at 1.5% y-o-y in Q4 for the CPI and 1.55% y-o-y for the average underlying inflation rate. There are signs that Australian GDP growth will be materially stronger when Q4 GDP is released early in March, but inflation in Australia may take some time to lift. There is a likelihood that the RBA could keep its cash rate unchanged at 1.50% throughout 2017 lagging well behind the moves starting to lift official interest rates in the US and most recently China.
Returning to the US economy, many leading indicators of economic activity are pointing to the growth acceleration evident through most of 2016 continuing in the early months of 2017. Final January consumer sentiment is running at a cycle-high 98.5 while indicators of sentiment in US homebuilding companies, manufacturing and provision of services have all strengthened noticeably including the period of President Trump’s inauguration and the first few days of government by executive order. While some of the changes being made by President Trump relating mostly to border controls are inconsistent with stronger US growth, there is still a strong sense in US financial markets that on balance President Trump could boost US economic growth.
US Q4 GDP slowed to 1.9% annualised growth pace from 3.5% in Q3, but that still placed US economic growth noticeably faster than through the second half of 2015. Also, the contributions to Q4 GDP from household consumption spending, housing and business investment were all quite strong. The big negative for US growth in Q4 was net exports detracting 1.7 percentage points. US growth has been fast enough to keep the unemployment rate low at 4.7% in December, near the cycle low-point of 4.6% set the month before and 5.0% in December 2015. The trickle down in the unemployment rate through 2016 to a level consistent with full-employment has started to prime higher wages growth. Most US companies expect to pay higher wages over the coming year and average hourly earnings in December were already showing annual growth of 2.9% y-o-y, close to the level supporting higher inflation. The Fed has indicated that it will lift its funds rate three times in 2017, but there is a growing sense that this will be the minimum change, not an unrealistic stretch as Fed rate forecasts were viewed by the market in 2016.
In China, Q4 GDP growth accelerated marginally to 6.8% y-o-y from 6.7% in Q3. There were signs in December economic readings that the growth drivers continue to rebalance away from industrial output and towards retail sales and service sector activity. There are also signs that the focus of China’s policymakers is starting to shift away from supporting GDP growth in the near-term using expansionary budgetary and monetary policies towards dealing with problems such as excessive residential construction, high house price inflation and poor bank lending practices. China has become a balancing act between trying to support growth in the near-term and pursuing economic reforms that limit near-term growth but provide a better chance of sustaining growth longer-term. Last week, the People’s Bank of China surprised by lifting the interest rates on its medium-term lending facilities to banks by 10bps to respectively 2.95% for its 6-month facility and 3.1% for its 1-year facility. The rate move is a small one but it is indicative of a shift towards less growth supportive policies implying less strong GDP growth later in 2017.
In Europe, both GDP growth and inflation are showing signs of starting to lift. Q4 GDP growth is due this week and is expected to rise 0.4% q-o-q, 1.7% y-o-y. Inflation accelerated to 1.1% y-o-y in December and is expected to push up further to 1.5% y-o-y in the preliminary January reading due this week. While the European Central Bank’s official interest rates still have a negative sign on the front the ECB is starting to reduce its monthly asset purchases or QE. Political risks still abound in Europe with several elections due this year and tricky negotiations ahead with Britain over exiting the EU.
The Australian economy was an unusual odd-man-out in December exhibiting signs of weaker growth. An unusual combination in Q3 2016 of falling housing activity, falling government investment spending and weakness in net exports led to a negative Q3 GDP reading, -0.5% q-o-q sharply reducing annual growth from a downwardly revised 3.1% y-o-y in Q2 to 1.9% in Q3. In January, signs are accumulating that negative GDP growth in Q3 will rebound to strongly positive growth in Q4. There are signs of a return to strength in housing activity, with November housing finance commitments lifting (0.9% for owner-occupiers and 4.9% for the value of investor loans) and a 7% lift in home building approvals in November. Retail sales showed reasonable growth in October and November and international trade showed a major improvement with a lift in to trade surplus, $A1.2 billion in November from a deficit of $A1.1 billion in October. At this stage, Q4 real GDP growth (when published early in March) should be at least +0.5% q-o-q, but nominal GDP growth will be considerably stronger, possibly close to 2.0% q-o-q driven by the huge 12.4% q-o-q lift in Australian export prices in Q4.
The heavy-lifting for the turnaround in Australian GDP growth between Q3 and Q4 2016 is coming predominantly from net exports in volume and especially in value with the sharp increases in export prices. Growth primed mostly by international trade does not give a particularly strong boost to employment and that is still showing in the monthly labour force data which although showing some improvement in November (employment up 37,100) and December (+13,500) are still not particularly strong. Wages growth remains quite weak too (+1.9% y-o-y in Q4). Australian inflation remains very subdued (around 1.5% y-o-y on all measures in Q4) and still soft labour market conditions and a relatively strong Australian dollar exchange rate imply little acceleration in annual inflation over the next year or so.
From the RBA’s point of view there are good reasons to wait and see what develops in the global economy as well as how well or otherwise growth is supported locally. There are few compelling reasons to adjust monetary policy in the near term. At this stage the cash rate is likely to remain at 1.50% through to the middle of 2017 and even then the chances of a cash rate change are not high. Australian lending interest rates, however, may continue to move higher led by developments in international bond markets.