Many forecasters are looking for global economic growth to reach 4% in 2018, which if achieved would make it the strongest global growth rate in over a decade. At the start of 2018, growth is still firing up in many parts of the globe including the United States, China, Japan and Europe. Many developing economies are also recording stronger growth readings too. Even Australia, hobbled by a huge household debt burden and a faltering housing market, looks set to grow more strongly in 2018.
When economic growth has been strong and promises to remain strong over the coming year it is natural to question how long good times can last? There is a self-reinforcing momentum in the current global economic recovery -strong growth promoting greater employment, more household income and wealth, more spending and trading between nations, greater business profits and spending. Such a build-up in growth momentum does not usually come to a grinding halt of its own accord, but is usually slowed or stopped by rising interest rates driven by the market and/or central banks.
A key factor providing the fuel for the current momentum in global growth is that interest rates are still very low assisted in part by the slow pace and low amount of the removal so far of the vast monetary accommodation provided by central banks in the wake of the global financial crisis. Central banks have seen no need to proceed other than cautiously removing monetary accommodation including the US Federal Reserve operating in an economy which has enjoyed one of the more pronounced and lengthy economic recoveries since the global financial crisis.
With global economic growth broadening and strengthening through 2017 and promising another good year in 2018, central banks are on watch for signs that the economic growth is stretching capacity to produce to a point that will drive up inflation beyond current low annual readings, still mostly around 2% y-o-y and lower. Central banks are also trying to assess that even if there is some evidence that inflation will push up, that the move threatens to be sustained.
The signs relating to the inflation outlook remain mixed. Producer (factory gate) prices are lifting in the US, Europe and much of Asia presenting a potential threat of higher retail price inflation down the track. Faster wages growth, a key element in a higher inflation outlook, remains absent in most economies, even those where unemployment rates have fallen below levels that were consistent with higher inflation in the past.
At this stage, the views of central banks regarding the outlook for inflation have not changed much from where they stood most way through 2017 – higher inflation is likely to show up at some point, but not in the near-term. Their inflation view is in turn helping to frame their views about monetary policy change. Slow small steps removing monetary accommodation remains the order of the day for most of them. The RBA feels it does not even need to do that for some time given special local factors such as precariously high household debt and unusually low local wages growth even in a low wages growth world.
Despite the central banks indicating no real change to their monetary policy plans late in 2017 and early in 2018, government bond yields have pushed up since the start of the year. The US 2-year Treasury yield has risen nearly 20bps over the past month touch 2.00% its highest level since September 2008 at the outset of the global financial crisis. The US 10-year Treasury yield and the Australian 10-year bond yield have risen since the beginning of 2018 respectively 14bps to 2.55% and 12bps to 2.75%.
These upward movements in bond yields are comparatively minor so far and would probably need to move up another 75bps or more over the next few months to constitute a real threat to strong global growth prospects and by one remove the buoyancy of risk assets such as shares. If central banks maintain their views on the monetary policy outlook – more likely than not in our view – the current push up in bond yields will falter well short of a further 75bps lift in yields.
Nevertheless, in our view there will come a point where continuing strong global economic growth further increases the likelihood of higher inflation ahead. That point is probably several months away but when it arrives will cause central banks to announce more aggressive plans removing monetary accommodation. We pencil in the RBA starting to hike its cash rate in August with at least one more hike beyond before year end. By August/ September we also see bond yields 75bps, or more, higher than where they stand currently.