Slow-paced global economic growth with little sign of inflation pressure continued through July. US economic readings were a touch firmer on balance whereas economic readings out of China, Europe and Australia were mixed-strength. Global financial markets recovered quickly from Britain’s referendum decision to leave the EU assisted by a smoother and quicker change of British Prime Minister than expected. It is worth noting, however, that the detailed and likely protracted British EU exit negotiations still lie ahead. Financial market sentiment has been boosted by a growing belief that central banks will continue to ease policy to try and boost economic growth. In the case of the US Federal Reserve, the view is that it will not lift its funds rate at either its July policy meeting this week or the one after in late September. In Australia, market sentiment has swung strongly towards a belief that the RBA will cut the cash rate at its next meeting in early August, contingent upon a low Q2 CPI inflation reading this week.
Returning to economic data released over the past month, in the United States economic growth according to the final revision of Q1 GDP softened to 1.1% annualised pace from 1.4% in Q4 2015. The first reading of Q2 GDP is due later this week and the market consensus forecast shows likely improvement to 2.6%. May and June US economic readings, although still mixed-strength, are consistent with accelerating economic growth in Q2. Monthly nonfarm payrolls, after quite soft increases in both April and May, lifted sharply by 287,000 in June and weekly initial jobless claims through the first half of July tracked down to their lowest (strongest) readings since the data series began more than 40 years ago. The firm US labour market, together with growing US household wealth are helping to prime US retail spending, up 0.6% in June, after lifting by 0.2% in May and a more than 1.0% gain in April.
Rising household consumption spending provides the major impetus for US GDP growth in Q2, but strong residential investment spending is likely to contribute again too. June housing starts rose by 4.8%, permits were up by 1.5% and existing home sales increased by 1.1%. US indicators of manufacturing activity have been on a rollercoaster ride over recent months, but appeared to lift in June with the ISM manufacturing survey response pushing further in to expansionary territory at 53.2 from 51.3 in May. The non-manufacturing, or services sector, ISM survey was also strong in June at 56.5 from 52.9. Even though inflation remains low in the United States the stronger turn in many other economic readings heighten the risk that the Federal Reserve may want to return to a path of slowly normalising US interest rates. It is unlikely that the Fed will lift its funds rate (currently in 0.25-0.50% range) at its policy meeting this week, but it may hint that its late-September meeting could be a live meeting for a rate hike.
In China, annual GDP growth in Q2 at 6.7% y-o-y matched growth in Q1, but the quality of growth is in doubt with a greater proportion of spending coming from government sources. The influence of government spending was especially pronounced in the June reading of urban fixed investment spending which rose by a softer-than–expected 9.0% y-o-y and with private spending up only 2.8% y-o-y. June industrial production lifted to 6.2% y-o-y from 6.0% in May while retail sales improved to 10.6% y-o-y from 10.0% in May, both readings providing some hope that annual GDP growth can continue to stabilise. One problem assessing China’s economic outlook is the incompatible nature of various policy measures needed to sustain economic growth. Many state-owned enterprises are very inefficient and close to failing but are also very heavily indebted to China’s banks. The longer-term health of China’s economy would be better served allowing them to fail, but in the near-term that means less conduits for delivering government spending, significant employment dislocation and the possibility of a banking crisis. This struggle with what costs of economic reform are politically acceptable is likely to become a more prominent theme in China.
In Europe, Q2 GDP growth is due later this week and on consensus forecasts annual growth may slip slightly to 1.5% y-o-y from 1.7% y-o-y in Q1 2016. Just as European monthly economic readings took a better turn through the northern spring and early summer Europe has suffered a series of confidence sapping events including strain on the European Union from Britain’s vote to leave and continuing issues dealing with the movement of large numbers of refugees from the Syrian conflict overlaid by terrorist attacks in France and Germany. The ZEW Europe economic sentiment survey for July, responding to these various events, showed a marked fall to -14.7 from +20.2 in June. Neither the July policy meetings of the Bank of England nor the European Central Bank decided to adjust monetary policy settings although the statements after both meetings implied they would respond to any signs of economic weakness by easing policy further.
In Australia, the Federal election returned the Government, but with almost no majority and a bigger and wider range of cross-benchers in the Senate holding the balance of power. International credit rating agencies took a view that the Government may face greater difficulty legislating budget saving measures and placed Australia’s AAA sovereign credit rating on negative watch. Economic readings released in July pointed to fading strength in retail sales (up only 0.2% in May after rising 0.1% in April), still quite firm but moderating housing indicators in May (home building approvals down 5.3% and housing finance commitments down 1.0%) and modest employment growth, up 7,900 in June after a revised 19,200 gain in May. Much of the data illustrates the development of a two-speed economy with New South Wales and Victoria growing well, but on the back of robust housing activity, while other states are showing flat or declining economic activity.
The RBA chose to leave the cash rate unchanged at 1.75% at its July policy meeting, but it indicated in the statement accompanying the decision that it is watching approaching economic indicators to see if the current stance of monetary policy remains appropriate. Given evidence already to hand that spending in the economy is starting to soften and has become more regional in nature and with the likelihood of more evidence that inflation has stayed very low with the release of the Q2 CPI this week we see a high probability that the RBA will cut the cash rate by 25bps to 1.50% at its policy meeting on 2nd August. We also see another 25bps rate cut to 1.25% at the November policy meeting for much the same reasons as the likely August rate cut.