Global economic readings in July took a slightly more positive turn with firmer than expected economic readings on balance out of the world’s two biggest economies the United States and China. Potential problems for the global economy arising from the Greek debt negotiations also faded as the European Union and Greece came to an agreement about another bail-out package for Greece. Another longstanding geopolitical issue relating to Iran’s nuclear ambitions also reached a resolution in July. Despite mostly positive news for the global economy through the month, however, most commodity prices continued to weaken highlighting downside risk to Australian national income.

The world’s biggest economy, the US, still seems to be pulling out of its soft patch in Q4 2014 and Q1 2015. The advance reading of Q2 GDP out later this week seems likely to show annualized growth close to 3.0%, up from -0.2% in Q1. Indicators of US housing activity have strengthened noticeably over recent months. The National Association of Homebuilders’ index lifted to 60 in July, its strongest reading since November 2005 in the midst of the last US housing boom. US employment growth has stayed comparatively firm too with non-farm payrolls up by 223,000 in June after increasing by 254,000 in May. The latest weekly initial jobless claims also implies strength in the US labour market, falling by 26,000 to 255,000 the lowest (strongest) reading in 42 years.
Despite pockets of clear economic strength, the US economy still has some soft patches. Notwithstanding strong readings of consumer confidence and sentiment, retail sales remain erratic month-to-month unexpectedly falling in June by 0.3% after lifting by 1.0% in May. Manufacturing industrial production has been consistently soft, showing no growth in either May or June. This inconsistency in US growth caused the Federal Reserve to downgrade its 2015 economic growth forecasts back in June but it continues to indicate that it will deliver its first interest rate hike in 11 years later in 2015. US economic growth still seems to us to be insufficiently entrenched to withstand the start of a rate hiking cycle and the likely stronger US dollar that will go with it.

In China, economic readings released in July hinted that the slowdown in growth may be coming to an end. June industrial production rose by 6.8% y-o-y, better than the 6.1% reported in May. June retail sales rose by 10.6% y-o-y up from 10.1% y-o-y in May, while June urban fixed asset investment spending was steady at 11.4% y-o-y. Q2 GDP rather than slipping below 7.0% y-o-y as widely expected, held at 7.0%. July was also notable in China as the authorities took direct steps to arrest the sharp decline in the sharemarket. One interpretation of events in China is that policy initiatives are working to stabilize the economy around the annual 7% growth rate planned. However, not all indicators are pointing to stabilizing growth. The flash manufacturing PMI reading for July slipped further in to contractionary territory registering 48.2, down from 49.6 in June. The continuing fall in industrial commodity prices also implies that China’s growth rate remains under downward pressure.

In Europe, economic readings have turned mixed-strength. May retail sales rose by only 0.2% while May industrial production fell by 0.4% in May. The unemployment rate was steady at 11.1% in May. The European Central Bank (ECB) met in July and played a straight bat to developments in Greece barely changing its comments about Europe’s economy, leaving interest rates unchanged and continuing to buy 60 billion euro of securities a month. With the latest package announced for Greece, the ECB continues to support the liquidity of Greek banks who are slowly providing access to higher amounts of cash for their customers. Capital controls remain in place for Greek residents and the terms of the latest bail-out package imply weaker Greek economic growth will persist and may lead to heightened political instability down the track.

In Australia, mixed growth signals persist although weak commodity prices crimping Australian national income still point to pronounced downside risks to economic growth. The strongest part of the economy remains housing activity although there are signs that housing may be topping out. The number of owner-occupier housing finance commitments were surprisingly soft in May falling by 6.1%. APRA’s macro-prudential controls are also showing signs of biting bank lending for investment housing with some announcing rate increases of up to 27bps. Home building approvals remain very strong, up in May by 2.4% and by 17.6% y-o-y, but the contribution of housing activity to GDP probably peaked back in Q4 2014 when it grew in real terms by more than 6% in the quarter.

Beyond housing, promising signs of acceleration in household consumption in Q1 2015 seem to have faded in Q2. Retail sales rose only 0.3% in May after falling by 0.1% in April and appear to have remained soft in June. Australia’s international trade performance also appears to have deteriorated sharply in Q2 with a cumulative trade deficit of $A6.9 billion in April and May against a cumulative deficit of $A4.5 billion in the three months ending March.

Set against softer retail trade and weakening international trade, employment has taken a stronger turn, up by 7,300 in in June after lifting 39,900 in May and leading to the unemployment rate stabilizing around 6.0%. The mixed-strength economic readings seem consistent with economic growth running a touch weaker than forecast by the RBA back in May. The recently released Q2 CPI, +0.7% q-o-q, +1.5% y-o-y also seems to be tracking a touch lower than the RBA expected. The next set of economic forecasts to be released by the RBA early in August will need to recognise the continuing softness in the economic outlook. Even though the RBA is concerned about house price inflation and whether interest rate cuts are adding to the problem we still believe that the RBA is likely to deliver at least one more cash rate cut to assist flagging general domestic spending by households and businesses. We still see a 25bps cash rate cut to 1.75% in August and cash rate being no higher than 1.75% in the following year.