Economic data reports through June in most advanced and developing economies remained consistent with slow-paced global economic with continuing strong disinflationary pressure. These conditions were recognized in the US Federal Reserve’s June policy meeting decision leaving its federal funds interest rate unchanged. Late in the month, Britain’s referendum about whether to stay in the European Union delivered an unexpected majority in favour of leaving. An uncertain phase lies ahead in terms of when Britain exercises its formal divorce from the EU, how the EU reacts to Britain through the process plus financial and real economic reactions. Most likely central banks, including the RBA, will stand ready to try and avoid any untoward weakening of what are in any case modest economic growth prospects at best. The protracted period of low and falling interest rates has become more entrenched in our view.
Returning to economic data released over the past month, in the United States economic growth softened in Q1 to 0.8% annualised pace from 1.4% in Q4 2015, but April and May economic readings point to accelerating growth in Q2, possibly around 2.5%. Housing activity, in particular, has had a good late spring and early summer. May existing home sales rose 1.8% m-o-m after gaining 1.3% in April. New home sales fell 6.0% m-o-m in May, giving up only half a truly exceptional 12.3% gain in April. Housing starts and permits remained elevated in May, while the June National Association of Homebuilders’ index improved to 60, its strongest reading so far this year. Apart from strong housing activity US consumers have been spending more freely too. Retail sales rose a further 0.5% m-o-m in May after a 1.3% lift in April indicating a strong contribution to Q2 GDP from household spending.
Beyond housing and consumer spending, growth indicators have mostly been mixed-strength. Industrial production rose 1.1% m-o-m in May. Early regional reports from purchasing managers in the manufacturing sector for June have mostly taken a stronger turn. May durable goods orders, however, fell by 2.2% m-o-m. The May non-farm payrolls report presented the biggest negative surprise showing a rise of 38,000 against analysts’ expectations of a 158,000 lift and with the April result revised lower to a 123,000 gain from an initial print of 160,000. The payrolls data caused the Fed to reassess its view that the US labour market was maintaining strong improvement to a view that some signs of softening are starting to show. The change in the Fed’s view about US employment conditions together with increasing uncertainty about global growth prospects caused the Fed to delay its plan to slowly normalise US interest rates at its June policy meeting and cast doubt on whether the rate normalisation plan can be revived until September at earliest.
In China, more evidence showed that GDP growth is flattening out in Q2 around 6.7% y-o-y, rather than accelerating as was the hope in markets early in 2016. Export growth slipped further in USD terms in May to -4.1% y-o-y from -1.8% in April. Growth in urban fixed asset investment slipped in May to 9.6% y-o-y from 10.5% in April and growth in retail sales edged down to 10.0% y-o-y from 10.1% in April. Running slightly against the growth moderating trend, industrial production rose 6.0% y-o-y in May the same as in April. The ability of the authorities to pursue easier economic policies in response to patchy growth may also have been compromised by evidence of too rapid lift in house prices in China, up 6.9% y-o-y from 6.2% in April.
In Europe, GDP growth was 1.7% y-o-y in Q1 2016, the same as in Q4 2015 on upward revision. There are signs of improving economic activity in Europe which has allowed the unemployment rate to fall to 10.2% in both April and March from more than 11% a year ago. What signs of modest economic improvement there have been may be stifled by Britain’s referendum decision. Business and consumer confidence are likely to be dented in Europe and in Britain and the damage could run for months if Britain’s divorce process from the EU is protracted. Both the Bank of England and the European Central Bank are likely to work towards maintaining more liquidity than otherwise would have been the case if Britain had voted to stay in the EU.
In Australia, real GDP growth was stronger than expected in Q1 up 1.1% q-o-q, 3.1% y-o-y from +0.7% q-o-q, +2.9% y-o-y in Q4 2015. Much of the strength in Q1 came from a surge in export volumes alone accounting for 1.0 percentage points of growth in the quarter. Domestic demand was soft, up only 0.1% q-o-q , but with quite strong growth in consumption spending and housing offset by a continuing decline in business investment spending. Softness in domestic demand seems to have driven relative weakness in employment growth since late 2015. Employment rose by 17,900 in May, but all of the lift was in part-time positions. April and May economic data are showing continuing increase in export volumes, albeit not as strong as in Q1, housing activity holding up for the time being, but a gentle fade developing in retail spending – retail sales rose by only 0.2% m-o-m in April after increasing 0.4% in March. The approaching general election will make little difference to the economic outlook based on what can be gleaned of the economic policy positions of the two main parties. The least supportive outcome for the economic growth outlook would be a hung parliament.
The RBA decided to leave the cash rate unchanged at 1.75% at its early June policy meeting and gave no indications in the statement accompanying the decision of any pressing need to change the cash rate in the near-term. We see another low CPI outcome later in July pressuring the RBA to lower the cash rate further. Uncertainty in the wake of the UK referendum adding another downside risk to the soft global growth outlook will also reinforce pressure on the RBA to cut the cash rate further as will likely the fading strength in household spending in Australia. Spending has not bottomed.
Our view remains that the risks to Australia’s growth rate remain skewed to the downside. We also see very low wages growth continuing to exert downward pressure on the already low inflation rate. Quite likely the RBA will need to adjust its inflation forecasts even lower later in 2016. We now see at least two more 25bps cash rate cuts this year, probably in August and November, taking the cash rate down to 1.25% by the end of the year. We also see the cash rate staying low through 2017.