Even though financial markets rebounded in March, global economic readings still point on balance to growth losing momentum. Concern about the volatility of financial markets and its potential to limit further fragile economic growth caused the European Central Bank to ease monetary policy further and the US Federal Reserve to delay and lower its interest rate hiking plans. In Australia, the Q4 GDP report was surprisingly strong bolstered by good growth in household spending. The RBA again held the cash rate unchanged at 2.00% at its March policy meeting and although still comparatively upbeat about the Australian economy is watching international economic developments carefully, especially in China. The RBA continues to point out that continuing low inflation provides it with the capacity to lower the cash rate should demand in the economy show signs of weakening.
In the United States economic readings released in March showed GDP growth in Q4 after revisions at 1.4% annualized growth, up from an initial print of 0.7%, but down from 2.2% in Q3. Growth in the US is being supported by relatively strong household spending, but that strength seems to have faded in Q1 2016 with household consumption spending up only 0.1% m-o-m in February after a similar sized increase in January. Housing indicators remained mixed-strength in February with existing home sales down 7.1% m-o-m, but new home sales up by 2.0%. February housing starts rose by 5.2% m-o-m, but permits fell by 3.1%. In terms of manufacturing activity, regional surveys were mostly much stronger, especially the March Philadelphia Fed survey, up to +12.4 from -2.8 in February, but February industrial production was weak, -0.5% m-o-m, as were February durable goods orders too, -2.8% m-o-m and -1.0% excluding lumpy transport goods orders.
The US labour market took a noticeably stronger turn in February with non-farm payrolls lifting by 242,000, much more than expected, and after the January reading was revised up to a gain of 172,000 from an initial reading of 151,000. The unemployment rate, however, remained steady at 4.9% while average hourly earnings surprisingly fell by 0.1% m-o-m. While on many measures the US labour market is very strong, there remain signs it could become stronger still without driving up inflationary pressure in the US too much. There are hints of higher inflation developing in the US, but so far the Fed sees these signs as unlikely to develop far. At its March FOMC meeting, the Fed left its funds rate unchanged at 0.25% to 0.50% range and the various forecasts of the FOMC members of where the funds rate is likely to be at the end of 2016 were lowered on average to 0.90% from 1.40% previously. The Fed also mildly downgraded its GDP growth forecasts beyond 2016 while keeping its inflation forecasts largely unchanged, that is no consistent return of annual inflation to 2% over the next two years at least.
In China, the Government’s latest five-year economic plan announced earlier this month sees GDP growth lower and in a range for the first time of 6.5% to 7.0%. The plan implies policies will be used flexibly to lift growth if it threatens to be unacceptably low. The Peoples’ Bank of China illustrated that policy flexibility and delivered a further 50bps reduction in the reserve ratio requirement of banks taking it down to 17%. Meanwhile, the February and January-February economic readings point to GDP growth still fading. February exports were especially weak, -25.4% y-o-y from -11.2% in January, the softest reading since 2009. Also disappointingly soft were the January-February readings of industrial production, +5.4% y-o-y from +5.9% in December, and retail sales, +10.2% y-o-y from +10.8% in December. On the positive side, urban fixed asset investment in January-February improved unexpectedly to +10.2% y-o-y from +10.0 in December confirming other earlier signals that residential property development may be starting to rise again in China.
In Europe, the ECB had heralded that it would revisit its monetary policy setting at its March policy meeting and it mostly met market expectations that policy would be eased meaningfully. Apart from lowering its policy interest rates – the ECB deposit rate was reduced a further 10bps to -0.40% – the ECB also announced an additional 20 billion euro a month of asset purchases (QE) and an extension of eligible assets it can purchase to include investment grade bonds issued by non-bank corporations. The ECB also announced that monthly QE purchases now totaling 80 billion euro monthly would continue through at least March 2017. Four new targeted longer-term security repurchase operations were also announced, partly to encourage banks to borrow from the ECB, but also to demonstrate that the ECB still had many more monetary policy instruments it could use in need. European economic data was mixed, stronger in February for industrial production, +2.1% m-o-m and in January for retail sales, +0.4% m-o-m, but with headline inflation slipping back in to deflation, -0.2% y-o-y. European unemployment rate, although still very high, continues to edge lower, down to 10.3% in January from 10.4% in December.
In Australia, Q4 GDP was surprisingly strong, up by 0.6% q-o-q and by 3.0% y-o-y and Q3 GDP was revised higher as well to 1.1% q-o-q, 2.7% y-o-y. The main reason for the unexpected strength in GDP through the second half of 2015 was acceleration in household spending funded mostly by running down the household savings ratio. Whether this strength can be maintained early in 2016 will depend a lot on confidence in the household sector. Employment growth seems to have taken a softer turn early in 2016 with employment up by only 300 in February after falling 7,300 in January. The unemployment rate after rising to 6.0% in January from 5.8% in December, fell back to 5.8% in February, a saving grace for consumer sentiment for the time being.
Retail trade lifted 0.3% m-o-m in January after being flat in December and again there is an issue of whether retail trading conditions are quite as firm as they were back in October and November. Home building activity is also in the process of peaking and starting to fall. January home building approvals fell by 7.5% m-o-m and were down by 8.5% y-o-y, a sign that the strongly positive contribution to economic growth through 2015 will be fading entirely through 2016. The biggest drag on Australian economic growth, the continuing rundown in mining investment spending is still showing no sign of abating. The RBA continued to maintain an upbeat view of Australia’s economic prospects both in the minutes of its March policy meeting and in various speeches, but it also made it plain that it remains prepared to lower interest rates if demand weakens.
Our view remains that the risks to Australia’s growth rate remain skewed to the downside. We see the RBA cutting the cash rate further, probably in May and June taking the cash rate down to 1.50% in the second half of 2016. Even with further cash rate cuts bank lending interest rates may not fall, but at least they will not rise, a risk with periodic funding pressure on banks persisting.