Signs of moderate improvement in US economic activity through May have been sufficient for the Federal Reserve to hint at resumption of their slow rate-hiking process in June. Elsewhere, the opposite has been the case with indications that economic growth is struggling and policymakers are considering easing policy settings. In Australia, a much lower than expected Q1 inflation report paved the way for the RBA to revise downwards its annual inflation forecasts and cut its cash rate at its May policy meeting by 25bps to 1.75%. The extent of the downward revisions to the RBA’s inflation forecasts hints at more cash rate cuts later this year.
In the United States, economic growth softened in Q1 to 0.8% annualised pace from 1.4% in Q4 2015, but April economic readings point to accelerating growth in Q2. Indicators related to home building activity in particular lifted strongly in April. New home sales lifted by 16.6% m-o-m to the strongest level since early 2008. Pending home sales jumped by 5.1% m-o-m, pointing to more strong sales in the months ahead. April housing starts lifted by 6.6% m-o-m and housing permits by 3.6%. Apart from new housing activity, April readings of retail sales, +1.3% m-o-m and up 0.8% excluding automobile sales and industrial production, up 0.7% m-o-m were stronger too. Regional manufacturing surveys have mostly taken a softer turn in May hinting that industrial production may not sustain its April gain, but May readings of consumer sentiment and confidence have lifted and are running close to their highest readings in the US recovery phase so far, pointing to further gains ahead in retail sales.
Signals from the US labour market have been mixed-strength. Non-farm payrolls showed one of the softer monthly gains of the past year or so in April, up by 159,000 after a downwardly revised 208,000 gain in March. The unemployment rate was steady at 5.0% in April, rather than falling a notch to 4.9% as widely expected by analysts. Average hourly earnings, however, rose quite strongly, by 0.3% m-o-m after gaining 0.2% in March. Weekly initial jobless claims have been on a roller-coaster ride over the past month or so, down at their lowest levels since 1973 in the second half of April, rising sharply in the first half of May to their highest readings in three months and sliding sharply again since. Reading through the week-to-week volatility jobless claims are pointing to strong monthly non-farm payrolls ahead, one factor in a noticeable change in the tenor of speeches towards interest rate hawkishness from senior Federal Reserve officials, including from Chairman Janet Yellen. These speeches all imply that the approaching June policy meeting could deliver a 25bps hike in the Fed’s funds rate and beyond that another rate hike is possible before the end of the year.
In China, the promise of stronger growth ahead contained in better-than-expected March economic readings was dashed in mostly softer-than-expected April readings. April fixed asset investment spending slipped to +10.5% y-o-y from +10.7% in March. Most analysts expected acceleration given a variety of fiscal spending initiatives announced over recent months. April industrial production slipped to +6.0% y-o-y from +6.8% in March and April retail sales were up 10.1% y-o-y decelerating from 10.5% in March. Policymakers in China have been well positioned in the past to respond to softer economic conditions by easing policy settings. They may be less able to respond this time as there are some signs that earlier policy easing has been counter-productive, reigniting residential property price inflation and fostering unacceptably high risk lending by banks in China to those borrowers chasing asset price inflation. House price inflation rose sharply in April to 6.2% y-o-y nationally but that figure masks much higher house price inflation in the likes of Beijing, up 18.3% y-o-y; Shanghai up 28.0% y-o-y; and Shenzen up 62.4% y-o-y.
In Europe, economic readings remain consistent with annual GDP growth running at mid-1% annual pace. After easing monetary policy further at its early March policy meeting, the ECB left policy unchanged at its April meeting, much as expected, and seems unlikely to change policy at its June meeting even though it will be revisiting its economic forecasts at that meeting. In Europe, the two biggest economic problems are high unemployment and price deflation. Both problems continue to moderate – the unemployment rate was down to 10.2% in March and the headline CPI showed annual change of -0.2% y-o-y in April, but is expected to improve slightly in May to -0.1% y-o-y.
In Australia, the first part of May was dominated by the RBA’s decision cutting the cash rate 25bps to a new record low 1.75%, the Government’s budget that essentially left the overall stance of budgetary policy unchanged – although with a range of potential winners and losers from budget announcements – closely followed by the announcement that the Federal election would be held on 2nd July. Ahead of these various announcements the economy was showing signs of gathering a touch of momentum according to March economic readings, although with the labour market losing momentum and with continuing very low growth in wages. Turning to the key March readings, home building approvals lifted by 3.7% m-o-m, retail sales rose by 0.4% m-o-m, and the international trade deficit narrowed sharply to $A2.2 billion from $A3.0 billion, the improvement mostly driven by a 4% lift in exports in the month.
While the March economic readings were encouraging there is no real confidence the improvement will continue. The labour market appears to be in the process of softening. Employment rose by 10,800 in April but with full-time employment falling by 20,200. Since November last year monthly employment growth has been soft and has mostly featured rising part-time employment but falling full-time employment. Paid hours worked have fallen by 1.7% since the end of 2015. Q1 wages growth set a new low record for the survey rising by only 0.4% q-o-q and 2.1% y-o-y. The softer labour market and very weak growth in wages represent a big constraint on how well the household sector can continue to spend. Household spending growth, however, is essential given further evidence in the Q1 private new capital expenditure survey, down in real terms 5.2% q-o-q and down 15.2% y-o-y that the big downturn in business investment 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 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.