Global economic readings continued to run on balance softer than widely expected. Q3 GDP readings for the US, Europe and Japan all came in softer than expected. Monthly readings out of the US relating to October have been a mixed-bag, although non-farm payrolls lifted strongly increasing the probability that the US Federal Reserve (Fed) may start to lift its funds rate at its mid-December meeting. In China, Europe and Japan the monetary policy focus is different from the US, looking at ways of providing more assistance to boost weak economic growth. Australian economic readings have surprised mostly on the positive side of expectations over the past month, especially local employment readings. The RBA has indicated that it sees the economy showing signs of improvement and is inclined to leave the local cash rate unchanged, although it still has capacity to ease policy further in need.
Returning to developments in the United States, the advance reading of Q3 GDP was surprisingly soft showing 1.5% annualised growth down from 3.9% in Q2. Retail sales lifted only modestly in October up by 0.2% while industrial production suffered a third consecutive monthly fall and was down by 0.2% in October. Indicators of housing activity have turned very mixed. October housing starts fell by 11.0%, although forward-looking housing permits rose by 4.1% in the same month. The National Association of Homebuilders’ survey reading came in at 62 in November, still very strong, but down from the 10-year high reading of 64 in October.
Employment growth in the US, however, after two relatively soft readings in August and September, returned to life spectacularly in October with non-farm payrolls up by 271,000, the strongest gain this year. The unemployment rate also edged down to 5.0%, a new low in the current economic recovery, and average hourly earnings lifted by 0.4%, more than widely expected. The consistent strength of labour market readings in the US makes it quite likely that the Federal Reserve will lift the funds rate by 25bps at its mid-December policy meeting and the balance of comments from senior Fed officials, including the minutes of the Fed’s October policy meeting, is leaning that way. The next big issue facing financial markets is the pattern and timing of Fed rate hikes beyond December.
In China, October economic readings still point to the economy struggling to find a base. International trade data were worse than expected with exports down by 6.9% y-o-y and imports down 18.8% y-o-y. Industrial production edged down to a new post global financial crisis low of 5.6% y-o-y, while urban fixed asset investment growth edged down to 10.2% y-o-y. Inflation readings were also weak with the CPI up 1.3% y-o-y, but producer prices down by 5.9% y-o-y. One small positive offset was retail sales that improved slightly to 11.0% providing tentative evidence of rebalancing in China’s economy the way the government would like in favour of local spending and services. The new 5-year economic plan was strong on intention, but low on detail, but made it clear that beyond next year the longer term average growth target for China is nearer to 6.5%, not 7%. China’s policymakers, including the Peoples’ Bank of China, have more flexibility than most to assist growth if they wish and more policy easing moves are likely.
In Europe, Q3 GDP growth was a touch disappointing at +0.3% q-o-q, +1.6% y-o-y, from +0.3% q-o-q, +1.2% y-o-y in Q2. Q3 GDP growth was soft in Europe’s three big economies, Germany +0.3% q-o-q; France +0.3% and Italy +0.2%. Spain continued to grow faster than most, up 0.8%, continuing to provide evidence that the hard hit periphery of Europe is showing signs of bouncing back. September retail sales and industrial production were softer than expected and fell, respectively -0.1% and -0.3%. On a more positive note Europe’s unemployment rate fell to a two-year low of 10.8% in October. The terrorist atrocities in Paris will most likely dampen business and consumer sentiment in Europe for a period. The ECB had already provided notice before the events in Paris that it would likely ease monetary policy further at its December policy meeting, and such action is even more likely now.
In Australia September and October economic readings have mostly taken a positive turn. Retail sales rose by 0.4% in September after a similar increase in August. Home building approvals lifted by 2.2% in September. The monthly trade deficit narrowed by more than expected to $A2.3 billion in September from $A2.7 billion in August. Over the three months ending September the trade deficit narrowed by more than $A2.5 billion and net exports will make a positive contribution to Q3 GDP growth due early in December. Employment growth was unexpectedly strong in October, up by 58,600 and bringing the employment increase over the 12 months ending October to more than 300,000, or up by 2.7% y-o-y. The unemployment rate fell unexpectedly in October to 5.9% from 6.2% in September.
Australia still faces a challenging economic environment. Housing activity is in the process of peaking. Household income growth remains very low – annual wages growth was still a very low 2.3% y-o-y in Q3. Mining investment spending will continue to decline for some time and mineral export prices continue to decline. These negative forces saw the RBA actually reduce its near-term economic growth and inflation forecasts in its quarterly monetary policy statement produced earlier this month. Normally such downward revisions to growth and inflation forecasts would lead the RBA to cut interest rates further. Instead, the RBA is seeing enough momentum in services and sectors of the economy helped by the depreciation of the Australian dollar over the past two years to believe the economy will improve further over time without the need for more support from lower interest rates.
Our view on the cash rate outlook has changed in the light of recent commentary from the RBA and the stronger turn in some economic readings, notably firmer employment data. We still think it likely that growth will struggle in 2016 and that inflation will stay very low. However, the RBA is unlikely to be convinced until it sees a softer tone in the data over a few months. That proof is unlikely to be available until mid-2016 in our view. We still expect the next cash rate move to be downwards, but the earliest such a move may occur is probably May next year. More certainly, Australia’s cash rate is unlikely to be any higher than the current 2.00% through 2016 and possibly extending in to 2017.