Global economic readings have taken a softer turn on balance in October, a development recognized by official international economic agencies, such as the IMF and World Bank, and also leading to a further easing in monetary policy in China and strong indication from the European Central Bank that it will ease further its monetary policy setting at its next policy meeting in December. In the US, the consistent strength in economic readings during Q2 2015 has turned mixed strength since creating a sense that the Federal Reserve will continue to baulk at starting to lift its funds rate. In Australia, sub-trend growth seems to have persisted, but the Reserve Bank has been reluctant to lower interest rates further, although a de facto tightening of monetary conditions from home loan interest rate increases announced by the big four banks and a modest appreciation of the Australian dollar point to a much stronger likelihood of the RBA cutting the cash rate again before long.
Taking first developments in the United States, economic readings turned from mostly strong in September to mixed-strength in October and are consistent with the advance reading of Q3 annualised GDP growth, due later this week, showing growth below 2.0%, down from 3.9% in Q2. Retail sales in the US were disappointingly soft in both August, 0.0% m-o-m, and September, +0.1% m-o-m pointing to much less support from household consumption for GDP growth in Q3 than occurred in Q2. Industrial production has also taken a weaker turn in the US as well, falling by 0.2% m-o-m in September after a 0.1% fall in August. Manufacturing purchasing manager surveys have been particularly weak and point to the August and September weakness in industrial production persisting.
Not all US economic readings have turned weaker. Most indicators of housing activity have been very strong. September existing home sales rose by 4.7% m-o-m, while new housing starts lifted by 6.5%. The October National Association of Homebuilders’ index rose to highest level since 2005, 64.0 from 62.0 in September. Several labour market indicators have been strong too of which the most impressive has been the weekly initial jobless claims series, below 260,000 in the last two readings, the lowest and strongest readings in 42 years. A curious counterpoint to the strength in initial jobless claims is a softer turn in non-farm payrolls, up 142,000 in September after a downwardly revised 136,000 increase in August following a year of gains averaging well over 200,000 a month.
The Fed, after sending mixed messages about its rate intentions at its September policy meeting continues to hint that it will start raising interest rates soon, but the fading strength in US economic readings, still no signs of inflation (annual CPI inflation fell to 0.0% y-o-y in September), point to US interest rates staying lower for longer. The market has reduced the probability of a December rate hike and the strong rally in risk assets around the world in October is in part a reflection that markets have pushed out the timing of a first Fed funds rate hike well in to 2016.
In China, GDP growth slowed in Q3 but less than the market expected, to 6.9% y-o-y from 7.0% in Q2. The parts of China’s economy that the authorities want to be the main drivers of growth going forward are improving. Tertiary sector activity accelerated to just over 8% y-o-y in Q3. Monthly retail sales have been improving too, edging up to 10.9% y-o-y in September from 10.8% in August. On the softer side, urban fixed asset investment spending, the main driver of past growth in China continues to moderate, down to 10.3% y-o-y in September from 10.9% in August and industrial production slowed in September to 5.7% y-o-y it weakest annual growth pace since the global financial crisis. The authorities responded to what is still comparatively soft GDP growth by cutting official interest rates for the sixth time in the current policy easing cycle. The Peoples’ Bank of China’s one year lending rate was cut by 25bps to 4.35%; the one year deposit rate was cut by 25bps to 1.50% and the reserve ratio requirement applying to banks was also cut by 50bps to 17.5%.
In Europe, promising signs of improving economic activity in Q2 when annual GDP growth accelerated to 1.5% y-o-y, appear to have faded a touch in Q3. August retail sales were flat while industrial production fell 0.5% m-o-m. The unemployment rate in Europe flat-lined at a still very high 11.0% in August. The European trade surplus, although still very high, narrowed to 19.8 billion euro in August, from 22.4 billion euro in July. European exports fell by 1.3% m-o-m in August, more than the 0.7% fall in July. Inflation also slipped to mild deflation, -0.1% y-o-y in September. The European Central Bank left interest rates and its asset purchase (QE) targets unchanged at its October policy meeting, but ECB President Draghi’s statement after the meeting made it plain that the ECB was concerned by downside risks to growth and would respond at its next meeting in December.
In Australia, August and September economic readings have been mixed-strength and seem to point to annual GDP growth slipping further to below 2.0% y-o-y in Q3. Retail sales lifted by 0.4% m-o-m in August after falling by 0.1% in July. At this stage, household consumption appears to be a touch softer than in Q2. Housing activity, which has been showing signs of substantial strength appears to be topping out. August home building approvals fell by 6.9%, although are still growing 5.1% y-o-y. All four big banks announced increases in their variable interest home loan rates in October ranging between 15bps and 20bps as part of their response to higher capital adequacy requirements. The first weekly home loan auction clearance rate after the banks’ rate announcements has reduced to the lowest point in three years, another sign that the housing market has peaked.
The RBA points to solid employment growth as one reason why the economy is performing tolerably well. Readings of job vacancies remain quite strong but the latest employment reading for September showed an unexpected fall of 5,100, although coming after strong gains in August and July. The issue remains, however, that there are several identifiable weak spots ahead for employment growth including further rundown in jobs in mining and ancillary services, the winding down of car manufacturing and parts through 2016 and 2017 and housing activity well past its best. There is a strong prospect that the unemployment rate will start to rise at some point over coming months.
Since the RBA’s last policy meeting in early October when it again left the cash rate unchanged at 2.00%, economic readings have turned more mixed-strength, the global economic growth outlook has continued to moderate, the Australian dollar has appreciated against the US dollar and on a trade weighted basis, the outlook for Australian mineral export prices has softened further and the big four banks have lifted home loan interest rates. We see a strong likelihood that the RBA will lower its cash rate by 25bps to 1.75% on Melbourne Cup Day and that it will probably follow up with a further 25bps cut to 1.50% either in December or at its first meeting next year in February.