Despite sharp falls in many share markets around the world in October indicators of global economic growth remain quite strong. Signs of continuing strong growth, however, are being ignored by many analysts looking instead at what can go wrong, the range of downside risks to the outlook for global economic growth in 2019 and 2020. The United States may become the first of the major economies where the central bank drives up its policy interest rate beyond a neutral setting to a point where economic growth is actively constrained. The potentially growth-crimping trade war between the US and China has no end in sight. Higher interest rates are intensifying potential debt problems in emerging market. Mounting geopolitical concerns in the Middle East. There are many identifiable downside risks to global economic growth but there is little evidence that the pace of global economic growth will fade too much based on key economic and survey readings released in October.
US economic reports released in October still bear witness to a strong economy at risk of over-heating and generating higher inflation. The advance reading of Q3 GDP showed annualised growth at 3.5%, down from 4.2% in Q2, but better-than-widely -expected mostly because consumer spending was stronger-than-expected, up 4.0% compared with 3.8% in Q2. The other strong elements in the US Q3 GDP report were inventory accumulation reversing a decline in Q2 and government purchases, up 3.3%. On the softer side, a wider US international trade deficit saw net exports detract 1.8 percentage points from growth and housing investment detracted from growth too, falling at 4.0% annualised pace. Business investment spending was also a soft point in the report rising only 0.8%, but after an 8.7% gain in Q2.
It is unlikely that US GDP growth will weaken much while US consumers continue to lift their spending at close to 4% annualised pace. Factors supporting stronger consumer spending include very low unemployment (the unemployment rate fell to 3.7% in September, the lowest rate in nearly 50 years). Wages are growing faster than all measures of US annual inflation – average hourly earnings increased 2.8% y-o-y in September and look set to rise at above 3% y-o-y pace very soon. Measures of consumer sentiment (98.6 for the University of Michigan survey in October and close to cycle high-point) and confidence (138.4 for the Conference Board survey in September, the highest reading in 18 years) point to strong future spending by US consumers.
The US Fed is responding to the strength of the US economy and the risk that increasing capacity constraints might foster higher inflation by warning that it may not be enough to keep hiking its funds rate – currently 2.00 to 2.25% range after the September meeting 25bps hike – towards a neutral setting around 3.00%. It may need to push the funds rate at some point above the neutral setting in to actively growth constraining territory above 3.00%. At the very least, the Fed looks set to hike 25bps in December and another 25bps in March 2019. It is not only Fed policy interest rate action that is pushing up US interest rates, the reversal of its bond purchasing, balance sheet expanding program in the years after the Global Financial Crisis is adding to upward pressure on US interest rates. The ballooning bond issuing program of the US Treasury to fund the Trump Administration’s tax reduction and government spending initiatives are adding pressure as well. One saving grace is that inflation in the United States is still comparatively restrained. Indeed, the Q3 GDP price deflator slipped surprisingly to 1.7% y-o-y. With inflation still relatively subdued, interest rates may rise further in the United States, but not by too much or too quickly
In China, GDP growth slipped to 6.5% y-o-y in Q3 from 6.7% in Q2. The latest monthly readings for September point to the style of rebalancing in drivers of economic growth that the authorities want to see occur. In particular, a further acceleration in retail spending to 9.2% y-o-y in September from 9.0% in August and under 9% in July is a promising development and if it continues will help China to withstand the eventual hit to its growth rate from the trade war with the US. China’s international trade is still very strong as Chinese companies bring forward exports to the US where they can to try and avoid higher tariffs. China’s exports lifted to 14.5% y-o-y in September from 9.8% in August. This very strong growth in exports is likely to weaken under the impact from higher US import tariffs on Chinese goods. It also seems likely that high US tariffs on Chinese goods will be in play for an extended period as the US seeks to diminish the growth prospects of China as part of the aim of its trade war. China is already responding to the threat with policies aiming at boosting domestic demand in China. Accelerating growth in retail sales inside China is a sign that the trade war may not diminish China’s growth prospects.
In Europe, annual GDP growth on the final reading for Q2 came in at 2.1% y-o-y, down from 2.5% in Q1. The first look at Q3 GDP is due this week and annual GDP growth may have settled lower to 1.9% y-o-y. Most economic readings released in Europe in October have been on the soft-side of expectations although the unemployment rate was at a cycle-low 8.1% in August and is well below 4% in Germany. The European Central Bank met and left its key policy rates unchanged but is still on track to end its bond purchasing program at the end of this year and starting lifting policy interest rates later next year. Europe’s economic outlook is challenging for the ECB. There are potential downside growth risks related to the trade war and political tensions inside the European Union perhaps extending to potential banking crises in the likes of Italy At the same time growth in Europe is stretching capacity in several economies including Germany and pressure is building on inflation.
In Australia, economic growth lifted pace quite sharply in the first half of 2018, notwithstanding comparatively soft activity in the housing sector. GDP rose by 0.9% q-o-q in Q2 after an upwardly revised 1.1% gain in Q1. At this stage Q3 GDP (due for release early in December) is tracking around a 0.8% q-o-q gain which would lift annual GDP growth to 3.5% y-o-y from 3.4% in Q2. At the heart of Australia’s improving growth story is the strength of the labour market. The unemployment rate fell to a six-year low point of 5.0% in September. In New South Wales and Victoria, the unemployment rates fell to 10-year low points of respectively 4.4% and 4.5%. While wages growth is still rising only slowly, pockets of more rapid wages growth are developing and are likely to spread.
Strong labour market conditions are encouraging the household sector to spend even in the face of weak housing and high household debt.
The export sector is another area of strength in the economy assisted by relatively fast rising export prices and a comparatively soft Australian dollar exchange rate. Business investment spending is improving slowly. Rising government spending is providing strong contribution to growth too.
Housing activity continues to weaken and will detract from GDP growth over the next year at least. House prices have further to fall in Australia’s two biggest cities, Melbourne and Sydney, but the price falls are starting to improve housing affordability and are setting the groundwork for an owner-occupier led lift in housing demand starting potentially in 2020.
The RBA is still keeping its cash rate at the emergency low 1.50% rate established more than two years ago when Australian economic growth and inflation were much lower than they are currently. We expect the RBA to start upgrading its growth and possibly its inflation forecasts in November, a prelude to a first cash rate hike in the first half of 2019.