In this final economic report for 2017 we look back over the past year and look forward to 2018. For the most part 2017 was a year of positive economic surprises. Global economic growth broadened and strengthened beyond expectations. Inflation and interest rates remained relatively low. Central banks either stopped easing monetary policy or started/continued withdrawal of monetary accommodation but not to the point that stopped the long rally in share markets and credit. The outlook for the early part of 2018 seems to be similar to what occurred in 2017, although the risk is increasing of a spoiling rise in inflation and interest rates.
The big surprise in 2017 was the increasing strength of the global economic recovery causing forecasters to repeatedly lift their estimates of growth as the year progressed. Beginning of the year growth forecasts have been exceeded in most major economies and regions. In the United States, despite qualms about the economic policies and competence of President Trump and despite the Federal Reserve lifting its funds rate three times by 25bps to 1.50% and starting to reduce the size of its bond holdings, growth has strengthened to a 3.3% annualised pace on the latest reading for Q3, well above long-term trend growth.
Importantly, the drivers of US growth have broadened to include robust household consumption spending and rising business investment spending. US company profits are rising strongly, employment growth is very strong, the unemployment rate is the lowest since 2001 and wages are starting to rise and are out-pacing inflation. Most leading indicators of US economic activity are running close to record highs. Strong growth and demand internationally is proving to be a boon for US companies. The most extensive US tax cuts for companies and individuals in thirty years look set to be legislated this week.
In short there is considerable growth momentum in the US and it will need to be a powerful circuit breaker to stop that momentum.
Most likely the eventual circuit breaker will be tighter Fed monetary policy and higher interest rates. So far, the pace of Fed policy tightening has been very slow because there has been no threat of US inflation pushing too high. Strong growth through 2017 has used up more spare capacity and in 2018 more growth could push the US economy close to full capacity and push wages growth above 3% y-o-y territory spelling higher inflation ahead. There is more dissension in Fed policy meeting discussions about how close the economy is to full capacity and the change of Fed leadership in February from Janet Yellen to Jerome Powell may also slow the eventual move to more aggressive Fed policy tightening. A move towards more aggressive policy tightening seems likely in 2018 but probably beyond mid-year.
The world’s second biggest economy, China, has also grown more strongly than expected at the beginning of the year. Most forecasters at the beginning of 2017 expected China to suffer a pronounced growth set-back in the second half of 2017 as policies aimed at restricting speculation in residential real estate and the output of polluting manufacturing industries such as steel production started to bite. As it turned out, China has managed to cap the residential property market and without too pronounced a pull-back in urban fixed asset spending. China has also managed to contain growth in steel production without sending annual growth in industrial production down to zero as widely feared early in the year. Factors helping China’s economy to grow well have included the positive impact of strong global growth on China’s exports and strong growth in services and retail trade. China is finishing 2017 with GDP growth above 6.5% y-o-y and looks set to grow at similar pace or better through the first half of 2018. It is possible that China may view strong growth as a good environment to institute more aggressive economic reforms and that could dampen growth a touch in the second half of 2018, but that does not diminish still strong growth prospects early in the New Year.
Europe provided the biggest positive growth surprise in 2017. At the beginning of the year analysts were fearful of a right wing, protectionist shifts in elections looming in Holland, France and possibly Germany too. Banking problems were feared in Italy. Brexit and its aftermath were a concern too. Most analysts foresaw downside risk to European GDP growth forecasts for 2017 in 1.5% to 2.0% range. In the event, improving global growth fostered strong growth in European exports. Election results turned out better than expected for the most part. Banking issues faded. Stronger European growth fostered stronger employment growth which in turn promoted even stronger growth and by Q3 Europe’s GDP was up 2.6% y-o-y, above long- term trend. The European Central Bank maintained very accommodative monetary policy and is still planning to hold its -0.40% deposit rate through 2018 and will still be buying bonds, albeit in reduced amounts. The revival of the European economy is still intact heading in to 2018.
Australia came through 2017 remarkably well too for a country that at times seemed determined to shoot itself in the foot repeatedly – taking on board too much household debt; repeatedly undermining an otherwise strong banking sector (what should have been an enviable asset in the post global financial crisis decade); and government distracted and enfeebled by the long-running citizenship dispute. Strong global growth came to Australia’s assistance too boosting service exports and holding up commodity prices better than most predicted early in the year. Strong growth in infrastructure spending swung in to play helping to boost growth. Even though wages growth was weak, employment growth was the best in two decades and continues to help to boost household disposable income.
Australia is likely to enter 2018 on a reasonably strong footing. The biggest potential threat is rising interest rates, although the RBA should be able to hold the cash rate at 1.50% through to the second half of 2018. Eventually strong employment growth will foster higher wages growth and higher prospective inflation. At that time the RBA will need to lift interest rates and hopefully by then Australian households will have contained growth in debt. Otherwise, 2018 is shaping up favourably for Australian growth prospects too – at least through the first half of the year.
The next economics report will be published on Monday 8th January 2018. Wishing our readers a Merry Christmas and a happy and prosperous New Year.