Global economic readings in September remained mixed-strength with US economic readings quite firm on balance, Europe a touch stronger, but China and many emerging world economies continuing to weaken. Australian economic growth weakened in Q2 although employment growth remained firm. An unsettling feature of the month was confusion about the policy intention of the US Federal Reserve as it baulked at raising the near zero Funds rate at its September policy meeting on concerns about the US and global economy, but continued to state that it would be confident enough to hike before year end. Concerns continued to arise about the effectiveness of policies in China in arresting weaker growth. Financial markets remained very volatile in response to the uncertain outlook in the United States and China.
Taking first developments in the United States, the economic data has mostly been quite strong, but with the notable exception of a weaker turn in US manufacturing activity. Industrial production fell by a greater-than-expected 0.4% in August. Forward looking manufacturing purchasing manager indices have taken a much weaker turn in September, particularly those relating to the eastern states. In contrast, new housing activity could hardly be stronger. New home sales rose by 5.7% in August while the September National Association of Homebuilders’ index edged up to 62, the highest reading in 10 years. The final reading of Q2 GDP also showed further upward revision to 3.9% annualized growth from 3.7% and mostly from upwardly revised household consumption spending to 3.6% annualized pace from 3.1% previously.
US economic readings taken in isolation present a very strong case for the Fed to start lifting interest rates, but at its September policy meeting the Fed chose to wait focusing on global economic concerns and turbulence in financial markets. There was also inconsistency in the Fed’s comments on the rate outlook in the sense that it is still saying a rate hike is coming before year end – either at the October or December policy meetings – but it is unlikely that concerns about the global economy will lessen in that period, the main factor causing the Fed to wait at its September meeting. The uncertainty surrounding the first Fed rate hike looks set to persist.
In China, economic readings released in September were again mostly softer than expected and implied that growth continues to slow despite the policy easing initiatives of the authorities to date. Exports were especially weak in August down 8.9% y-o-y against market expectations of a 5.2% fall. Industrial production edged up to 6.1% y-o-y (market expectation 6.5%) from 6.0% in July while urban fixed asset investment spending rose by 10.9% y-o-y in August, less than 11.1% market forecast, and down from 11.2% in July. Another disturbing feature of China’s regular data is worsening producer price deflation, -5.9% y-o-y in August compared with -5.4% in July and evidence of a worsening margin squeeze on businesses in China. The one bright spot in the August data was acceleration in retail sales to 10.8% y-o-y from 10.5% in July, a sign that the rebalancing of growth drivers towards local consumption spending and services is occurring
In Europe, economic readings have strengthened a touch on balance. Q2 European GDP growth was revised up to +0.4% q-o-q, +1.5% y-o-y from the preliminary reading of +0.3% q-o-q and +1.2% y-o-y. European international trade is showing record monthly surpluses boosted by strong export growth. Retail sales were stronger-than-expected too in July, up by 0.5% in the month and by 2.0% y-o-y. Encouragingly, Europe’s very high unemployment rate is falling from 11.1% in June to 10.9% in July, the lowest unemployment rate since February 2012. The European Central Bank at its September policy meeting, while not changing monetary policy settings, made it plain that it could extend the size and duration of its monthly asset purchases or QE if the need arose. All told Europe’s economic outlook is brightening although considerable challenges remain.
In Australia, economic growth continued to slide further below potential growth in Q2. GDP lifted by only 0.2% in the quarter and by 2.0% y-o-y, down from 2.5% y-o-y in Q1. Income measures were much weaker than GDP in Q2 with real net national disposable income down by 0.9% q-o-q and -1.1% y-o-y. On a per head basis net national disposable income fell 1.2% q-o-q and -2.3% y-o-y. Really weak growth in national income looks set to persist and is the main constraint on domestic spending in the period ahead. For the time being the RBA is choosing to look on the bright side – slow past improvement in consumer spending (although a 0.1% fall in July retail sales hint at a softer turn in Q3), solid employment growth and relative stability in the unemployment rate around 6% – as reasons to sit pat with the current cash rate at 2.00%.
On the political front a swift challenge toppled Prime Minister Abbott in favour of new Prime Minister Malcolm Turnbull. The change served to boost business and consumer confidence, but it seems unlikely that the lift in confidence will translate in to more spending given much more tangible constraints such as persistently weak income growth, further rundown in mining investment and signs that the one area of real strength in the economy, housing, may be topping out.
Another area of concern is that growth in employment is becoming increasingly dependent upon the relative strength of New South Wales. In the 12 months ending August employment in New South Wales rose by 118, 800 more than in the other five main states combined, 110,100 over the same period. The issue is that there are several identifiable weak spots ahead for employment growth outside New South Wales 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.
The RBA may choose to wait until the data makes it plain that excess capacity in the economy is increasing. Our view is that the RBA may cut the cash rate by 25bps at its November policy meeting to 1.75%. It is possible that the RBA could wait a little longer before cutting the cash rate again. What is relatively clearer in our view is that the next move on the cash rate is likely to be downwards and that probably one rate cut will not suffice