Evidence of strong global economic growth accumulates, but the downside risks to future growth are growing too. Annual GDP growth in Q2 was at multi-year highs in the US, Japan and Australia and not far away from recent high points in China and Europe too. July and August economic readings in most advanced economies were strong mostly. Signs that robust economic growth is running in to capacity constraints are still largely limited to the US where the Federal Reserve (Fed) has progressed furthest normalising interest rates from post-GFC emergency low settings. The downside threats to global economic growth are not immediate-term but sit on the horizon out in late 2019 or 2020, consequent upon lower international trade volumes from escalating restrictive international trade policies; the slow climb in interest rates led globally by the US Fed; or a new international debt crisis developing out of unforeseen contagion links to the debt problems in several key emerging economies.
In the near-term upside surprises look set to continue in the economic data readings out of the United States driven by strong growth in income of US corporates and households. For the US household sector jobs growth remains strong – non-farm payrolls rose another 201,000 in August – unemployment is near its lowest point in 20 years – 3.9% in August – and annual growth in average hourly earnings is rising, up to 2.9% y-o-y in August. Household wealth continues to grow strongly with house prices up by more than 6% y-o-y and the US share market (S&P 500) is up 17% over the past year. Measures of consumer sentiment and confidence both strengthened in September to respectively 100.8 and 133.4, high readings that point to already robust consumer spending continuing.
Most indicators of US business activity are near their cycle high point readings too. The August ISM manufacturing index lifted to 61.3 from 58.1 in July while the ISM non-manufacturing (services sector) index soared in August to 60.7 from 55.7 in July. Home building activity is strong as well with the National Association of Homebuilders’ index holding at 67 in September and with housing starts in August up 9.2% m-o-m.
Broad-based strong US growth is stretching capacity, especially in the labour market. The Fed is monitoring closely the risk of higher inflation and will almost certainly deliver another 25bps Funds rate hike to 2.00% at its policy meeting this week. The strong growth momentum in the US economy implies that the Fed will remain upbeat in its economic forecasts and will continue to signal more rate hikes occurring approximately every three months for the next year at least.
The Fed will probably recognise President Trump’s escalating trade war as a potential inhibitor of US growth but set against other Trump policies that are boosting growth, such as corporate and personal tax cuts and higher infrastructure spending. On balance, upward pressure on US interest rates is building.
In China, the latest monthly economic readings for August are consistent with China sustaining annual GDP growth in Q3 (data due in mid-October) at around the 6.7% y-o-y pace reported in Q2. The trade war with the US is proving growth positive so far with Chinese exporters bringing forward shipments to the US wherever possible to get in ahead of tariff increases. In August, exports rose 9.8% y-o-y and China’s bilateral trade surplus with the US was a new record $US31.1bn. The bring forward of export orders may continue to boost China’s export trade for a few more months but will inevitably see a give-back in export growth early in 2019. The issue is whether domestic demand in China can expand faster to take up the slack from slower export growth? In August, retail sales lifted to 9.0% y-o-y from 8.7% in July holding out hope that household spending may lift to fill whatever void is created by the trade war. It is also worth keeping in mind that the authorities in China are in a position to use easier monetary policy and more government spending in need.
In Europe, annual GDP growth on the final reading for Q2 came in at 2.2% y-o-y, down from 2.5% in Q1. The main driver of improving European growth before the set-back in Q2 was strong employment growth reducing very high unemployment. In Europe’s biggest economy, Germany, strong employment growth drove the unemployment rate down well below 4% and started to foster higher wages growth. Unemployment has still been falling in Europe in recent months but more slowly and patchily. The unemployment rate was steady at 8.2% in June and July. European international trade has been coming under more pressure over recent months too. At this stage European economic growth is still strong enough to maintain gentle upward pressure on inflation (2.0% y-o-y in August with a core reading of 1.0%). While the European Central Bank is becoming more cautious about Europe’s economic outlook it still maintained in its latest policy meeting that it will finish its purchases of securities (quantitative easing) by the end of 2018 and will deliver a first interest rate hike in the late summer 2019.
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. Annual GDP growth lifted to 3.4% y-o-y in Q2, the strongest in four years. Contributions to the annual growth rate are broad-based coming almost equally from consumption spending, investment spending and exports. Strong GDP growth has continued the strongest run of employment growth in 20 years. Employment in August was up 44,000 (the equivalent lift in US non-farm payrolls in one month would be 570,000!) and is up more than 300,000 over the past year. The unemployment rate in August was at a 6-year low 5.3%.
Despite very strong economic data business and consumer confidence slipped in September. The long simmering civil war inside the governing Liberal Party erupted in to a Prime Ministerial change in late August leaving a legacy of disquiet about the political future and what policy changes may lay in store ahead of the Federal election (probably in May next year) and after on a probable change of government. Other potential clouds on the horizon include the impact of a widening trade war on Australia and the spending behaviour of the heavily indebted household sector facing risks from rising interest rates and potentially falling wealth under pressure from falling house prices.
In the near-term, stronger economic growth, further falls in the unemployment rate and the beginnings of more pronounced lift in wages seem likely. If these trends continue they are likely to more than offset the potential negative influences on Australian growth. They are also likely to lead to some revival in house prices and housing activity from say mid-2019. For the time being the RBA remains only cautiously optimistic about the economic outlook. It also has the comfort of inflation sitting just under the 2-3% target band to allow it to maintain the emergency low 1.50% cash rate that has been in place since mid-2016. As more evidence shows that Australia continues to grow well placing more pressure on future inflation we expect the RBA to firm up its economic forecasts setting the scene for a series of cash rate hikes. We pencil in February 2019 for the first 25bps cash rate hike to 1.75%.