After an absence of five weeks it is interesting viewing how the economic landscape has changed. In the US, mounting evidence of sustainable economic growth and slightly higher inflation has increased concern in financial markets that the Fed is on track to start tapering its $US85bn a month bond buying program (QE) from its next policy meeting in mid-September. Interestingly, the latest US July new home sales figures showing a much bigger than expected 13.4% fall in the month and on substantially downwardly revised May and June readings could indicate that the US home building recovery is quite vulnerable to the increases in fixed mortgage rates. Quite likely the Fed will be sensitive to the signs of softness in home building and tapering QE will be delayed beyond September. Regardless of what happens to QE, the Fed has been clearer in its pronouncements on when the near zero Fed funds rate, or conventional monetary policy, will change – not for a long time to come. Low variable rate borrowing costs and increasing availability of bank finance suggest the US economic recovery can weather what will likely be a temporary softening in home building activity.
View changes about the US economy have been relatively minor compared with the changes in market views over the past five weeks about Europe and Asia. European growth readings for Q2 have been stronger than expected confounding almost universally pessimistic market views. Moreover, the signs for Q3 suggest even stronger readings. August flash Eurozone PMI readings have all moved further into expansion territory with the region’s manufacturing PMI lifting from 50.1 in July to 51.3, the strongest reading since May 2011, and the services sector PMI lifting from 49.6 to 51.0. Having just travelled through the UK, Belgium, France and Germany what was most noticeable was evidence of substantial construction activity and almost booming retail spending. The interesting part about European Q2 GDP readings is that that they show broad-based economic activity. In Germany, the 0.7% q-o-q GDP lift showed household consumption up 0.5% and a 1.9% lift in gross fixed capital formation, while the recently upwardly revised UK Q2 GDP reading at 0.7% q-o-q showed household consumption up 0.4% and gross fixed capital formation up 1.7%. Europe is still grappling with the debt crisis, but better than expected growth should make the process of dealing with the crisis more manageable.
Asia has moved oppositely to Europe over the past five weeks with concerns mounting about fading growth prospects and worries emerging about potential capital flight to parts of the world with better growth prospects. Concerns about Asia, by far Australia’s biggest export market, have also imbued views about Australia’s growth prospects to the point where the RBA did what we thought they would not and lowered the cash rate another 25bp to 2.50% in early August. In our view, the pullback in Asian growth prospects is temporary. China may already have passed the softest point of its growth cycle with the August flash PMI released last week jumping back up unexpectedly in to expansion territory, 50.1 against market expectation of 48.3 and a 47.7 reading in July. Importantly, the separate responses on output and new orders both rose strongly. It should hardly be a surprise that growth in China is starting to improve given that its major export markets, the US and Europe, are on an improving trajectory. With fast growing Asian intra-regional trade, China will set the pace for the rest of the region including Australia.
Even with Asian growth close to taking a turn for the better in our view, the downscaling of mining investment plans in Australia will continue for a while yet representing a drag on growth prospects. But the Asian inspired resource boom is far from over, just changing its spots. Over recent weeks there has been more emphasis on the longer-lasting export boom that comes from the substantial investment that has already occurred – much stronger iron ore export volumes initially to be followed by huge LNG exports starting in 2015. Another natural resource export boom near-term, starting in November and extending through early 2014, is a likely major lift in the value of grain exports after poor grain seasons in North America and much of Europe in the northern summer. In terms of the non-resource part of the economy home buying activity is lifting strongly helped by very low interest rates. Household consumption spending is quite soft, but even this may soon improve. Stronger housing activity usually generates stronger consumption spending in its wake. The coming election, whatever its outcome, will remove one area of uncertainty influencing household spending behaviour. Moreover, Australian households have been saving and putting off purchases for some years now. Just as households in the US and Europe have started to spend more freely, there is no real reason why Australian households should not follow suit. When they do, just as occurred in the US and Europe, it will come as a complete surprise to most economic commenters and just as has recently occurred in Europe, the Australian economic forecasting community will rapidly start to adjust Australian economic growth forecasts upwards – one reason why we doubt whether the RBA will lower the cash rate any further.