The weather has been very chilly in south-eastern Australia over the past few days and the way that international economic events seem to be shaping up that chill looks likely to extend to the economic outlook globally and in Australia. By the middle of this week it will be clearer how far economic growth in China has slowed with the release of Q2 GDP and the run of June monthly economic readings. At the same time the latest EU ultimatum to Greece will come in to play, Federal Reserve Chair Janet Yellen will deliver her semi-annual testimony to the House Financial Services Committee and the European Central Bank will hold its latest policy meeting. More likely than not Fed Chair Yellen and the ECB are both likely to conclude that the headwinds likely to restrain global growth have intensified.
Taking Fed Chair Yellen’s approaching statement first, the US economy continues to recover and taken in isolation the extent of the recovery is approaching the point where the Fed might consider starting to lift the Funds rate. Taking account of developing international economic events, however, continuing US economic recovery is not quite so assured. It is not so much the direct international trade consequences to the US of softer economic conditions in China and increasing European turmoil that matter, but important indirect consequences of which one of the more important is strong safe-haven buying of the US dollar pushing up the exchange rate and potentially by a lot. Also developments in China and Europe threaten to weaken global demand for oil adding to downward pressures on oil prices and throwing the US shale oil industry back to the boundary of becoming uneconomic.
US economic recovery would almost certainly be compromised by a combination of a much stronger US dollar and much softer oil prices. In these circumstances Fed Chair Yellen would almost certainly start to rethink how soon the Funds rate should rise. Our view is that unless conditions take a marked and surprising turn for the better in both China and Europe the “potential” US interest rate hike at the Fed’s September policy meeting is likely to be delayed and probably well in to 2016.
In terms of China, dealing with the imploding bubble in the sharemarket has become messy with the authorities resorting to increasingly distorting market stabilizing measures, the last of which is the six-month ban on sales by major shareholders. China’s ambition to become a major and sophisticated financial market has taken a knock. Moreover, it has taken a knock just as the run of economic data looks set to take a softer turn. Q2 GDP is likely to show annual growth below 7.0% y-o-y, by no means overly disturbing for an economy the size of China. However, the June monthly economic readings look set to show that growth is still fading with notable softness in exports and industrial production, but little evidence of compensating strength in retail sales and urban fixed investment spending.
The saving grace for China is that the authorities have been easing policy and have much more room to move in need. The less than impressive intervention in the sharemarket, however, raises questions about whether the authorities are quite as adept at managing China’s economic growth cycle as many believe they are. At the very least, China as a powerful growth force in the global economy, is much less certain for the time being.
In Europe, the rollercoaster in financial markets’ reaction to the latest developments in the Greek debt saga continues. Over the weekend it seems that the EU finally lost patience with Greece. The EU has demanded that Greece legislate a raft of austerity measures by Wednesday to gain a third bailout package. If the Greek Government complies, it not only goes directly against the wishes of Greek people expressed in the referendum a week ago, but it also consigns the already very weak Greek economy to a deeply recessionary future. If the Greek Government does not do what the EU demands an exit from the euro currency is virtually unavoidable with a period of severe contraction in economic activity still likely in the near-term. This damned if they do/ damned if they don’t ultimatum issued to Greece by the EU is hardly conducive to sustaining the tentative economic recovery in Europe.
Against the backdrop of these unfolding international events the RBA is preparing its latest set of Australian economic growth forecasts. Domestically, there is already evidence that household consumption spending growth is not as firm as it looked a few months ago. Having said that employment growth seems to be firmer than expected earlier and the unemployment rate appears to be stabilizing, rather than still rising. Housing activity is still strong, although there are early warning signs in softer housing finance commitments that housing may peak over coming months. Business investment spending still looks weak.
Turning to the influence of international events on the RBA’s forecasts the most worrying developments have been in China promoting a renewed leg down in industrial commodity prices, notably the price of iron ore. Developments in the international economy are also working to keep inflation pressures subdued, even with the weakening Australian dollar.
All told, it is likely that the set of economic forecasts that the RBA produces with its next quarterly Monetary Policy Statement early in August will have a softer look than its previous set of forecasts produced in May. The case is strengthening for the RBA to cut the cash rate by 25bps to 1.75% at its August policy meeting.