In March, indications of slowing global economic remained limited. High inflation continued to ease slowly. Problems emerged at...
In March, indications of slowing global economic remained limited. High inflation continued to ease slowly. Problems emerged at three US banks and Credit Suisse in Switzerland. Financial markets worried about a potential systemic banking problem in the making, but concerns were partly allayed as the problems in the troubled banks were seen as mostly specific to those banks rather than systemic. The authorities in the United States and Switzerland intervened promptly with measures to deal with the specific issues with those banks. Central banks made it plain that dealing with high inflation was still their key priority and the US Federal Reserve, the European Central Bank and Bank of England at their policy meetings after news broke of the US and Swiss banking troubles all hiked official interest rates.
While the central banks claim that they are not blinking in their inflation fight, government bonds rallied strongly in March and to the point where they are indicating that central banks will start cutting interest rates later this year. The isolated banking problems surfacing in the US and Switzerland in March were viewed as likely to compromise economic growth prospects bringing an end to central bank rate hikes and early cuts to official interest rates beyond to deal with much weaker growth. In contrast to the bond market view of weaker economic growth ahead, the prompt and individually tailored official actions taken to deal with the isolated banking problems indicate that still quite robust economic activity will keep inflation on a slow trajectory lower keeping central banks on inflation-watch the remainder of this year at least.
In the US, most economic reports released in March show relatively firm growth. A recession is still possible in the US, but it is not imminent. The February ISM manufacturing PMI lifted to 47.7 from 47.4, while the ISM non-manufacturing (services) PMI held up firmly in expansionary territory at 55.1 from 55.2 in January. Indicators of housing activity were mostly stronger. February home building permits rose 13.8% m-o-m while housing starts rose 9.8%. The March National Association of Home Builders’ index lifted to 44 from 42 in February.
The US labour market remains very strong with non-farm payrolls up 311,000 in February after lifting by 504,000 in January. While the US unemployment rate rose to 3.6% in February it remains well below the roughly 4.5% unemployment rate that the Federal Reserve will need to see to be confident that inflation will come back to 2% target.
US inflation is well down from its peak in mid-2022 but progress is slowing and with the annual rate still much too high. The CPI was up 0.4% m-o-m, 6.0% y-o-y in February, but with the core CPI (excluding food and energy prices) up 0.5% m-o-m, 5.5% y-o-y. While goods prices are steady or declining, service prices are edging higher. The Fed at its March policy meeting sought to reassure that the isolated problems at Silicon Valley Bank in California and Signature Bank in New York were particular problems related to those banks and that US bank in general were still well-capitalised and safe. The main problem facing the Fed was still high inflation and while smaller rate hikes were now needed (the Fed hiked the funds rate 25bps to 5.00%) it was prepared to take more action if needed. The Fed’s still quite hawkish stance on rates implies to us that the strong March bond market rally has gone too far.
In China, economic releases in March continue to show an economy on a slow recovery trajectory. February purchasing managers’ reports lifted further in to expansionary territory above the 50 expansion/contraction marker. The official manufacturing PMI rose to 52.6 in February from 50.1 in January while the non-manufacturing (services) PMI rose to a strong reading of 56.3 from 54.4 in January. The key monthly readings of domestic demand and output all improved in February pointing to China’s economy rebounding after the abrupt opening up after covid lockdown. February fixed asset investment lifted 5.5% y-o-y (+5.1% in January) while February industrial production rose 2.4% y-o-y (+1.3% in January). Retail sales were up 3.4% y-o-y in February after falling 1.5% y-o-y in January. It is worth keeping in mind that China is a low inflation country by international comparison with the CPI down 0.5% m-o-m in February and up only 1.0% y-o-y. Retail sales in China are showing quite strong real improvement. China will be a rare strengthening economy through 2023 contributing positively to global economic growth, however GDP growth is unlikely to push up to the past average well above 6% over the past two decades. At the beginning of the month the Peoples’ Congress set a growth aim for 2023 of 5%, low by historic standards, but ambitious in the context of economic issues that China faces.
In Europe, Q4 GDP growth was revised down to flat (0.0% q-o-q) in Q4, but still up 1.8% y-o-y. Growth in Q1 is looking softer notwithstanding strength in demand for services. The March services sector PMI lifted to 55.6 from 52.7 in February well above sub-45 style readings consistent with a recession ahead. As is the case in all other major economies, goods producing industries in Europe are softer and the March manufacturing PMI slipped to 47.1 from 48.5 in February. However, Europe’s labour market remains tight with the January unemployment rate still near a quarter-century low point at 6.7% in January. CPI Inflation is high, 8.5% y-o-y in Europe in February and 10.5% y-o-y in Britain. Even with the Credit Suisse problem in Switzerland threatening potential banking issue in Europe, the ECB was obliged to hike the deposit rate 50bps to 3.00% at its March policy meeting and the Bank of England hiked the base rate 25bps to 4.25% at its policy meeting. Europe’s central banks are in the difficult position of still needing to tighten monetary policy further to deal with still unacceptably high inflation, while also needing to plan for dealing with any adverse banking issues.
In Australia, economic indicators released in March have been mixed strength. Q4 GDP growth was softer than expected at 0.5% q-o-q, 2.7% y-o-y. Real household consumption spending was up only 0.3% q-o-q while all major categories of private investment spending fell. Spending on dwellings was down 0.9% q-o-q and spending on ownership transfer costs (associated with real estate purchase costs) was down 6.2% q-o-q. Non-dwelling construction was down 2.7% q-o-q and spending on machinery and equipment was down 1.2% q-o-q. The only real point of strength was external demand with exports up 1.1% q-o-q and imports down 4.3% q-o-q.
Moving to indicators relating to early and mid Q1 economic activity, housing activity remains very soft, notwithstanding some signs of stabilising house prices, probably a false dawn related to low supply of houses on the market rather than strong demand. January home building approvals fell by 27.6% m-o-m and the value of new housing finance commitments fell by 4.9% m-o-m both indicating that underlying housing fundamentals remain very weak.
In contrast to very weak housing, January retail sales lifted by a stronger-than-expected 1.9% m-o-m, but coming after a 4.0% fall in December. Annual growth in retail sales, however, at 7.5% y-o-y is barely above 7.4% y-o-y annual CPI inflation registered for January. The RBA wants to see retail sales running softer to reduce demand pressure on inflation. The February retail sales report out tomorrow will provide additional information on demand strength that will influence the RBA’s decision whether to continue hiking the cash rate or pause at its board meeting next week.
Another key consideration at that the April meeting will be assessing whether the labour market is still running too tight. Employment growth has been erratic over the turn of the year with falling employment in both December and January followed by a bigger-than-expected 64,600 lift in February. Unusual seasonal factors were in play with more people than usual changing jobs over the recent summer. Taking the entire 3-month period 37,000 jobs were added averaging 12,300 per month, noticeably lower than the previous 3-month period ending November 2022 when 115,000 jobs were added averaging 38,300 per month or the 3-month period before that ending May 2022 when 125,700 jobs were added averaging 41,900 per month. This noticeable slowing in jobs growth in the most recent 3-month period provides some evidence that the labour market is less tight, although the unemployment rate at 3.5% in February is still too low to reduce the risk of wages chasing high cost-of-living increases and underpinning inflation.
What can be said from recent Australian indicators is that the RBA is in a position to exercise choice whether it should continue hiking rates or take a pause. One powerful argument favouring a pause is that several past rate hikes are still to flow through to borrowers. Seeing how borrowers react when they actually pay higher rates is worth assessing before hiking further. At this stage we see the last 25bps cash rate hike to 3.60% in early March being the last one for several months. It is possible that 3.60% is the peak cash rate for this cycle but more data relating to the strength of demand and the labour market will influence whether that proves to be the case.