According to initial reports of Q2 GDP, the pace of global economic growth is slowing, but responses from the world’s central banks are either easing monetary policy or turning towards policies that reduce the risk of slow growth turning into recession over the next year or so. Q2 GDP reports released so far from China and the US both show slower annual growth compared with Q1, but with comparatively strong growth in household spending, this has countered the damage to growth in key sectors in both economies. China is taking a hit to growth from weaker exports, whereas in the US, disruptions from the trade dispute is mostly via business supply lines, costs and margins. This is starting to cut business investment spending. The promising signs in late June and early July of the US and China to resume trade negotiations appear to be fading again. The saving grace however is that policymakers, especially the central banks, are looking at ways of priming spending.
In the US, the Q2 GDP growth of 2.1% annualised was better than expected although softer than the previous 3.1% reported in Q1. One key strong element in the Q2 GDP report was consumer spending which was up 4.3%, the strongest lift since Q4 2017 and much higher than Q1 2019 with just 1.1%. US household spending growth is likely to remain underpinned by strong employment growth (non-farm payrolls rose 224,000 in June), 3%+ annual wages growth and rising household wealth. The prospect of more growth in household spending, the biggest single element of US GDP, makes it unlikely for the US economy to suffer recession over the next year.
The weak part of US GDP growth is business investment spending which was down an annualised 5.5% in Q2, the worst outcome since Q4 2015. Although US businesses are benefitting from strong growth in sales to US household and government sectors (government spending rose at 5% annualised pace in Q2), export sales are compromised by the trade war and the supply of imported goods from China are priced much higher following the various tariff increases imposed by President Trump.
The US Federal Reserve (Fed) meets later this week with comments from various senior Fed officials, including Chairman Powell, indicating that although the Fed still expects the US economy to grow well, it is also mindful of the downside risks in the growth outlook posed by the continuing trade war. The Fed has given a strong indication that it will cut the funds rates by 25bps to the 2.00-2.25% range at its end of July meeting, but will balk at cutting rates as much as the unduly recession-risk obsessed interest-rate market is expecting.
In China, Q2 GDP growth slowed to 6.2% y-o-y from 6.4% in Q1. The monthly data for June tells a story of an economy weighed by weak international trade. Although exports and imports fell 1.3% y-o-y and 7.3% respectively, domestic sales and output are still holding up comparatively well. Fixed asset investment spending accelerated to 5.8% y-o-y from 5.6% in May, while industrial production increased 6.3% y-o-y in June from 5.0% in May. Most encouragingly, retail sales growth accelerated to 9.8% y-o-y in June from 8.6% in May. These June readings show that while the trade war is hurting the economy, the moves by the authorities cautiously deploying more expansionary fiscal and monetary policy may be assisting domestic spending to offset international trade weakness. China seems to have a higher chance than its case a month ago of keeping annual GDP growth at 6% or higher in the second half of 2019.
In Europe most leading economic indicators have stayed weak in July. The preliminary July manufacturing PMI slipped further below the 50 expansion/contraction line falling to 46.4 from 47.6 in June. Despite being better than the recorded -7.2 in June, July consumer confidence remains weak at -6.6. Q2 GDP is due later this week and is expected to show only 0.2% q-o-q growth and a reducing annual growth to 1.0% y-o-y from 1.2% in Q1. At its July policy meeting, the European Central Bank left policy interest rates unchanged, but in the accompanying commentary it focused on downside risks to European growth prospects and its readiness to adopt easier policy. In Britain, Boris Johnson won the leadership race for the conservative party and became the new Prime Minister, promising to deliver Brexit on 31st October with or without a new agreement with the EU. The new Prime Minister’s plans will run the gauntlet of a deeply divided Parliament and country, provided that he survives an EU governing body deeply opposed to changing the deal offered for Brexit, especially the conditions related to Ireland. The chances still look very slim in avoiding a period of heightened economic uncertainty for Britain and the EU beyond the end of October.
In July for Australia, signs of moderate-paced economic growth generating good growth in employment without much upward pressure on inflation continued. Although international trade tension prices for Australian exports have lifted strongly over the past year (in Q1 2019 up 4.5% q-o-q, +15.3% y-o-y and likely to be up at least 15% y-o-y when Q2 export prices are released later this week), this will deliver a big, albeit narrowly-based, boost to national income. Nominal and real Q2 GDP due for release early in September should see best quarterly growth in a year boosted by strong net export contribution but also assisted by better contributions to growth from household consumption spending and business investment spending.
During July it became clearer that home-buying activity had bottomed and that house prices have stopped falling. Lower home mortgage interest rates were offered after back-to-back official cash rate cuts by the RBA in June and July; easing of APRA home lending rules; and income tax cuts flowing with 2018-19 tax returns made it likely that the improvement in home buying activity will extend through Q3 and Q4 2019, also boosting home building activity in 2020.
There are still downside risks to Australian economic growth prospects from the entrenched international trade war and high Australian household debt combined with slow household income growth. Immediate-term growth prospects however, look better than in the second half of 2018 and early 2019. The RBA’s two 25bps cash rate cuts to a record low of 1.00% were not aimed at lifting an economy that is at risk of sliding into recession, but rather at helping the economy to generate lower unemployment whilst lifting inflation over time back into the target band.
The RBA notes a significant change in the Australian economy over the last 18 months combined with an increased flexibility in the labour market. This has allowed a strong increase in demand for labour to be met by an even stronger increase in supply. The labour force participation rate has moved up by more than a percentage point since mid-2017 to a record 66% and still appears to be increasing. Rising supply of labour is one factor sustaining relatively slow growth in wages which in turn is keeping inflation low. The RBA has delivered a sizeable rate and is likely to wait and judge the impact on employment growth, wages and inflation. Our view is that the upward impact on all three will be noticeable over coming months avoiding the need for more rate cuts. If we are wrong, however, the RBA has made it plain that it will not hesitate to cut the cash rate further.