Q2 GDP reports for major economies showed that most fell around 10% q-o-q. The United States fared a touch better, with GDP falling at an annualised rate of 31.7%, or down 7.9% q-o-q while Europe was worse, down 12.1% q-o-q. Australian Q2 GDP is due to be released this week and the market expects a fall of around –6.0% which would place the country as one of the better performers in what has been the worst quarter for the global economy since the 1930s.
The restrictions imposed to contain the first wave of COVID-19 infections caused the sharp reductions in economic activity in Q2 which were at their worst in the first half of the quarter. Later in the quarter economies were starting to respond to the largest stimulus spending by Governments since the early years of World War II. Moreover, the stimulus spending was increasingly supported by central banks prepared to buy government bonds and expand their balance sheets almost in lockstep with the expansion of government borrowings.
Partial economic reports for June and July for most major economies have shown sharp increases in activity although the pace of improvement may moderate in August and September as a second wave of COVID-19 infections, with backtracking on earlier plans to re-open economies, limits recovery. Nevertheless, coordinated Government and central bank stimulus supporting business and household income, keeping interest rates very low and encouraging private sector borrowing while improving the ability of banks to lend should limit setbacks to economic recovery.
In the US, economic readings continued to strengthen mostly during August despite continuing civil unrest and high COVID-19 infection rates causing tighter restrictions in some states. Housing activity at the leading edge of economic activity has been very strong. July housing starts and permits lifted respectively 22.6% m-o-m (up 17.5% in June) and 18.8% (up 3.5% in June). The August National Association of Homebuilders’ index rose to 78 from 72 in July. Buoyant home building activity is supported by surging home sales. July existing home sales rose 24.7% m-o-m after increasing 20.2% in June, while July new home sales rose by 13.9% after lifting 15.1% in June.
While housing readings have been the standout indicators of recovery in the US, July retail sales were firm, up 1.2% m-o-m on top of an 8.4% increase in June and industrial production in July was up 3.0% m-o-m after increasing 5.7% in June. July non-farm payrolls rose by 1,763,000 after increasing 4,719,000 in June and the unemployment rate fell to 10.2% in July from 11.1% in June.
Even with these strong economic readings in June and July the US economy has a long way to go to get back to where it was before the COVID-19 crisis. Back then the unemployment rate was down at 3.5% and with inevitable bumps along the road to recovery it will take several years for the unemployment rate to fall towards a similarly low rate again. The Federal Reserve (Fed) remains cautious about the US economic outlook and the latest statement from Fed Chairman Jerome Powell has changed the Fed’s operating target for inflation to an average rate that allows inflation to overshoot on the upside of target for some time without requiring the Fed to tighten policy.
In effect, the Fed is indicating that when the US economy eventually starts running at full capacity and generating consistently above-target inflation, the Fed will allow the economy to run hot for some time before starting to lift interest rates. Given how far the US economy is running below capacity and the years it will take to reach full capacity plus a period running hot beyond the Fed is giving a clear signal that the Fed funds rate will be no higher than the current 0.25% until the mid-2020s or beyond.
In China the bounce off the bottom of the COVID-19 economic downturn has started. GDP rose 3.2% y-o-y in Q2 after falling 6.8% in Q1. June and July monthly readings point to the recovery continuing but at relatively modest pace and missing a key element evident elsewhere, a lift in retail spending. The best of China’s recovery has been in exports, up in July by 7.6% y-o-y, and industrial production, up 4.8% y-o-y in July. Government stimulus spending in China has been modest by international comparison, one reason why fixed asset investment spending is comparatively weak, down by 1.6% m-o-m in July. Retail sales too remained weak in July and were down 1.1% y-o-y still a far cry from pre-COVID-19 readings running closer to +10% y-o-y. Weak retail sales and its corollary high household savings indicate Chinese households’ lack of belief that the authorities have their interest at heart and can lift economic activity in a way that benefits them.
In Europe, Q2 GDP fell by 12.1% q-o-q and is down 15.0% y-o-y. May, June and July economic readings point to some recovery in Q3 even with a pronounced second wave of COVID-19 infections developing in France and Spain in particular. June retail sales rose strongly by 5.7% m-o-m while industrial production lifted 9.1% m-o-m after a 12.3% increase. Europe’s unemployment rate has barely risen through the COVID-19 crisis standing at 7.8% in June. Government income support to those affected by COVID-19 shutdowns has been generous by international comparison and most certain to continue. The EU has also set out a clear and substantial fiscal stimulus program to assist European economic recovery. While COVID-19 flare ups can dent recovery prospects, those dents are likely to small in Europe given the commitment to recovery spending by European Governments and backed by the ECB continuing to provide whatever support it can.
In Australia, Q2 GDP will be released on Wednesday and is expected to show a fall of around 6.0% q-o-q, -5.3% y-o-y compared with Q1 –0.3% q-o-q, +1.4% y-o-y. The back-to-back quarterly falls will confirm that Australia has been in technical recession for the first time since 1991. At the beginning of August increasing restrictions in Victoria to contain a second wave COVID-19 outbreak plus setbacks reducing restrictions elsewhere threatened to stifle economic recovery and deliver another negative GDP quarter in Q3. As the month has progressed that now seems less likely with some July economic readings coming in noticeably stronger than expected.
The preliminary reading of July retail sales was unexpectedly strong, up 3.3% m-o-m to a record high $A30.7 billion, 12.2% up on July 2019. The July labour force readings were stronger than expected with employment up 114,700, hours worked up 1.3% m-o-m and the unemployment rate only edging up to 7.5% from 7.4% in June. Household income support was more certain in August after the Government’s July announcement that it was extending the September cutoff date for JobKeeper and JobSeeker supplement payments.
Even with Victoria in lockdown Q3 will start on a comparatively stronger footing that may be sufficient to generate a small, positive GDP reading. Even if GDP growth is positive in Q3, measured GDP will still sit more than six percentage points below where it was at the end of 2019. It will take at least three years for the Australian economy to recover the trajectory it was travelling before COVID-19 hit. Wage growth and inflation are likely to stay subdued for a similar period.
The RBA left all its monetary policy settings unchanged at its August policy meeting. On the basis of its latest economic forecasts contained in the early August Monetary Policy Statement showing a highly uncertain economic outlook but one that encompasses a slow, bumpy economic recovery with persistently low annual inflation nearer to 1% than 2%, there is no prospect of the cash rate being any higher than the current 0.25% over the next three years at least.