Global economic growth has continued to improve through July, however uncertainties remain. Annual Gross Domestic Product (GDP) readings in the US were firm and China was stronger the n expected. Europe is also now showing strength in its economy with particular help from Spain. Inflation readings in most countries remain subdued but continued economic growth is allowing central banks to reverse the very easy monetary policy settings led by the US and now Canada. In Australia, the RBA left room for further rate cuts which in turn are allowing scope to maintain steady rates for now, pressure for a rate rise is expected to build later in the 2017 calendar year. Global bond yields continue to reflect a world devoid of growth highlighting the risks to the fragile recovery. We expect bond yields to give in to stronger global economic growth in the latter half of the year.
In the US, Q2 GDP showed a lift to 2.6% annualised growth from 1.2% in Q1. Consumption spending provided support with the expectation that this will continue into the next quarter (both business and household). Employment growth remains strong, and although wages are stubborn, household wealth has risen along with company earnings. All in all, we expect US economic growth to continue and for the US Federal Reserve to continue its path of reducing its balance sheet and raising rates.
The dysfunction of the Trump Administration has reached new heights. Importantly, Congress failed to negotiate a path for the repeal of Obama Care, a key promise by Trump, and it seems likely that the planned tax cuts and budget spending will also have difficulty. The Fed has been slowly removing fiscal stimulus despite some mixed data. The path is towards neutral interest rate settings and a reduction in the balance sheet, far from a contractionary stance.
China?s GDP reading for Q2 was stronger than expected at 6.9% which explains the rise in commodity prices. Export growth was impressive and domestic demand continues to grow with growth in urban fixed asset investment spending and retail sales growth providing support. We are still of the view that China will continue to face challenges in maintaining its? stated 6.5% GDP growth rate while adjusting key growth drivers and managing economic reform. The RBA is forecasting our Terms of Trade to decline over the period ahead.
Europe continues to improve, supported by a resurgent Spain. Q2 growth is due for release this week and it seems likely that strong growth will be maintained. Leading indicators of business and consumer sentiment have been strong and imply the lift in European growth will continue into the next quarter. The resolution of key political elections having cleared the way. Europe still has plenty of spare capacity so it is expected the European Central Bank (ECB) will allow the recovery to run on with little risk of inflation.
The Australian economy continues to grow at a modest pace. Employment rose sharply in June, well supported by full time employment which is encouraging. Strong employment growth lifts household disposable income which would explain the sharp lift in retail sales. The lift in retail sales combined with net exports and government spending also look set to boost GDP growth. But risks remain. Residential construction has possibly peaked and other economic indicators are mixed but generally improving. Even with the pickup in growth there is little pressure on inflation and little to no wages growth, consistent with other developed economies.
The case for a rate rise by the RBA is?staring to build although a rising?Australian dollar may complicate?things. On balance we think the?Australian Dollar will continue its?general downward trend as the US?Fed moves to reduce its balance sheet?and increase the cash rate. Consensus?expectations are for the RBA to?increase rates late in 2018 however,?the strengthening economy could?encourage the household sector to?increase its already high borrowings.?Low interest rates and an improving?economy may cause incentive to?borrow more and this may lead to?unacceptable risks to financial?stability. We think the RBA will start?hiking the cash rate based on?economic growth trajectory before
inflation reaches its stated target?band. This could be in November?2017 but more likely early 2018. The RBA will want to get the household sector in order to avoid a boom bust scenario and move to neutral interest rate setting of circa 3.5%.