Economic data released in August show soft global economic growth and again patchy progress reducing inflation. Key major central banks, including the US Federal Reserve, are indicating that the focus of monetary policy has or is about to shift towards limiting damage to economic growth rather than continuing the fight against inflation still sitting above their various targets. Australia’s RBA remains an odd-man-out warning that it cannot cut the cash rate in the near term with local inflation still too high. However, the prospect of several central banks cutting interest rates while economic growth is slow but not in recession is promoting buying in bond and share markets.
In the United States, economic growth appears to be moderating in Q3 with trackers pointing to around 2.0% annualised growth, from 2.8% in Q2. The labour market is less tight of late with nonfarm payrolls up 114,000 in July compared with +179,000 in June. These figures are likely to be revised lower over time after the US Bureau of Labor Statistics announced the biggest annual downward revision since 2009 to its nonfarm payrolls in the latest annual report (year to March 2024), down 818,000. As the revisions come through in monthly reports, they are likely to show still firm growth in nonfarm payrolls over the past year, but not the unusually high monthly reading at times 300,000 and above that seemed the marker of a very tight labour market.
Other US labour market indicators show a less tight market. The US unemployment rate increased to 4.3% in July from 4.1% in June and 3.7% at the end of 2023. Average hourly earnings rose in July by 3.6% y-o-y, down from 3.8% in June. The less tight US labour market and moderating annual wage growth means that the Federal Reserve can be more confident that inflation will continue to moderate, albeit glacially slowly. In July, the US CPI was up 2.9% y-o-y, a fraction lower than 3.0% in June with the core CPI (excluding food and energy prices) at 3.2% y-o-y from 3.3% in June. Even though the Federal Reserve has a long way to go to achieve its 2% inflation target, the current Fed funds rate at 5.50% is too restrictive and gives the Federal Reserve room to start cutting rates at its next policy meeting in September.
Other US economic indicators still show moderate economic growth persisting supported by government spending and US consumers. Retail sales are growing firmly, up 1.0% m-o-m in July. It is the likelihood of continuing US economic growth in the near term that is likely to limit the amount of interest rate cuts as well the pace of US rate cuts. The Federal Reserve does not need to cut rates quickly and substantially to stave off recession and will have cause from slowing progress reducing inflation to go cautiously and slowly cutting the Fed funds rate.
In China, economic growth continues to slow and with little sign that the authorities will take steps to arrest the decline. In July, the regular monthly economic indicators continue to disappoint. Fixed asset investment spending moderated to 3.6% y-o-y from 3.9% in June. Industrial production at 5.2% y-o-y was down from 5.3% y-o-y in June and while retail sales lifted 2.7% y-o-y, up from 2.0% in June, the improvement is far below what is needed to boost China’s soft growth prospects. The most telling statistics highlighting China’s economic malaise are house prices, down 4.9% y-o-y in July from -4.5% in June and the unemployment rate, up to 5.2% in July from 5.0% in June. The continuing over-supply of new homes, forcing down prices and destroying household wealth coinciding with rising unemployment begs for government policies aimed at boosting household income. Instead, the Government is focused on plans to boost high tech companies that are likely to have limited effect countering soft growth in consumer spending.
In Europe, GDP rose in Q2 by 0.3% q-o-q and by 0.6% y-o-y. Spending on services aided by strong growth in tourists is helping to keep Europe growing but at a slow pace well below long-term average. The support for growth from services is keeping labour market conditions tight with the unemployment rate marginally higher at 6.5% in June, but still tracking close to a 25-year low. Wage settlements remain above 5% y-o-y and that means that while inflation has come down below 3% (in July the CPI edged up to 2.6% y-o-y from 2.5% in June) there is a risk it may not stay down. The European Central Bank is aware of the risk of inflation rekindling but also wants to support sub-par economic growth. After the first rate cut back in June, the ECB passed in July, but is talking about cutting rates again. In the United Kingdom, the Bank of England is also torn between slow economic growth prospects and inflation that while down may rekindle. The Bank of England interest rate setting committee voted narrowly in favour of a rate cut at its July meeting, reducing the base rate 25bps to 5.00%.
In Australia, the RBA held the cash rate at 4.35% at its August policy meeting and the minutes show the meeting discussed whether a rate hike was warranted. While Australian inflation is moderating it is showing signs of stickiness around 4% y-o-y on an underlying basis. That is still too high from the RBA’s perspective, and they are also concerned that inflation will stay above 2-3% target for too long. In the latest RBA economic forecasts released in the August Monetary Policy Statement the RBA lengthened the time before inflation comes consistently inside target through to 2026. Forecast inflation above target for so long means that the RBA cannot consider cutting the 4.35% cash rate in the near term. RBA Governor, Michelle Bullock, clarified that the short term means at least six months.
Essentially growth in demand in the Australian economy, while slowing is still running ahead of slow output growth. Economic releases in August indicate that the imbalance has not improved with firm growth in retail sales, up 0.5% m-o-m in June and employment up 58,200 in July. Q2 wage growth was firm at 4.1% y-o-y and above where the RBA feels is consistent with achieving its inflation target. While the unemployment rate has lifted to 4.2% in July from 4.1% in June that is not up at a level consistent with non-accelerating inflation, placed in most research around 4.5%.
While the RBA recognises that the economic outlook is uncertain and can change, their base case forecasts show productivity not lifting as much as hoped previously meaning that productivity-adjusted wage growth is too high. Government spending growth, mostly state-government spending growth, is too strong and hampering the task of bringing demand and output in line. The RBA also needs to see how boosts to household disposable income from government support initiatives and tax cuts will pan out in growth in household spending. The RBA needs to judge all these over coming months against a backdrop of inflation moderating, but still running too high. Even though markets are toying with the idea of the RBA starting to cut the cash rate late this year, that looks fanciful. The RBA is unlikely to have data to hand to support a case for a rate cut until at earliest February next year and more likely in our view May next year.