Economic data released in March showed most major economies close to recession or experiencing slow growth. US growth remained a stronger outlier to the mostly soft growth story internationally and showed signs of stickier inflation than most. Australia stayed in the slowing growth camp albeit with a flicker of stronger growth in some reports released in March. Most central banks are hinting at starting to cut interest rates later this year while cautioning that the scale of the cuts may be small and that interest rates may hold higher for longer.
In the United States, most economic indicators point to relatively firm growth persisting in Q1 2024 with GDP trackers pointing to 2% or better annualised growth when the advance GDP report is released in late April. Housing at the leading edge of economic activity is on an upswing. The March National Association of Homebuilders’ index lifted to 51 from 48 in February. February building permits, housing starts, and existing home sales lifted respectively by 1.9% m-o-m, 10.7% and 9.5%, and while housing indicators are volatile month-to-month the trend line has been upwards since Q3 2023.
Turning to coincident and lagging indicators of US economic activity, February retail sales rose 0.6% m-o-m while in the labour market, non-farm payrolls rose by 275,000 (albeit after downward revisions to the out-sized previously 300,000+ readings in December and January) and the unemployment rate lifted to 3.9% from 3.7%. Even with the latest lift in the US unemployment rate it remains low by historic comparison – the last three years at 4% or less, the longest run sub 4% since the 1960s.
The Federal Reserve (Fed) is dealing with a US economy that should slow under pressure from past rate hikes taking the Fed Funds rate to 5.50%, but is showing growth resilience extending to still too high wage growth (average hourly earnings up 4.3% y-o-y in February) and progress reducing inflation stalling at too high a rate with annual CPI inflation lifting to 3.2% y-o-y in February from 3.1% y-o-y in January and producer prices accelerating too, up to 1.6% y-o-y in February from 1% in January.
Resilient growth and sticky inflation are delaying when the Fed can start reducing the high 5.50% funds rate and limiting how much rates can be cut once the process starts. The March Fed policy meeting left the funds rate unchanged at 5.50% and with the difficult economic outlook sent the mixed message of potential to start cutting rates from mid-year but with rates needing to stay higher for longer.
In China, while there was a flicker of improvement in some of the January/February economic readings the economy remains beset by continuing weakness in the property sector extending to the shadow banking sector. Most of the regular economic reports were a little better in February with exports up 7.1% y-o-y, previously up 2.3%; fixed asset investment up 4.2% y-o-y (up 3.0%); and industrial production up 7.0% y-o-y (up 6.8%). A notable exception to the improving reports was February retail sales, up 5.3% y-o-y but off the previous reading of 7.4%. Essentially China needs to turn towards local consumer spending to boost growth. The latest economic plan also announced in March provided only small changes to encourage consumer spending amid plans to move the Chinese economy towards high value add tech manufacturing, but without any comfort to the investors who could help make the plan work. At this stage, the aim of the authorities to deliver 5% economic growth in 2024 looks set to be frustrated by weak consumer spending growth in China and increasing reluctance of foreign investors to maintain a stake in China.
In Europe, economic reports released in March continue to show almost no growth in the euro-area. Europe’s retail sales rose in January by 0.1% m-o-m, but after falling 0.6% in December. January industrial production fell 3.2% m-o-m and Europe’s trade surplus narrowed to 11.4 bn euro from 16.4 bn in December. Weak European growth is reflecting in better progress getting inflation down than elsewhere with CPI inflation down to 2.6% y-o-y in February from 2.8% in January. The European Central Bank (ECB) at its March policy meeting indicated that inflation might be down to 2% target by mid-year paving the way for a rate cut in June. The ECB with a deposit rate of 4.00% looks set to be the first major central bank to start cutting rates, although the Bank of England (current base rate 5.25% and unchanged at its March policy meeting) dealing with an economy in recession but stickier inflation could pip the ECB to the post.
In Australia, the Q4 GDP report was soft showing only 0.2% q-o-q real growth and taking the annual growth rate down to 1.5% y-o-y from 2.1% in Q3 2023.
However early Q1 economic reports, other than for the housing sector, are looking firmer. January retail sales rose by 1.1% m-o-m, albeit after a revised 1.6% fall in December. The labour market took a stronger turn in February with employment up a much stronger-than-expected 116,500 and after the initial 500 increase in January was revised to 15,300. The unemployment rate dropped sharply to 3.7% in February from 4.1% in January.
Housing indicators were mixed in March. Demand for housing remained strong causing a further lift in house prices. That demand, notwithstanding support from strong immigration numbers, may fade given a turn weaker in housing finance commitments over recent months. The value of new home loans fell in January by 4.6% m-o-m after falling 5.5% in December. What is more certain, however, is that housing construction and supply is still very weak. Home building approvals fell 1.0% m-o-m in January after falling 10.1% in December.
Because of the combination of weak housing supply and still strong demand, housing activity is both detracting from economic growth, while adding to inflation through higher house prices and rents.
The RBA at its March policy meeting recognised that a complicated economic outlook could be running close to its latest February economic forecasts allowing a slight shift in its guidance on interest rates from warning of potential to hike rates further to not ruling anything in or out. The latest strong labour force report was released two days after the policy meeting and indicates that too tight labour market conditions may make reducing annual wage growth below 4% y-o-y more challenging.
RBA Governor, Michele Bullock, made it plain that wage growth around 4% y-o-y would be consistent with returning inflation to 2-3% target only if labour productivity lifts the way the RBA has forecast. The latest RBA forecasts also have wage growth moderating towards 3.5% y-o-y later this year. In our view both the lift in productivity and moderation in annual wage growth are in some doubt. We doubt whether the RBA will be able to start cutting the cash rate until December this year at earliest. Even when it starts cutting rates the current evidence showing a still very tight labour market and upward pressure on wages means that the extent of rate cuts in this cycle could be very small.