High inflation and mostly strong economic growth featured among the world’s major economies during January although immediate...
High inflation and mostly strong economic growth featured among the world’s major economies during January although immediate economic growth prospects are softer because of the Omicron wave. Also, key central banks, including the US Fed, are promising to act tougher on inflation words not matched by actions so far that have been modest, or non-existent. The threat of higher official interest has unsettled financial markets but has not undermined still strong medium-term growth prospects for the real global economy. Those firm growth prospects may be enhanced as China’s slowing growth rate through 2021 returns to stronger footing helped by more stimulatory policy settings.
Turning first to the US economy, although the Omicron wave dented household spending in December (personal spending down 0.6% m-o-m) Q4 GDP growth was very strong coming in at 6.9% annualised up from 2.3% in Q3. Consumer spending accelerated to 3.3% annualised in Q4, up from 2.0% in Q3. Q1 2022 GDP growth, when it is released in late April, will show marked growth deceleration because of the dampening impact of Omicron on consumer spending. Our assumption is that the damage to consumer spending will be at its worst in January and February readings before a sharp rebound occurs in March and beyond.
Although Omicron is the most infectious Covid variant so far it is also by far the mildest for the fully vaccinated allowing governments to encourage businesses and households to go about their business with the lightest of restrictions. Households are warier of Omicron than governments say they should be, but the likely speed of the peak and decline (exceptionally fast infection rates invariably peak, implode and collapse) in the Omicron wave means that households will soon be on the same page as governments and ready to spend up.
The US household sector is in very good shape. Although employment growth has slowed in recent months, the unemployment rate is back to very low pre-pandemic levels at 3.9% in December. Wage growth measured by average hourly earnings rose in December by 0.6% m-o-m, 4.7% y-o-y and looks likely to head well above 5% y-o-y in January and February. The US household sector has accumulated a savings war chest assisted by generous government payments through the pandemic. Spending on housing at the leading edge of economic growth is very strong. New home sales rose by 11.9% m-o-m in December after lifting 11.7% in November. All told, the US household sector is fit to spend freely once short-term impediments to confidence ease.
The main threat to medium-term US growth prospects is inflation and the responses of the Fed and the bond market to it. High inflation was looking less temporary and more entrenched in December. The CPI was up 0.5% m-o-m, 7.0% y-o-y, the highest annual inflation reading since 1982. In core terms the CPI was up 0.6% m-o-m, 5.5% y-o-y. Pipeline inflation pressure was high in December with final stage producer prices up 0.2% m-o-m, 9.7% y-o-y.
The Fed talked much tougher on fighting inflation in December and January but even though indicating that net bond and mortgage paper buying will turn to net selling and that the funds rate will need to rise soon and at least three times this year the Fed still deferred turning tough words to actions at its January policy meeting. The US bond market is also acting as if 7.0% y-o-y inflation will turn to 2.5% inflation or less in two or three years. The US 10-year bond yield still sits below 2.00% yield, remarkably low given high inflation. Fed inaction and low US bond yields will change but not particularly fast it seems. Even when the change comes, US households and businesses are well-placed to cope with increases of at least one percentage point in the funds rate and bond yields.
China’s economy continued to lose growth momentum in Q4. GDP rose 4.0% y-o-y down from 4.9% in Q3. The slowing in China’s economic growth rate has been a function of a less aggressive policy support program than occurred in other major economies in the worst parts of the pandemic as well as active policies punishing parts of the economy not in step with President Xi’s principles for Chinese society. China was an odd man out during 2021 with growth slowing under policy dictate while other economies speeded up helped by policy stimulus. The roles have started to reverse in 2022. China has started to ease monetary policy reducing Reserve Ratio Requirements and its official interest rate, down by 10bps to 3.70%. It has also started to spend more stimulating the economy at a time when stimulus spending is moderating elsewhere. China’s GDP growth rate looks set to accelerate this year, albeit off a low base in late 2021.
Europe’s annual GDP growth rate stepped down to 3.7% y-o-y in Q3 although the q-o-q growth rate at 2.2% was strong. Growth in Q4 has been dampened by Omicron and a fading energy supply crisis. Most monthly economic indicators have held up quite well and the latest January purchasing manager reports showed the manufacturing sector PMI increasing to 59.0 from 58.0 in December, while the services PMI slid in January to 51.2, still expansionary territory but down from 53.1 in December. Europe’s inflation rate is very high with the CPI up 5.0% y-o-y in December and producer prices up 23.7% y-o-y. European bond yields and the ECB’s official interest rates, most with a negative sign on the front are out of kilter with high inflation and will rise soon. The threat of war between Russia and the Ukraine could heighten energy supply and price issues again in Europe working against the tentative signs of improving supply chains that might otherwise ease inflation pressure.
In Australia, pre-Omicron economic readings have been very strong. November retail sales rose by 7.3% m-o-m; home building approvals were up 3.6%; and housing finance commitments were up 6.3%. In December, employment rose by 64,800 and the unemployment rate fell to 4.2%, the lowest reading since 2007, and down from 4.6% in November. The economy was pushing ahead very strongly before the Omicron wave and in our view will push ahead very strongly again in March and beyond assisted by a household sector with large, accumulated savings to spend. A Federal pre-election Budget in March will add impetus to household spending.
Inflation, while not at the high levels common in other OECD economies, is high by Australian standards and is stretching the RBA’s 2-3% target. The Q4 CPI report for a second consecutive quarter came in above market and RBA forecasts. The Q4 CPI rose 1.3% q-o-q, 3.5% y-o-y from 1.0% q-o-q, 3.0% y-o-y in Q3. The RBA’s preferred underlying inflation reading rose 1.0% q-o-q, 2.6% y-o-y. Other Q4 price readings indicate a building inflation pipeline. Q4 import prices rose 5.8% q-o-q while final stage producer prices rose 1.3% q-o-q. While petrol prices and house prices were the biggest contributors to the Q4 CPI rise a broad range of manufactured goods prices rose at or above the headline CPI pace.
The Q4 CPI report means that the RBA will need to revise its inflation forecasts higher again in the February Monetary Policy Statement due on Friday. That will place the RBA’s headline CPI forecasts at or above 3% through 2022, 2023 and early 2024. It will also place underlying inflation above 2.5% throughout the forecast period as well. In effect, the RBA will be admitting tacitly that inflation running consistently above target is not only a matter of recent and current wage growth. In any case the risk of less than temporary high inflation is that it eventually embeds in higher wage rises threatening a lengthy period of increasing prices and wages.
We expect the RBA to shift position this week to at least recognising that high inflation may need to be tackled with higher interest rates later this year. If it does not shift position, the risk is a loss of inflation fighting credibility which could prompt bigger increases in longer-term government bond yields than would otherwise occur.