Economic Update - August 2019
Written and accurate as at: Aug 15, 2019 Current Stats & Facts
The month of July was in some ways a month of reckoning. The Reserve Bank of Australia cut the official cash rate to 1.00%, the lowest ever recorded. It is challenging to fathom our cash rate was at 7.25% back in August 2008 and almost impossible to comprehend the lofty highs of 17.5% back in January 1990. The RBA explained their decision by declaring the necessity to improve confidence and enable consumption.
Ironically, consumer sentiment fell, increasing concern for the RBA and the government. The US Federal Reserve reversed its trend by cutting its interest rate from 2.5% to 2.25%. They cited a slowing US economy, weaker global growth, uncertainties associated with the ongoing trade war, and consistent undershooting in inflation as the reasons for the decision. Germany joined several European countries which have negative interest rates (not a typo), and China suffered their slowest GDP growth in almost 30 years.
Australia
The RBA has now reduced the official cash rate to 1.00%. The minutes from the July meeting acknowledged further cuts are likely. The primary motive being lower interest rates would support the economy with a lower value of the exchange rate and lower required interest payments on borrowing. They believe this will free up cash for other expenditure by households and businesses.
Australia's unemployment rate sits at 5.2% with job ads data suggesting immediate deterioration, coupled with inflation, consistently undershooting the target reiterates the scope for further rate cuts. Even though our unemployment rate seems low the Australian economy has significant spare capacity given underemployment (defined by those FT workers on less than full-time hours and PT workers that are willing and able to work more hours in the labour market) sits at a very high 8.6%. Meanwhile, GDP growth is just 1.8% with Government spending accounting for - a record - 80% of this figure. Government contributions have been highly necessary, considering GDP per capita has been negative for the past three quarters, in what could be described as a GDP per capita recession.
The NAB business survey for June showed that business conditions remain subdued, particularly in retail, with only the mining sector performing well, while business confidence declined. Perhaps of more interest was the significant drop in consumer sentiment in July, even in the face of positive consumer news such as rate cuts, the move by APRA to cut the serviceability mortgage rate, the passing of the tax cuts through the parliament, substantial gains in equity prices, and the first monthly rise in house prices for some time.
On the positive side, Australia’s commodity prices remain firm, and the mining sector is experiencing a ‘mini-boom’. Iron ore moved to above US$120 per tonne, and with export volumes strong, China accounted for over 40% of Australia’s exports of goods. The 2019-20 federal budget assumed a US$88 per tonne iron ore price, well below current prices with every US$10 above forecast adding around $4 billion to the budget surplus. Up until now, the Australian dollar has primarily ignored the lift in commodities, instead of focusing on narrowing interest rate differentials. Importantly, the vastly improved fiscal position provides room for more stimulus if required.
United States
Fed chair Jerome Powell signalled his intention to cut rates at the July meeting and did not disappoint by cutting from 2.5% to 2.25%. The pivot in policy over the past six to nine months has been in response to a combination of a slowing US economy, weaker global growth, uncertainties associated with the ongoing trade war, and consistent undershooting in inflation. Minutes from the Fed’s last meeting revealed increasing concern that a US-China trade war is indirectly causing businesses to delay investment plans and hold back on wage and price increases. “Uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US outlook,” Powell said.
At a hearing by the US House Committee on Financial Services, Powell said that the central bank was prepared to “act as appropriate” to prop up economic expansion and support inflation amid a raft of risks and uncertainties, including weak inflation, slower global growth, and a pullback in business investment due to lingering US-China trade frictions.
Europe
The recent Eurozone Composite report suggests that growth picked up in June, driven mainly by the services sector offsetting the sharply contracting manufacturing sector. Business expectations over the next year have fallen to the lowest level in around four years, further evidenced by the IFO Institute’s leading index showed that the mood among managers has weakened to its lowest level in nearly five years. The IHS Markit Global Business Outlook fell to its lowest level since 2012 in June, with new orders reducing sharply and business optimism at the lowest level on record. The survey sees the trade war causing a marked fall in confidence among US and Chinese companies. French 10-year bonds joined German bonds to yield a negative rate of return, reflecting expectations of slowing growth and prompting ECB president Draghi to reiterate that the central bank had “considerable headroom” to seek to stimulate the economy in the face of threats to growth, which include tensions over global trade. Some of the specific key events include;
- Ireland - the country’s finance minister has said the country faces 85,000 potential job losses and a sharp economic slowdown if the UK crashes out of the EU in October.
- Spain - prime minister Pedro Sánchez said that talks between his socialist party (PSOE) and the anti-establishment Podemos party had collapsed, pushing the country closer to repeat elections.
- Greece - the center-right party regained power after a sweeping general election victory. Incoming prime minister Mitsotakis said he would focus first on cutting taxes, reducing red tape and attracting foreign investment.
- France - passed a digital services tax on companies with revenues of more than €750 million globally and €25 million in France will apply a 3.0% charge on turnover. a
Japan
The recent Bank of Japan (BOJ) survey illustrated a picture of continued softness in the manufacturing sector and resilience in the service sector. The studies are suggesting growth in the June quarter to be around an annualised rate of 0.3%, down from the 2.1% seen in the March quarter. The slowdown reflects subdued domestic consumption and struggling exports. On a trend basis exports are falling at around a 5.0% rate so far this year, reflecting the slowdown in China and Europe and the trade war.
China
On balance, Chinese data over the past month has been slightly better than expected. Although GDP growth in the quarter slowed to 6.2%—the lowest level since 1992— and the June manufacturing PMI readings were both below the critical 50 levels, other data has been more positive. The service sector PMI came in at 54.2 while industrial production lifted to 6.3% year-on-year in June from 5.0%, and retail sales growth jumped to 9.8% from 8.6%. A surge in auto sales ahead of a change to emission standards underpinned the improvement. Indeed, consumer spending and the service sector is becoming an increasingly important driver of Chinese growth. From less than half of GDP in 2011, consumer spending is now 54% of GDP while accounting for almost two-thirds of the growth in 2018. Tax cuts earlier in the year have helped shield the economy from the impact of the trade war.
Exports declined 1.3% year-on-year in June—the first full month of the tariffs—with exports to the US declining by 7.8%. Exports within Asia partly offset this decline, rising 12.8% over the year. For now, it appears the Chinese economy is achieving its 6.0–6.5% growth target, but the ongoing trade war is now becoming a material downside risk.