Taking a look at the US and it was shortened trading week amid the Thanksgiving holiday period. The recent flow of economic data has lost momentum, which has coincided with the Atlanta Fed's 'nowcast' measure that provides a forecast for economic growth sliding to 2.5% in Q4, down from 2.8% around a week earlier. This follows softer-than-anticipated outcomes from retail sales and industrial production last week, and over the course of this week data for residential construction and durable goods orders, which relates to business investment, also disappointed.
Financial markets have responded to this slowing momentum by scaling back expectations for Federal Reserve interest rate increases in 2019. Markets are expecting a further rate increase in December but are now only fully pricing in two increases for 2019, which is below the implied expectation of the Fed for three increases next year according to their latest 'dot plot'. Commentary from Fed officials over the past week, including from Chair Jerome Powell, had appeared more nuanced by referencing trade tensions, fading fiscal stimulus, and financial market volatility. The softer outlook hit US equity markets heavily, resulting in declines of 3 to 4% over the week.
Over in Europe, developments were much calmer compared to the Brexit-driven turmoil from a week earlier. Despite speculation that UK Prime Minister Theresa May would face a leadership challenge, there had not yet been enough support from within the Conservative party to trigger a no-confidence vote. In another encouraging sign for the PM, a draft declaration between the UK and the EU had been agreed relating to the transition arrangements post-Brexit between the two regions. The draft agreement will still ultimately need to be supported by the UK parliament.
Meanwhile, the minutes from the European Central Bank's meeting in November retained the assessment that the risks to the euro area economy were broadly balanced. While the downside risks had increased, recent data was still seen as consistent with a broad-based economic expansion and gradually higher inflation. Weak global sentiment and the prevailing uncertainties in the region combined to send Europe's major equity indices lower by around 1 to 2% this week.
Locally, the S&P/ASX200 index eased marginally this week, though there had been a very sharp decline in the IT sector in response to declines on the tech-heavy US Nasdaq index, while the Energy sector slid by 3.8% on continued weakness in oil prices. More broadly, our chart of the week shows that 2018 is shaping as a year that Australian investors will be keen to fade to the past with the ASX200 having fallen by around 6% year-to-date after being hit hard during October's correction in US markets. This followed a recovery after a volatile period across global markets in the early part of the year.
Chart of the week
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The minutes from the November Board meeting contained several points of interest, notwithstanding that earlier in the month the Bank published its detailed assessment of economic conditions and forecasts in its quarterly Statement on Monetary Policy. Overall, the Board remains confident in their outlook for the domestic economy, with output growth forecast to run well above trend in 2018 and 2019, averaging around 3.5% in year-ended terms.
Non-mining business investment is expected to provide a strong contribution to growth driven by surveyed measures of business conditions running at above-average levels and an elevated pipeline of non-residential construction projects to work through.
For households, growth in consumption expenditure is expected to continue at around its current pace of 3% in year-ended terms over the next few years, broadly matching their forecasts for growth in disposable income. This would appear to indicate that the Board remains sanguine to the possibility of a negative-wealth impact from declining property prices, which, in general, were assessed to be largely contained to Sydney and Melbourne, with conditions mostly stable in the other capital-city markets.
Assessments relating to residential construction appeared less optimistic. The declining trend in building approvals was noted, though residential construction activity is still expected to add to output growth over the next year or two given that the pipeline of work is elevated. Meanwhile, liaison with developers had indicated that both pre-sales and financing for larger projects had become more difficult to obtain.
In assessing how the domestic economy had progressed, the Board highlighted that conditions had improved and that outcomes for output growth and the labour market had been stronger than anticipated relative to their expectations from 12-months earlier. This had been assisted by an income boost from a stronger Terms of Trade and a lower Australian dollar. However, wages growth and underlying inflation had only progressed largely in line with expectations.
Looking ahead, the Bank upwardly revised its forecast for economic growth, while lowering its outlook for the unemployment rate and slightly lifting its anticipation for the pace of wages growth. Wages growth remains key for the RBA, with a gradual increase likely necessary for inflation to remain sustainably within the 2-3% target band.
The overall assessment indicates that there has been little to dissuade the Board from their view that their policy stance is working towards supporting economic growth, while also achieving gradual progress in lowering the unemployment rate and in lifting wages growth and inflation. The Board retained its guidance that its next move in interest rates is more likely to be an increase than a decrease. However, financial markets continue to scale back expectations for this outcome, not fully pricing in an interest rate increase before at least April 2020.
Many of these themes were reiterated by the RBA Governor in his speech on Tuesday night, which also addressed the issue of trust in the financial sector in a clear reference to the ongoing Royal Commission into the banking and financial services industry.
Governor Lowe did, however, provide some interesting commentary around the lag in wages growth to improvements in the broader economy. According to RBA analysis, between 1995 and 2012 growth in real hourly earnings had averaged 2% per year, but over the past 6-years there had been little growth in earnings on this measure. Though this had not been an exclusively Australian experience, it had contributed to a diminished sense of shared prosperity from the achievements of the domestic economy.
It was highlighted that with earnings growth flat, household debt levels high and property prices declining these were factors working in the opposite direction to the RBA's expectation for growth in household expenditure to continue at its current 3% annual rate.
