The semi-annual testimony from Federal Reserve (Fed) Chair Jerome Powell reiterated recent guidance that its tightening cycle was on pause in the face of rising "cross-currents" that pose uncertainty to the economic outlook. These uncertainties would need to clear and inflation lift notably for the Fed to change its course. The Fed plans to end its balance sheet run-off later this year, with a terminal value potentially in the range of $3.3 to $3.5 trillion from its current size of near $4 trillion. Within this, the Fed will look to maintain an ample level of bank reserves (currently around $1.6 trillion) to ensure liquidity and prevent an escalation in short-term interest rates.
Also in the US, GDP growth for the December quarter was stronger than expected at an annualised pace of 2.6%, but a step down from Q3's 3.4% pace. Growth in the quarter was driven by household consumption and an uptick in business investment, though the latter has been trending lower due to slowing non-residential construction and deteriorating activity in the residential sector. Public investment and inventories added very modestly to growth, while net exports remained a headwind.
In the UK, events this week pointed to the Brexit withdrawal date of March 29 being delayed. PM Theresa May announced that if her Brexit plan failed to gain parliamentary approval by March 12, which appears likely, a vote would be held the next day (13/3) to determine if MP's were supportive of a no-deal exit, a scenario they have previously rejected. In that case, a vote would be held on March 14 to gain support for "a short, limited extension to Article 50", which could be for around 3 months but conditional on approval from the European Union (EU). Rejection of the extension proposal would take the UK towards a disorderly no-deal exit from the EU.
Earlier in the week, officials from the Bank of England (BoE) outlined to the Treasury Select Committee the conflicting policy considerations that would be encountered under a no-deal exit. In that instance, Governor Mark Carney said that the BoE "will provide all the stimulus we can subject to delivering price stability consistent with our remit.” However, Governor Carney also noted that the BoE's scope is limited with its official interest rate at 0.75%, while a no-deal exit would be inflationary due to a likely "substantial" fall in the Sterling and the implementation of trade tariffs.
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In Australia, the focus turned to next week's National Accounts that will contain the GDP growth figures for the December quarter. Ahead of that release, there were updates posted for construction work done (see our analysis here) and private sector capital expenditure (read our review here), both of which feed into quarterly GDP growth calculations.
For construction work done, activity deteriorated notably over the second half of 2018. Output fell by 3.1% in Q4 against an expected rise of 0.5%, which followed a downwardly revised contraction of 3.6% in Q3. The details showed that the residential construction cycle has turned down and is consistent with the deterioration in building approvals that gathered pace towards the end of 2018. Engineering (infrastructure) work also fell away in Q4 by 5.0% after declining by 5.6% in Q3.
Residential construction activity in the private sector declined by 3.7% in the quarter, with new construction -3.6% and alterations (renovations) -4.0%. This followed a soft Q3 (-1.7% overall; construction -2.5% and alterations +4.7%), so on that basis, total activity fell by around 5% over the second half of the year — a marked turnaround from a strong first half where activity had lifted by around 8%. We can anticipate residential construction to subtract notably from GDP growth in Q4 and to remain a headwind over 2019 and possibly into 2020 considering the weakness from building approvals. That in itself will be an adjustment for the domestic economy given that residential construction has been a solid contributor to growth in recent years, save for a soft 2017.
While Q4 looks to be a disappointing outcome for engineering work, in particular with public sector infrastructure work falling by 10.3% in the quarter, this will probably prove to be a period of temporary weakness. This is because there is an extensive level work in the pipeline for public infrastructure projects, which are by nature long term and should be supportive of the uptrend in activity continuing.
Thursday's Capital Expenditure (CapEx) survey was stronger than expected and a broad positive. The survey provides a lead towards business investment in the National Accounts, in particular for equipment spending. CapEx overall lifted by 2.0% in Q4 beating the market forecast for +0.5%. Investment for the equipment, plant, and machinery component lifted by a modest 0.7% in the quarter, though the annual pace was a robust 8.1%.
The CapEx survey includes firms' investment intentions that were also on the strong side of expectations. Total CapEx in the 2018/19 financial year is now expected to be $118.4bn according to estimate 5, an upgrade of 4.0% on the previous estimate from three months ago and 3.6% above the same estimate taken 12 months earlier. Also, estimate 1 for CapEx in 2019/20 was $92.1bn to be 11.0% higher than the equivalent figure nominated a year ago.
While residential construction is set to be a headwind to growth, the same will no longer be able to be said of mining sector investment. In recent years, the domestic economy has had to weather a sharp unwinding in mining investment from the construction-driven boom in the early part of the decade, which has resulted in total business investment subtracting from growth. For 2018/19, mining investment will drag modestly (-6.8%Y/Y) but will be outpaced by growth in investment from the non-mining sectors (+8.5%Y/Y). As shown in our chart of the week, below, the end of the line comes in 2019/20 when mining investment is forecast to rise for the first time in 7 years (+21.4%Y/Y), with non-mining investment still increasing but at a more moderate pace (+6.6%Y/Y).
Chart of the week
Lastly, CoreLogic's Home Value Index continued to report further declines in national property prices in February, though at a slightly slower pace (see here). The national index recorded a 0.7% fall in the month and -6.3% for the year, with prices now back at late-2016 levels. Looking at the major capitals, prices in Sydney declined by 1% in February to down by 10.4% over the past 12 months, while in Melbourne the monthly fall was also 1% taking the annual decline to 9.1%.
