Most notably, the manufacturing sector is weighing on the outlook, as trade tensions have weakened confidence and investment, while disruptions to established supply chains caused by the implementation of tariffs contributed to a near-stalling in global trade volumes over the year to the March quarter. These dynamics were evident in the latest round of global 'flash' Purchasing Managers' Index surveys released this week by IHS Markit, with eurozone manufacturing activity contracting further in June to its weakest in 6½ years (the reading for Germany fell to a 7-year low), while conditions in US manufacturing slumped to their lowest in a nearly a decade. In contrast, the services sector, which tends to be more domestically focused, is appearing to be more resilient to the global uncertainties given that conditions remain expansionary in the eurozone and the US, albeit around a moderating trend.
The latest meeting of the European Central Bank's (ECB) Governing Council was this week's highlight, where no change to its existing policy measures was the call on Thursday. That was largely anticipated by markets, though pricing for a rate cut to be announced had increased noticeably over the preceding days. In his post-meeting press conference, ECB President Mario Draghi could not have been more clear by stating that the economic outlook "is getting worse and worse" after earlier identifying in his introductory statement that "softening global growth dynamics and weak international trade" as well as declining sentiment in response to "the prolonged presence of uncertainties" from trade and geopolitical tensions and emerging market vulnerabilities as the key influences.
In the end, the Governing Council decided to opt for more time to consider its response, though the decision statement has prepared markets for a rate cut to be announced at its next meeting in September, and also mentioned that other stimulus options, including enhancing its forward guidance, tiering of the negative deposit rate applied on banks' excess reserves and restarting its asset purchase programme, are on the table. The precise combination of measures the Governing Council may settle on seems far from decided, though it will have the benefit of publishing an updated set of growth and inflation forecasts at the September meeting to explain its course of action.
Over in the US, GDP growth slowed from an annualised pace of 3.1% in the March quarter to 2.1% in Q2, though that was stronger than the consensus forecast for 1.8%. The headline result concealed a contrasting dynamic between households and businesses, as shown in our chart of the week (below). Underpinned by ongoing strength in the labour market, household spending accelerated from an annualised pace 1.1% in Q1 to 4.3% in the June quarter, led by the durable goods category.
However, as the Federal Reserve (Fed) continues to highlight, the risks to their baseline economic outlook reside mostly around business investment in response to trade tensions and weaker global growth. Those concerns are well-founded given that business investment fell sharply in Q2, driven mostly by weakness in spending on structures, and subtracted from overall economic output. Also indicative of the intensification of uncertainties businesses are facing, the boost to growth in Q1 from inventories and net exports was more than reversed in the June quarter. As a result, the Fed is all but certain to cut its benchmark interest rate target by 25 basis points to 2.0-2.25% next week.
Chart of the week
The other main development from abroad this week was in the UK, where Boris Johnson secured a comfortable victory in the Conservatives' leadership ballot to replace Theresa May as Prime Minister. It appears that the new PM will use the threat of a disorderly Brexit in an attempt to secure a new withdrawal agreement from the European Union, which he has said must exclude the Irish backstop solution to retain free movement of goods, services and people between Ireland (part of Europe) and Northern Ireland (part of the UK). Officials in Brussels were quick in rejecting such a proposal during the week, thus increasing the risk of a hard Brexit on October 31 and placing further pressure on the Sterling, currently trading at 2-year lows against the US dollar.
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In Australia this week, the highlight was a speech by Reserve Bank Governor Philip Lowe on "Inflation Targeting and Economic Welfare" to the Anika Foundation Luncheon in Sydney. The speech broadly outlined the factors weighing on inflation, both in Australia and offshore, but reaffirmed the RBA's commitment to its inflation targeting regime.
The governor highlighted that a substantial pick-up in workforce participation over the past couple of years had not been expected by the RBA and had meant that strong employment growth had essentially been met by new entrants into the labour force, thereby limiting the pace of wages growth and, in turn, inflation. Thus, soft inflation and the persistence of spare capacity had justified the Board's decision to cut the cash rate by a total of 50 basis points at its previous two meetings, which the governor said will "support demand in the Australian economy" in combination with "recent tax cuts, higher commodity prices, some stabilisation in the housing market, ongoing investment in infrastructure and a lift in resource sector investment".
In looking ahead, Governor Lowe said "the Board is prepared to provide additional support by easing monetary policy further" in order to help reduce spare capacity to support inflation returning to the 2-3% target. Markets are priced for an additional 25 basis point rate cut by year's end that would lower the cash rate to 0.75%.
The governor highlighted that a substantial pick-up in workforce participation over the past couple of years had not been expected by the RBA and had meant that strong employment growth had essentially been met by new entrants into the labour force, thereby limiting the pace of wages growth and, in turn, inflation. Thus, soft inflation and the persistence of spare capacity had justified the Board's decision to cut the cash rate by a total of 50 basis points at its previous two meetings, which the governor said will "support demand in the Australian economy" in combination with "recent tax cuts, higher commodity prices, some stabilisation in the housing market, ongoing investment in infrastructure and a lift in resource sector investment".
In looking ahead, Governor Lowe said "the Board is prepared to provide additional support by easing monetary policy further" in order to help reduce spare capacity to support inflation returning to the 2-3% target. Markets are priced for an additional 25 basis point rate cut by year's end that would lower the cash rate to 0.75%.
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