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In a highly significant move, the PBoC devalued the CNY to around 6.4 to the US$ this month and changed the mechanism for setting the daily reference rate. Key factors behind the CNY move were slowing growth and mounting pressure on exports from the sharp appreciation of the trade-weighted CNY, which rose 15% in the year to July. But depreciation pressures appear to remain strong amid a slowing economy and the stock market slide, forcing the PBoC to intervene in the market. And in further moves to bolster sluggish domestic demand and halt the stock market slide, the PBoC also cut the one-year lending rate again, by 25bp to 4.6% and it lowered the bank reserve ratio by another 50bp to 18%. But monthly data suggest that the economy remains weak; the correction in real estate continues unabated, industrial output growth has fallen back and the Caixin manufacturing PMI has slipped to a six and half year low of 47.1. We still expect GDP growth to average 6.6% in 2015 and then to slow to just below 6% in 2016, but with the main drivers of growth faltering the threat of a more pronounced slowdown in the Chinese economy is rising.
The contraction of GDP by 1.9% q/q in Q2 was not quite as bad as we had forecast, but still weaker than the consensus. Moreover, the breakdown indicates that the recession is much worse than the headline figure suggests.
The sharp downward revision to Q1 GDP was also worrisome, though at least points to improved consistency in data reporting, being more in line with other indicators.
Financial market volatility tempers consumer sentiment. However, we don't expect a significant "stock price" effect on consumer spending. With a domestic economy on a solid footing, rising consumer spending will support real GDP growth in the second half of the year.
Consumer spending trending above symbolic 3% pace for past twelve months. We see personal outlays strengthening in coming months on the back of stronger wage growth and robust employment.
Low interest rates and a fall in the savings ratio will support healthy consumption growth through 2016. Net exports will continue to make a positive contribution to growth, despite the recent RMB devaluation. The A$ is competitive and we expect it to depreciate further against the US dollar. But business investment, especially in the mining sector, will be a major drag on growth in coming quarters. We see GDP growth of 2.6% this year and 2.8% in 2016. Policy rates are on hold for the time being.
Although the events of the past month or so have strengthened the case for further monetary easing, we suspect that the ECB will not unveil any major policy changes at September’s interest rate press conference.
Despite ongoing fears about the economic outlook in China, the EC’s Eurozone Economic Sentiment Indicator strengthened further in August. This continues to support our view that the recovery may regain momentum in Q3.
Meanwhile, weak inflation numbers from Germany and Spain suggest that Eurozone inflation is likely to have eased in August from 0.2% perhaps to 0.1% or even zero.
Spain is enjoying very strong employment growth which is supporting consumption. However, the quality of the employment created so far is rather poor, with a prevalence of short-term, low paid contracts. This growth engine is not sustainable in the long run, as low wages combined with poor quality employment will restrict growth in disposable income. We remain sceptical about the benefits of recent labour market reform measures, although the true test will only come in the next downturn.
Target inflation fell to zero in July and may soon turn negative. Labour demand is strong, real household incomes are rising briskly and should underpin a consumer rebound in Q3.
GDP growth is likely to rebound in Q3, avoiding technical recession. Strong corporate earnings should help lift both wages and investment spending in the second half.
Key data elements
Target inflation (CPI excluding fresh food) slipped to zero in July (from 0.1%), avoiding the dip into deflation anticipated by the consensus. Excluding food and energy CPI inflation is higher at 0.6%. But all measures of inflation are well below the Bank of Japan’s 2% target. Elsewhere data on the labour market and household sector are positive with the unemployment rate falling back to 3.3% in July (from 3.4%). Labour demand is especially strong: the job-to-applicant ratio hit a new 23-year high in July at 1.21 (see chart). But the rise in monthly household spending was disappointing at 0.6% in July after a big fall in June.
Impact and outlook
“Back to deflation” headlines were avoided this month but there is an increasing risk that target CPI turns negative in coming months. Lower energy prices, plus China’s recent devaluation are the main downside risks. Over two years after the launch of QE the inflation target remains elusive: there is little prospect of the target being reached by mid-2016 – the current Bank of Japan forecast. On the real economy the data are encouraging and strengthen our view that recession – another quarterly GDP fall in Q3 – will be avoided. Of particular significance is the big jump in worker households’ real incomes – these are up 1.9% in July and 5.7% over the last 12 months (see chart). This supports our view that labour market earnings are now being significantly boosted by pay settlements and delayed bonuses. We expect consumption to recover modestly in Q3 after the large 0.8% quarterly drop in Q2. There are downside risks to the economy from China and financial market volatility. Prospects for consumption and investment are reasonable and we expect modest GDP growth through the second half of the year.
As expected, quarterly GDP growth in Q2 was left unrevised at 0.7%. But that growth looked pleasantly balanced, with net trade making the biggest contribution to output in over four years. Granted, the recent turmoil in China and other pressures on exporters point to support from overseas tailing off. But tailwinds to domestic activity mean that we stick with our view that GDP will rise by at least 2.6% this year.
Three cheers for the US economy! Q2 GDP growth pushed up to 3.7% on broad-based upward revisions. Strengthening private sector activity will support solid growth in the coming quarters, though the headwinds of weak global demand, stronger US dollar, and reduced oil capex will remain present. The economy will likely grow 3.0% in H2.
China’s slowdown now threatens to produce a significant global deflationary shock. Markets are waking up to the reality that Chinese growth is much weaker than headline figures claim – perhaps as low as 3% in H1 – and that ‘policy easing’ steps so far have had little impact. The recent depreciation and further slide in Chinese stocks are also major blows to the credibility of Chinese policymakers. Much more aggressive policy moves, including perhaps significant further depreciation, are needed to change the picture.
Chinese stocks have now collapsed by 40% from their May peaks, with the authorities apparently abandoning efforts to prop up the market. Meanwhile, pressure for further depreciation remains strong. This may prove hard to resist, especially as further monetary easing moves such as cuts in interest rates and bank reserve requirements – which are very likely – will tend to intensify depreciation pressures.
Weakness in China is contributing to a generalised negative picture in emerging markets, especially through weaker commodity prices, and has also hit stock markets in the major economies. Arguably, many of the effects we assumed in our China downside scenarios in May and June have now materialised. World growth in 2015 looks increasingly likely to undershoot 2014’s level – and measured using ‘alternative’ estimates of Chinese GDP, world growth could undershoot 2%.
Initial economic growth estimates for Q2 revealed that GDP was unchanged on the quarter, confirming our view that Q1’s momentum would not be sustained. A sharp deceleration in consumption growth was a key factor behind weaker Q2 performance, pointing to a fading of the boost delivered by lower oil prices. But both investment and stock building were also both scaled back. However, we expect GDP growth to bounce back next quarter from the weak Q2 base. The external environment is set to improve further throughout the second half of 2015, thanks to a weak euro and the strengthening Eurozone recovery. And with business sentiment, operating margins and access to credit all improving, investment looks reasonably well placed to recover, too – though the full impact may not materialise until next year. Overall, we have left our GDP forecasts for 2015 and 2016 largely unchanged at 1.3% and 1.7%, respectively. But the recovery remains dependent on the external backdrop, and although the risks associated with a Greek exit from the Eurozone have receded somewhat, worries over the outlook for emerging markets and China in particular have intensified.
The events of the past month have led us to push out our call for the first UK rate hike from February 2016 to May 2016. This week’s financial market turmoil was the final straw, but the dovish minutes of the August MPC meeting, the enduring strength of sterling and the likelihood of lower inflation over the next six months had already been pushing us in this direction.
This is a modal forecast which is consistent with our baseline forecast playing out. But the escalating downside risks would imply a mean forecast which shows the first rate hike coming later and the path of monetary tightening being shallower. This explains why the expectations of financial markets may appear to be more bearish than our own.
Although credit growth rates remain modest, private sector lending continues to improve in line with our view. Furthermore, business lending data showed positive growth for the first time since 2012, a very encouraging sign amid the current difficult global environment and a necessary pre-requisite in order to see investment picking up the baton in the Eurozone.
Spain’s detailed GDP breakdown confirmed the previous 1.0% rate and corroborated the strength of the Spanish economy, with household consumption, investment and exports all growing at very strong rates.
GDP growth accelerated in Q2, rising 5.6% y/y after posting 5.0% y/y in the previous quarter. This was largely driven by a rebound in government expenditure, particularly on infrastructure investment. By contrast, export growth continued to slow, a trend consistent with weak trade flows evident across the region.
Despite ongoing weak external demand, we still expect GDP growth to pick up modestly over H2 2015 and into 2016, reflecting strong fiscal spending and solid household consumption. However, the risks are skewed to the downside, with the possibility that upcoming government infrastructure projects are once again delayed. Furthermore, the fragile external environment also poses a threat to the outlook.
Although the German economy picked up only modestly in Q2 after a disappointing Q1, the data available for Q3 look more encouraging. But while we think that the economy will expand at a faster pace in H2, events in China suggest that the downside risks to growth are mounting. The GDP expenditure breakdown for Q2 confirmed that the pick-up in quarterly growth to 0.4% occurred despite a slowdown in domestic demand growth, with exports expanding by a healthy 2.2% in Q2 – the strongest quarterly rise since 2010. Orders data and survey-based measures of exports paint an upbeat picture for Q3. Overall, we still expect the pace of GDP growth to pick up in H2 – our forecast is for GDP growth of 1.7% this year and 2.1% in 2016. But while the threat of a possible ‘Grexit’ may have receded for now, significant downside risks to growth remain, most notably from the mounting danger of a hard-landing in China.
Worsening fears of a significant China slowdown and questions about the government's ability to prop up the economy, led to widespread investor panic on Monday. As we have cautioned previously, the Asian giant's slowdown could weigh severely on emerging markets growth, and in turn slow Europe and the US. In the current context, we view the odds of a September rate hike as lower than 50%, but still higher than 25% as currently priced by markets.
The timely survey data suggests that for now at least, Eurozone businesses and consumers may be shrugging off growing concerns about China and Emerging markets. But the fragile Eurozone recovery remains susceptible to shocks. Not only could a China crisis threaten the current recovery from broadening to investment and exports, it could also undermine the effectiveness of the ECB’s QE programme. There is now a significant chance that GDP growth will be weaker next year than this.
Durable orders surprise on the upside despite global headwinds. More importantly, core orders and shipments point to resilient domestic business investment.
The economies of Central and Eastern Europe have continued to perform well compared to other parts of Europe in recent years – not least due to investment, which has grown by a solid 5% per year since late 2013. Despite a near-term slowdown, we see the CEE region continuing to register relatively strong growth in the medium-to-long term, with both investment and consumption remaining supportive.
The near-term slowdown will be to a large extent driven by the ending of the current EU funding programme in 2015. This will see public investment slow significantly, exerting a 0.4-0.5pp drag on economic growth in 2015 and 2016 compared to before. Meanwhile, although consumption will remain reasonably strong, its growth rates will also ease as the boost from lower oil prices tapers off.
To soften the negative impact on GDP growth overall, it will be particularly important for Eastern European economies to sustain private sector investment, which has been strengthening since 2014, albeit still outpaced by public sector investment. Encouragingly, rising corporate operating surpluses suggest that the outlook for private investment is positive, although anaemic credit growth (except in Poland) remains a downside risk.
In the medium-to-long term, however, we believe that Eastern European economies’ lower exposures to the slowdown in China, solid bank balance sheets and low external imbalances – which in turn make them less vulnerable to US rate hikes – leave the region well positioned to benefit from improving activity in the Eurozone, before the next round of EU funding gathers steam. Robust growth in fixed investment should resume as a result.
Based on mortgage debt and house price data, there are currently no housing bubbles; but developments in Hong Kong, Brazil, Sweden, Denmark, Norway and Germany, as well as just possibly the UK, bear monitoring for the future. Negative interest rates in some countries add to these concerns.
Monetary policy over the last 25 years raises the question whether an advanced economy can grow without some form of asset price bubble. We will investigate this in a series of Research Briefings; and also whether asset price bubbles are a Bad Thing or a Good Thing.
Not all price surges are bubbles. Not all incidences of rapid credit growth lead to a bubble. But all asset price bubbles are preceded by rapid credit growth. Credit and money developments are therefore crucial to analyzing asset price bubbles.
Weaker Chinese activity and recession in Brazil and Russia have depressed world trade this year, dampening activity in East Asia and outweighing the boost from lower oil prices. For East Asia, the weakness in Chinese imports has major repercussions, both because China is a key trading partner and because these economies are important trading partners for each other. Demand for machinery and equipment, particularly cars and electronics, has fallen, with little relief in sight. Indeed, risks are weighted towards the downside, given CNY devaluation, market turmoil and escalating fears about the Chinese economic outlook.
However, within the context of a general lowering of growth forecasts and associated issues (including the outlook for currencies and interest rates), it should not be overlooked that the longer-term prospects for the region remain relatively positive.
As a key player in the global economy and an increasingly important market for UK exports, a prolonged slowdown in the Chinese economy would hit the UK’s growth prospects.
But the risk of a Chinese ‘hard-landing’ could also deliver benefits for the domestic economy, via cheaper commodities and by staying the MPC’s hand in raising interest rates. Simulations using the Oxford Global Economic Model suggest that a structural hit to Chinese growth would be a net negative to the UK, but less so than for many other economies.
The 0.3% quarterly rise in Q2 GDP was weaker than Q1’s 0.4%, but was still better than the average increase in 2014. A key factor behind the slowdown was probably weaker household spending – a sign that the main impact of lower oil prices is beginning to fade. Indeed, Q2 retail sales rose by a modest 0.3% and consumer sentiment fell sharply in July. That said, the renewed fall in the oil price recently should help to limit the rise in CPI inflation in H2 2015 and, with other drivers of spending likely to remain supportive, private consumption should continue to expand at a solid pace compared with recent years. For 2015 as a whole, we now expect GDP to grow by 1.4%, a touch weaker than last month, before renewed acceleration to 1.8% in 2016.
Consumer confidence rebounds strongly in August, with gains in both the present situation and expectations sub-indices driving the advance. Slowly accelerating wage growth and rising employment should drive a solid advance of household spending in the latter half of 2015.
New home sales rebound in July supported by solid income growth and still-high affordability. Looking ahead, tight inventories will spur additional construction which should boost the housing sector's contribution to GDP growth.
The PBoC cut both the lending and deposit rates again by 25bp to 4.6% and 1.75% respectively. In addition, it lowered banks’ reserve requirement ratios by 50bp.
This follows rate cuts by the PBoC in March, May and June and indicates escalating official concern about the economic outlook. But given the multiplicity of downward pressures on growth, a large fiscal stimulus is becoming increasingly likely.
A fresh downward revision to our global oil price forecasts, for both the short and medium term, points to a new, sizeable external and fiscal shock to Venezuela that will aggravate the country’s already desperately bleak economic outlook. The government is expected to devalue the currency further in order to boost revenues and reduce excess demand for imports and dollars. The adjustments will be a further blow to an economy already in freefall.
We now expect GDP to fall by 4% in 2016 after a 6% contraction this year, amid very high inflation rates. We are pencilling in a modest rebound in 2017 – that gathers pace in 2018 – but this assumes a turnaround in economic policy and the absence of serious political instability.
Although the German Q2 GDP expenditure breakdown revealed that domestic demand contracted in Q2, the sharp increase in exports supports the view that the weak euro is insulating the economy from ongoing external weakness in emerging markets. Given this and the improvement in both the headline and services Ifo indices, we still expect the recovery to pick up a little bit of momentum in H2.
The Indian economy started Q3 on a positive note, with July data showing improving PMI surveys and car sales registering double-digit growth. As a result, the Reserve Bank of India (RBI) ‘paused’ policy in August and appeared more optimistic on the country’s growth prospects. However, we remain fairly cautious. Several alternative indicators of growth, such as rural demand, credit growth and imports excluding oil and gold, remain subdued – underscoring our view that growth is still far from dynamic. The RBI did leave the door open for future interest rate cuts and many analysts are now highlighting the possibility of an inter-meeting cut, in line with our view. The trigger for this was the dip in consumer price inflation to below 4% in July. That said, we think that the timing of the next rate cut is now more dependent on global developments and the outlook for the rupee, rather than on domestic data.
A deepening contraction in the second quarter pushed the decline in Russia’s real GDP to 3.3% in the first half of the year, in line with our expectations that the economy will contract by 3.5% in 2015 as a whole. Consumption spending continued to fall sharply during Q2, while investment demand was hampered by persistently high credit costs amid renewed geopolitical tensions and an increasingly hostile global financial and economic environment. Moreover, the risks to the forecast have increased recently, with slumping oil prices and the possibility of a Fed rate hike pushing the rouble down to a six-month low. The chances have increased that the Central Bank of Russia may pause its easing cycle in September, which would keep lending conditions tight for households and businesses. This would delay any potential recovery in consumption and investment, and reduce the likelihood of the economy achieving our current baseline forecast of 0.8% growth in 2016.
Consumer prices through mid-August rose by 0.6% m/m, the highest for the month since 2004, taking the annual rate to 9.5%With further BRL depreciation likely, inflation should not abate anytime soon
In this months global macro chart book we highlight our key calls, summarise selected research and assessments and provide our latest favourite charts
At 54.1, the flash composite PMI edged up in August, well above the 50 mark that separates expansion from contraction. Today’s data releases point to the continuation of the recovery in the Eurozone and bode well for our forecast for Q3, at 0.5% over the quarter. Encouragingly, although growth was subdued in France, it expanded in Germany and elsewhere in the region on the back of improving domestic demand and a more favourable external environment.
The first July surplus for three years provides further evidence that a stronger economy is allowing the public finances to steadily improve. With prevailing economic conditions supportive and the additional tightening announced in the ‘Summer Budget’ still largely to take effect, there is a good chance that borrowing in 2015-16 as a whole will undershoot the OBR’s full-year forecast of £69.5bn.
Q2 GDP contracted by 0.4% q/q, with consumption and exports the main sources of weakness. The consumer is likely to rebound modestly in the second half. Labour market earnings should be boosted by July bonuses and back-dated pay settlements. The external picture is clouded by the slowdown in China, destination for just under 20% of Japan’s goods exports. But other export markets, such as the US and UK should underpin overall exports. We continue to forecast 0.8% GDP growth in 2015 and 1.8% next year. The BoJ is likely to extend QE later this year, to an annual rate of ¥100trn (from ¥80trn).
The flash Caixin manufacturing PMI index slid to a six and half year low of 47.1 in August, underscoring the sharp deceleration in industrial activity experienced this year. While the Chinese authorities will be hoping that last week's devaluation in the RMB will help stop the ongoing decline in activity through stronger exports, it fails to address the much larger real effective rise in the exchange rate experienced over recent years.
We expect the Chinese authorities will announce additional easing measures in the months ahead, including additional interest rate cuts and further reductions in the reserve requirement ratio.
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