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US: The US is expected to grow well ahead of potential this year
Eurozone: GDP growth slowed noticeably in the first half of 2018
UK: UK growth did improve in Q2 and similar looks likely in Q3
China: The Q2 GDP print of 1.8 per cent and leading indicators show a continued stabilisation
Japan: The strong growth recovery in Q2 confirms that the Q1 stumble was temporary.
The US is expected to grow well ahead of potential this year, at around three per cent, boosted by the personal and business tax cuts. Strong growth fundamentals have continued to drive gains in employment, with the unemployment rate expected to fall further to historic lows. Wage growth has picked up, after a long period of stability, to around three per cent. We expect further wage gains as the labour market tightens.
There has also been a pickup in inflation, with core PCE now close to the Federal Reserve’s target of two per cent. We expect it to move above target in the coming months. The Fed is expected to continue to raise rates at a steady pace, with one more this year and another three hikes in 2019. The broader impact of tariffs implemented so far is likely to be limited, with growth at most a few tenths weaker over the next year and inflation a couple of tenths higher than would have otherwise been the case.
GDP growth slowed noticeably in the first half of 2018 and the rest of the year is not likely to see any improvement according to leading indicators. But a slowdown from last year’s stellar pace of growth was always likely and probably desirable as capacity buffers are coming into view.
Headline inflation is finally at target and although core inflation remains stubbornly low (around one per cent), the ECB has been encouraged by the drift up in wages across the Eurozone which should feed through to inflation more generally in coming months. Nevertheless, they remain relaxed about their tightening time table, perhaps signalling that they would happily accommodate modest inflation overshoots.
UK growth did improve in Q2 (+0.4 per cent) after the weak Q1 and something similar looks likely in Q3. That may be enough for the Bank of England to retain its modest tightening bias, but risks are skewed to the downside.
The cloud of Brexit continues to loom large, is clearly hitting business and consumer sentiment and threatens investment and employment increases in the future if the mood deteriorates further, as looks entirely possible. Inflation stopped falling over the summer, but a renewed down trend should resume in coming months. Subdued growth and lower inflation is not a combination that requires higher interest rates at this stage, even allowing for the UK’s poor supply-side picture.
Tighter credit in its effort to deleverage and curb excess capacity had the desired effect. Though the 1.4 per cent Q1 GDP print still spooked some observers, the 1.8 per cent recorded in Q2 and leading indicators show a continued stabilisation. Inflation is being pushed up by commodity prices, and the weaker exchange rate should also feed through to imports.
The main impact of tariffs in the trade conflict with the US will begin to be felt in Q4, and possibly intensify next year, and challenge policymakers to stimulate domestic demand and offset the negative impact of the external sector. Credit and fiscal measures are more likely than interest rate cuts or further FX manipulation.
The strong growth recovery in Q2 confirms that the Q1 stumble was in large part due to temporary factors. Strong wage growth is a bright spot, though pass-through to core inflation is far from guaranteed. Therefore, further policy tweaks by the BoJ look unlikely for the time being.
While the global environment is less favourable and net exports have been a drag, domestic demand can continue its good run. Rising incomes, front-loading of spending before next year’s consumption tax rise and solid capex momentum remain supportive of domestic demand.
In common with other countries Canada saw a weak Q1 GDP reading (1.4 per cent annualised) followed by a solid rebound in Q2 to 2.9 per cent. The star performer was exports although household spending also recovered, helped by the continuing resilience of the labour market, while investment expenditure growth slowed again.
Meanwhile, headline inflation hit 3 per cent in July, although core measures have been steady at just under 2 per cent. The BoC is expected to raise interest rates once more this year and retain a tightening bias in 2019. Looking ahead, the main concern is the outcome of trade negotiations with the USA, but if that can be resolved satisfactorily, GDP growth of around 2 per cent can be expected.
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