Economic outlook

Global economy

The US business cycle continues to expand. Employment is growing, economic growth is moderate, and share and real estate prices are rising. With inflation below target, prospects are good that this expansion can achieve a record length. The main risk to this scenario is that the Federal Reserve (Fed) tightens credit too sharply—not by raising rates but curtailing credit growth in the private sector.

Economic activity in the eurozone is finally near potential. This is largely a result of the European Central Bank’s (ECB) asset purchase program. However, commercial banks will need to create credit more rapidly than at present, otherwise credit growth could weaken substantially when the ECB starts to slowly reduce its purchases. Eurozone inflation remains below target, reflecting the slow overall demand in the economy.

UK economic growth has slowed due to the weaker pound, raising inflation and eroding real (inflation-adjusted) wages. While investment and capital inflows have slowed, export order books are buoyant.

In the Asia-Pacific region, the Japanese economy has seen slightly better growth in 2017. However, inflation remains well below two per cent despite the implementation of a massive and sustained quantitative easing (QE) program from the Bank of Japan.

China has continued to alternate between squeezing and easing credit with the aim of keeping the economy on the rails ahead of the autumn congress of the Chinese Communist Party. Restrictions on capital outflows and the encouragement of more inflows have helped stabilize the currency in recent months.

Looking ahead, the global business cycle expansion remains intact, supported by ongoing growth in the US, a gathering upturn in the eurozone, and the start of a renewed upswing in global trade. The expansion among developed economies is benefiting the export-oriented, manufacturing economies of East Asia, the Americas, and some of the commodity-producing emerging economies. There is good reason to expect that the current expansion will be an extended one, perhaps the longest in US financial history (exceeding even the 120 month expansion between March 1991 and March 2001). The only real threat to this prospect is that central banks may make a mistake and tighten too much as monetary policy returns to normal.

Australian economy

The Australian economy is growing in line with the Reserve Bank’s forecast. Growth in consumption and the contribution from net exports was higher in the June quarter than the March quarter, and the decline in mining investment has mostly passed.

Household consumption growth has picked up despite ongoing weakness in income growth. Employment growth has been strong in all states and is expected to support income growth, and therefore consumption growth, over the coming months.

Price pressures were subdued across the economy in the June quarter, though retail electricity prices are expected to increase significantly in the September quarter. Housing market conditions continue to ease in Sydney and Melbourne but remain broadly unchanged in other cities.

Looking ahead, the outlook for employment over the next six months is positive. Job creation in the construction sector could prove to be an engine of growth over the medium term. Sharply rising infrastructure investment in NSW and Victoria will also help lift wages, stimulating consumer demand.

Actual versus forecast growth rates for key global economies are set out below (figures in brackets are Invesco’s forecasts):

Implications for Australian investors

While growth is more synchronous across the key global economies, ongoing uncertainty leads us to support the move away from traditional asset classes into alternative sources of return and risk. These include high conviction and benchmark-unaware strategies, as well as diversification into strategies with greater offshore exposures to mitigate the pronounced home country bias many Australian investors have. We also favour floating rate over fixed rate investments, implemented by investing in senior secured corporate loans at the expense of government bonds, which are at risk of posting negative returns over the medium term as interest rates inevitably rise.

Source: Invesco, as at 19 October 2017