Economic outlook

International shares

International shares swung between strength and weakness owing to ongoing trade tensions between the US and its trading partners, particularly China.  The US has used harsher rhetoric surrounding trade tariffs with the EU, Canada and Mexico and tensions rose. This weighed on business sentiment, particularly in the manufacturing industry, which is more exposed to direct tariffs. The US dollar continued to rise during the quarter, appreciating against major trading partners. This can be linked to the underlying strength of the US economy and the growing gap between interest rates in the US and other developed nations. The US Federal Reserve hiked interest rates a further 0.25 per cent to two per cent at the end of June.

Despite these issues, the underlying economic backdrop has remained positive during the quarter. This was led by the US, where strong GDP growth is expected for the June quarter as jobs growth continues at high levels. Global manufacturing and service indexes continue to remain in expansionary territory. However, points of softness can be found. In Europe, the economic momentum visible in January has tapered off and inflation remains subdued despite stimulatory monetary policy.

The Chinese economy showed some signs of slowing as industrial production and retail sales data fell below market expectations. Surveys of businesses have highlighted that trade tensions have negatively affected sentiment and this could cause China’s economy to slow. China’s economy continues to grow strongly – with the latest Gross Domestic Product (GDP) showing growth of 6.7 per cent – which is a positive sign for continued strong demand for Australian exports, particularly mining and education.

Australian economy

The Australian economy grew strongly, up 3.1 per cent in the year to March 2018, driven by strong Government spending on infrastructure as well as demand for Australian mining exports. Despite this, the outlook looks weaker for growth in the future owing to stagnant consumer incomes.

Wage data highlighted this situation with annual growth of only 2.1 per cent, in line with inflation at 2.1 per cent. This means individual incomes are just keeping up with general inflation leaving less capacity for additional spending. The Reserve Bank of Australia (RBA) is optimistic this situation will change given strong demand for workers and high business confidence. The demand for workers has not yet turned into sustained wage increases indicating there is a lot of ‘slack’ in the labour market. Underemployment, which is a measure of the amount of people that would work more hours if they could, remains at elevated levels. This points to a surplus of manpower that businesses can still use without having to offer more money to attract new hires, thereby keeping wages lower for longer. The RBA has said it expects any shift towards higher wages to be gradual, taking place over years rather than immediately.

Low wage growth does not necessarily mean low mortgage rates as banks need to borrow from overseas markets to fund their lending in Australia. In recent weeks, the cost of overseas funding has risen and this has flowed onto Australian borrowers. Several banks have raised mortgage rates in response to their higher funding costs.

The Australian dollar has depreciated substantially over the last three months. A few factors are responsible – the strength of the US economy relative to our own, the growing interest rate gap with US rates, currently 0.5 per cent, and concerns over trade tariff disputes and the negative implications for our major trading partner, China.

Source: IOOF