Economic Update - August 2023

This was the month that disappointment in China’s missing economic rebound turned into schadenfreude shock over further dire developments in its property market. Meanwhile, Australia and the US continue to chug along with slowing inflation and economic growth. 

What happened in Australia?

The RBA is in a holding pattern as it paused interest rates again in August. The economy continued to slow and inflation continued to decrease. Is the RBA hoping that it won’t need to raise interest rates again in this cycle? Can the new governor, Michele Bullock, ride inflation all the way back down to 2 percent?

There are several signs that the economy is slowing. Apart from services, consumers are spending less. Retail turnover fell for the third straight quarter in June with a 0.5 percent fall (see chart below). This is the first time since 2008 that retail turnover has fallen for three consecutive quarters.

Consumer spending on goods fell -1.2 percent in July on an annual basis. Non-discretionary spending fell -0.7 percent in July, the third month in a row. However, spending on services and non-discretionary items were up 4.6 and 4.2 respectively. This likely reflects the sticky inflation in services and food rather than increases in demand.

While consumers continued to spend less, the labour market remained strong. Unemployment increased slightly from 3.5 percent to 3.7 percent seasonally adjusted. Given this, the RBA knows politically and economically that it can continue to hold interest rates higher.

The best news for the RBA during August was to see a decrease in the Wage Price Index and monthly inflation. Monthly inflation fell from 6.1 percent in June to 5.8 percent in July on an annual basis. Housing inflation decreased slightly from 7.4 percent in June to 7.3 percent in July. The Wage Price Index rose 3.6 percent in the June quarter, slightly less than the March quarter (see chart below). Has wage growth peaked? If it has, this would further reduce the case for further interest rate increases.

What happened around the world?

USA

The US continues to stay in the goldilocks zone where everything is “just right”. Data releases in August showed a continuing decrease in inflation and a slowing economy. There is spring optimism in the air! A survey by the National Association for Business Economics (NABE) found that two-thirds of its members are now confident of a soft landing.

US inflation increased from 3 percent to 3.2 percent on an annual basis but this was mostly due to what was happening a year ago rather than what is happening now (base effects).

Most inflation categories showed moderate increases or decreases on an annual basis. The key exception was shelter which showed a 7.7 percent increase over the year. Shelter represents about a third of the overall index. However, the shelter index has a 12-month lag and commentators are encouraged by a recent cooling in rental and house prices.

The strong labour market is starting to show some signs of losing steam, which is good for the inflation outlook. For the third month in a row, nonfarm payroll came slightly under expectations in August with 187k (see chart below). Further, Unemployment rose from 3.5 to 3.8 percent in August. 

 All this suggests that the Fed will keep rates on hold in September, barring other news (like an increase in the price of oil!). This logic is supported by a continuing easing of national financial conditions (see chart below).

China

China-pessimism turned into China-fears in August with attention focused on the Chinese property market.

“What is happening in the Chinese property market is really unprecedented,” Charles Chang, S&P's Senior Director and Greater China Country Lead for Corporate Ratings.

Struggling property giant Evergrande filed for US bankruptcy in August while fellow giant Country Garden announced that it was expecting losses of USD 7.6 billion for the first half of the year. During the month, it missed some payments to creditors and reportedly has over USD 200 billion in debts outstanding.

Rather than helping moderate the property sector, the Chinese government’s tightening of lending conditions for property companies in 2020, has pushed the sector into chaos. Property developers  who were running Ponzi-like financial models have come unstuck. Local governments who had become addicted to revenue from land sales are now crying poor to the central government. And at the bottom, individual apartment “owners” are paying mortgages on properties that may never get built (see chart below). As a result property prices have crashed with reports of decreases of over -25 percent in some cities.

Once an engine of growth, the property sector and its debt is now a millstone around the neck of China. Several major investment banks have now reduced their 2023 GDP estimates for China to below 5 percent. Those prone to hyperbole are calling the end of the great Chinese boom. 

EU

Inflation was steady at 5.3 percent in July and unemployment was steady at 6.4 percent.

However, Q2 GDP grew by just 0.2 percent on a quarterly basis.

After two quarters of negative GDP growth, the German economy was flat in Q2 but S&P’s flash German PMI composite index for August showed the steepest decline in business activity since during the pandemic in 2020 (see chart below).

Despite the signs of a slowing euro area economy, the ECB remains committed in its focus on fighting inflation.

Japan

Japanese GDP for Q2 surprised on the upside with a 1.5% increase on a quarterly basis. Leading the way were exports, which have benefited from a weaker Yen against the US dollar so far this year. Private and government investment were also up.

Inflation remained steady at 3.3 percent in July. Governor Ueda said that he wants to see underlying inflation reach 2 percent. Weighted median inflation was 1.6 percent in July. The BOJ expects headline inflation to decrease over the rest of the year. However, If Japanese growth can continue to surprise, Governor Ueda may just get his wish of higher inflation.

UK

Inflation fell dramatically in July, falling from 7.3 percent in June to 6.4 percent in July. This should relieve some pressure on the Bank of England. GDP increased 0.2 percent in Q2 on a quarterly basis. Revisions to GDP also showed that the UK had recovered from the pandemic faster than expected. These results were seen as good news for an economy that has recently taken a battering.

What this means for Australian Private Debt

A soft landing seems increasingly likely in the US and Australia. This is good news for the Australian private debt market, which can continue to enjoy high interest rates and reasonably good business conditions. However, developments in China are a concern and could pose risks for Australian exports and the economy going forward.