Domestic demand remains the main growth driver. A breakdown of first-quarter GDP shows that all domestic demand components contributed positively to growth. Household spending was particularly buoyant having slowed in the fourth quarter. It had been penalised by factors whose effects have since dissipated, such as the Paris attacks, the fall in seasonal clothing sales and lower energy consumption due to the mild weather.
However, levels of business are being held back by foreign trade due to a subdued global economy. Robust domestic demand has led to an upturn in imports which has not been matched by exports, meaning that foreign trade has actually dragged somewhat on growth, despite a record trade surplus. This can be explained by lower import prices, which cancel out the effects of the rise in import volumes.
Labour markets are still improving and should continue to buoy consumer spending. In the first quarter, employment in the Eurozone rose by 1.4% year-on-year from 1.2% in the fourth quarter, its fastest pace since the first quarter of 2008. The unemployment rate stabilised at 10.2% in April.
Surveys suggest an ongoing upturn in the second quarter but at a slower pace than in the first. With a preliminary estimate of 52.8 for June versus 53.1 for May, the Eurozone’s composite PMI is consistent with annualised quarterly growth close to 1.5%, which remains strong but slower than the 2.2% growth posted in the first quarter.
Brexit’s impact on the Eurozone’s economy is likely to be relatively limited. The risk of contagion via foreign trade is limited, as exports to the United Kingdom represent only 2.7% of Eurozone GDP. The Eurozone’s growth loss should be in the region of 0.3-0.4%, compared to a growth trend in the region of 1.5 to 2.0% over the next twelve months. Although it seems unlikely that Eurozone investment will be significantly affected by the heightened uncertainty surrounding the UK, changes in financial conditions and any impact on confidence levels will need close monitoring.
Although May’s job creation numbers appeared very disappointing, the data needs putting into context. Only 25,000 new private sector jobs were created, the poorest figure since the end of 2010. Even when the drag effect of strike action at Verizon is removed, job creation would only have reached 60,000, far below the 168,000 jobs created on average per month for the first four months of 2016. A slowdown in jobs creation is not to be taken lightly but this data series is notoriously volatile and other labour market indicators have been more positive, such as the low levels of weekly jobless claims numbers registered for the first three weeks in June.
The unemployment rate has fallen and wages are showing signs of picking up. A lower labour force participation rate saw the jobless rate in May drop from 5.0% to 4.7%, which matches the FOMC members’ median forecast for the end of 2016. Average hourly earnings growth data from the non-farm payrolls report has settled at 2.5% year-on-year, but other indicators are suggesting a gradual pick up in the pace of wage growth, in particular that of the Atlanta Fed, which is less subject to composition effects.
The rebound in US growth continues into the second quarter. May ISM index reports are mixed but healthy retail sales for April and May show that household spending is accelerating, and mining production also moved up for the first time after eight straight months of falls. Real-time forecasts are pointing towards second-quarter growth figures nearing 2.5% on an annualised basis, compared to +0.8% in the first quarter.
Against this backdrop, the Fed left rates alone in June, and the likelihood of rate hikes at forthcoming meetings has clearly fallen. The surprisingly weak job creation data and the then imminent UK referendum on whether to remain in the EU resulted in the Fed keeping its rates on hold during its June meeting. Now that the Brexit risk has become reality, it is even less likely that the Fed will raise rates at its forthcoming meetings. The Federal Open Market Committee members’ median forecast is for two rate hikes between now and the end of 2016, but members’ forecasts are more divided than before. Now six members expect a single rate rise as compared to one previously. With the target rate over the long term lowered from 3.25% to 3.00%, the FOMC members are now only forecasting three rate rises for 2017 and 2018.
Following a pause in China’s economic growth rebalancing, both investment and credit numbers fell in May. Given that accelerating investment and credit activity in recent months had raised concerns that the authorities’ focus on sustaining short-term growth was aggravating economic imbalances, May’s slowdown can be seen as somewhat reassuring.
The gap between public and private investments is widening. Public investment, which accounts for over a third of total investment spending, continued to grow rapidly in May (+19.8% year on year), albeit at a slightly slower pace than in April. However, private investment only crept up 1% over the year having reached 10.1% in 2015, and the slowdown is worsening.
Overcapacity reduction is advancing. Narrowing producer price deflation and the slowdown in manufacturing investment are consistent with a reduction in excess capacity.
Manufacturing investment accounts for a third of total investment and the falloff heavily impacted May’s investment growth numbers. Industrial production remained stable at +6.0% year-on-year.
The property sector upturn has tailed off. Investment growth in the sector slackened in May, as did housing sales and new builds, although volumes nonetheless remain healthy. Uncertainties surrounding sector-linked VAT reforms may have stimulated transaction levels and a fallback is now possible.
Household spending picked up again to a healthy pace and conditions in the labour market appear stable. May’s upturn in retail sales volumes was due to an improvement in car sales, up 9.7% year-on-year. The National Bureau of Statistics (NBS) announced that going forward it would hold a monthly press conference to detail changes in the country’s economic and social conditions. At its latest press conference, the NBS revealed that 5.77 million jobs had been created during the first five months of 2016, achieving 57.7% of the government’s annual target.
The opinion expressed above is dated June 2016 and is liable to change.
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