Key insights from the week that was.
As COVID-19 uncertainty gripped markets this week, two key GDP partials were released in Australia.
A disappointing read on construction came first. Activity in the sector fell 3% in the three months to December as a lift in public work was overrun by a material decline in private sector activity. Specifically, new home construction and commercial building were off around 5%, while infrastructure work fell 3%. It is possible that activity in the quarter was impacted by smoke from summer’s bushfire emergency. However, activity contracted in all of the states, not just the south-east where the fires were located.
This decline in construction will have a material impact on next week’s Q4 GDP outcome, although an upside surprise in equipment investment looks set to offset.
Versus our expectation for a 0.5% decline in the three months to December, spending actually rose 0.8%, according to the Q4 CAPEX survey. By sector, mining investment looks to be stabilising, an emerging uptrend building after six years of decline. Investment by the services sector however is under pressure given weak domestic demand and global uncertainty.
With these two key partials in, our Q4 GDP forecast is unchanged at 0.5%. Domestic demand is set to contribute just 0.1ppt, net exports 0.2ppts and inventories 0.1ppts. The statistical discrepancy rounds GDP growth to 0.5%.
The CAPEX survey not only provides a guide on spending in the most recently completed quarter, but also plans for the current and coming financial years. The respective fifth and first estimates of investment plans point to disparate outcomes for mining and services.
For 2019/20, an 11% gain is projected for mining while services investment is anticipated to fall 3% — for a 1% gain overall (based on average realisation ratios). Come 2020/21, the divergence is even more stark, a 21% gain for mining against a 2% lift in services investment.
As highlighted in the CAPEX bulletin, while we are comfortable with the view that mining investment will accelerate, this first read on 2020/21 may prove optimistic. There is often a wide discrepancy between early estimates and the final investment reading. We also must note that these outcomes do not take COVID-19 into consideration. The outbreak could see businesses hold back on expansion, with a greater impact on 2020/21 than 2019/20 given the latter is near its end.
Data released over the past week elsewhere has been of limited significance. COVID-19 has therefore essentially been the sole focus of markets. While available data on the outbreak points to it continuing to come under control in China, a spate of cases across Europe, principally in Italy, and a further material increase in cases in Asia ex China, primarily South Korea and Japan, has unnerved markets.
While still not regarded as a pandemic by the World Health Organization, very clearly, the wider the spread of the virus, the greater its economic impact.
When we revised our global growth forecasts to incorporate an initial estimate for COVID-19, we highlighted that half the 0.2ppt shock to world GDP we saw (taking 2020 growth down to 2.8%) came as a result of the decline in activity in East Asia (ex China) manufacturing and services (domestic consumption as well as tourism and education exports). If the current outbreak in the region persists, there is a clear risk this estimate will prove an underestimate of the virus’ effect on both the region and the global economy.
Similarly, Europe’s economy is in a fragile state after being worn down by global trade tensions during 2019. There is therefore the risk that current uncertainties shock their economy as well, with households across the world likely becoming increasingly uneasy over traveling to parts of the continent. Arguably the impact will be concentrated in the region of Italy near Milan where the majority of cases have been reported, particularly now that travel restrictions have been put in place. The additional case seen in other locations could however also see would-be tourists avoid travel elsewhere, even though these cases are limited in number. Note, of the near 2,300 cases reported outside of China (78,500 cases) and South Korea (near 1,800 cases), Italy has reported around 530 cases; Germany has the second highest number of cases, but at just 26 it is a small fraction of the outbreak in Italy, let alone Asia.
As yet, there has not been a significant outbreak of the virus in the US. However, its spread elsewhere has certainly alarmed investors (the S&P500 down 12% from last week’s historic high) and also led to FOMC officials more clearly articulating the risks for the US and global economy. It should also be noted that the Markit services PMI out at the end of last week signalled that the US economy is not immune from a loss of Asian demand for service exports, particularly tourism and education. The 49.4 reading was the weakest since October 2013 and signals an outright contraction in activity in the sector in the month of February. We have long held that three federal funds rate cuts were justified in 2020 on the outlook for growth and inflation, beginning June 2020. Current developments provide further justification for such a course.
In coming weeks, we will continue to assess incoming data and information. The official China PMI’s for February out over the weekend will be the first new signal to consider.
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