Key insights from the week that was.
In Australia, Q2 GDP confirmed the economy is starting to turn a corner, rising 0.6% to be up 1.8% over the past year. The fact that household spending was the main driver of growth, up 0.9% and 2.0%yr, was perhaps the most encouraging revelation of the detail. Although this was partly due to abnormal seasonality and sales events, corroborated by a stronger lift in discretionary services spend, this result still marks a welcome and genuine shift. The steady recovery in real discretionary incomes is playing a crucial role, supported by continued gains in wages, moderating inflation, shrinking interest bills and tax relief.
Trends across the rest of the economy were little changed. Public investment continues to retreat from record highs as major infrastructure projects near completion. Though, this looks to be facilitating capacity rebalancing in the construction sector towards housing. Worryingly, businesses remain hesitant to invest in additional capacity, as evinced by the –0.4% decline in new business investment in Q2.
The external sector meanwhile provided a slight boost to economic activity in the quarter, net exports adding 0.1ppts to GDP. This support looks to have extended into Q3, July’s goods trade surplus of $7.3bn a seventeen-month high on the back of stronger exports to the US as well as softer imports. Globally, trade networks are adapting to US tariffs, but it will still be some time before the ‘new normal’ is fully understood. Our latest edition of ‘talking about trade’ takes stock of the latest developments in global trade and economic activity.
Before moving offshore, a final note on housing. The latest Cotality (formerly CoreLogic) data showcased another solid gain for house prices in August, up 0.8% (3.6%yr), highlighting the positive impetus rate cuts provide. Although dwelling approvals surprised to the downside with an –8.2% decline – due to continued volatility in the ‘units’ category – conditions are becoming more supportive as cost pressures ease and homebuyer sentiment strengthens. Affordability constraints remain the key risk to the uptrend, as discussed in our latest Housing Pulse.
Offshore, the data flow was light in the lead-up to tonight’s much-anticipated US August employment report. Of the releases to date, the US Federal Reserve’s latest Beige Book was most significant, providing another downbeat view of current conditions and the outlook.
“Most of the twelve Federal Reserve Districts reported little or no change in economic activity… and contacts reported flat to declining consumer spending because, for many households, wages were failing to keep up with rising prices”. Contacts also “frequently cited economic uncertainty and tariffs as negative factors”. On the labour market, “eleven Districts described little or no net change in overall employment levels”. Only “two Districts reported an increase in layoffs… but contacts in multiple Districts reported reducing headcounts through attrition—encouraged, at times, by return-to-office policies and facilitated, at times, by greater automation, including new AI tools”. Labour supply is also constrained, holding the unemployment rate down. In September, “half of the Districts… reported a reduction in the availability of immigrant labor”.
On inflation, “ten Districts characterized price growth as moderate or modest”… [but] nearly all Districts noted tariff-related price increases, with contacts from many Districts reporting that tariffs were especially impactful on the prices of inputs”. “Contacts in multiple Districts also reported rising prices for insurance, utilities, and technology services”. The tension the FOMC face between their inflation and employment mandates was also highlighted by New York Fed President Williams overnight, albeit with clear hope that these uncertainties would resolve themselves through 2026, allowing the FOMC to return policy slowly to a broadly neutral setting.
William’s optimism for growth needs a firmer foundation to build in coming months based on the latest ISM detail. The manufacturing ISM PMI ticked up to 48.7 in August as the new orders component rose to 51.4pts – still a weak outcome versus the five-year pre-COVID average of 56.3. The employment indicator meanwhile remained contractionary. For services, while the headline index lifted to 52.0 in August, the employment index languished at a contractionary reading of 46.5. Both ISM surveys therefore point to a material risk of economy-wide headcount reduction in coming months.
The US economy looks to need greater support than the two cuts we see into year end to complete this easing cycle. But, in the absence of a marked deceleration in inflation, this is hard to justify. In our view, the six rate cuts the market now have priced to January 2027 would require the unwinding of bilateral tariffs (possible given this week the Federal Appeals Court upheld the view that Liberation Day’s bilateral tariffs are illegal) or a much sharper deterioration in economic activity and the labour market, which would force the FOMC’s to look past current above-target inflation.
Over in Europe, the flash estimate for August inflation printed at 2.1%, the sixth consecutive actual read within 0.2ppts of the ECB’s 2.0% target, while the unemployment rate remained at historic lows in July, printing at 6.2%. On the surface, the latter result is indicative of a tight labour market; however, there is cause to believe current conditions are instead best considered balanced. Prior to the pandemic, from 2013 the unemployment rate trended lower in part due to the effect on total participation of population ageing, an evolving global phenomenon expanded on this week by Chief Economist Luci Ellis and Economist Ryan Wells. A preference for lower hours and an increase in participation amongst women and seniors have also boosted the level of employment in Europe. As a result, there is little reason to fear inflation spurred by the labour market. The ECB is therefore likely to take the policy rate to the lower end of the neutral range and then go on hold for an extended period, allowing GDP growth to firm slowly to trend through 2026.
