Weathering the storm


Drew Klease, Principal Economist 

Hurricane Irma and Hurricane Harvey will go down in US history as two of the country’s worst natural disasters. The storms have claimed over 100 lives in the US, plus around 40 more in the Caribbean and Cuba. While the extent of the damage is still being assessed, preliminary estimates suggest Harvey caused around $60-100 billion in property damage and Irma caused around $50-$75 billion in damage. If confirmed, these respective hurricanes would be the 2nd and 4th most costly in history (in inflation adjusted terms), after Hurricane Katrina in 2005 ($160b in today’s prices) and Hurricane Sandy in 2012 ($70b in today’s prices).        

How will the storms impact the US economy? Given that Florida represents around 5% of the US economy and that Houston accounts for a further 3%, the impact in the short-run is clearly negative. Lower production, particularly from Texas refineries, lost tourism and damaged crops in Florida and millions of people not performing their day-to-day jobs will hurt US economic activity. 

At this stage, our assessment is that the storms will wipe off around 1 percentage point from real GDP growth in the September quarter. However, thereafter, economic growth in the US is expected to be boosted by the rebuilding efforts, adding around 25bps to growth over the subsequent three quarters. 

The storms will also impact the inflation outlook. Gasoline prices have spiked due to the refinery disruptions in Texas, sending prices at the bowser up by 3.9% in August and a further 12% over the first two weeks in September. These higher energy prices helped push the CPI up by 0.4% in August, with an even stronger outturn likely in September.  

Of course, these energy-price effects will prove transitory as refinery production returns to more normal levels. More important were signs this week that core inflation is starting to firm after five disappointing months. In particular, the core consumer price index rose by 0.25% in August, the strongest monthly rate since January. 

While part of the increase reflected temporary factors, such as a rebound in accommodation prices following a sharp fall last month, the underlying details were likely to provide reassurance to the US Federal Reserve (Fed) that core inflation is now on an upward trajectory. Financial markets reacted to the inflation news, with the implied probability of a rate hike by the Fed in December jumping to around 50%, its highest level in almost 2 months. 

The US has also been weathering the political storm over recent weeks. In a rare showing of bipartisanship, President Trump backed a surprising deal with Democrat leaders to extend the US debt ceiling and provide government funding for another three months. The deal also included $15.25b in aid for Hurricane Harvey victims. 

While the recent hurricanes will no doubt cause havoc with near-term economic indicators, our fundamental view on the US economy remains unaltered. Solid underlying conditions should support growth of around 2.5% over the next year, tightening labour market conditions will begin to drive wage growth up and core inflation will continue to edge higher after the surprise softness in Q2. Fiscal stimulus from Washington will be modest, with President Trump only likely to get a small corporate tax cut through Congress. 

With growth above-trend and inflation starting to move higher, we continue to expect the Fed to tighten monetary policy gradually. Next week, we should get the widely-anticipated commencement of the Fed’s balance sheet reduction program. Given the details have already been announced by the Fed (with the exception of the start date), this move should not surprise markets. However, with the economic winds shifting towards stronger underlying activity and signs of a turn higher in inflation, markets should brace themselves for more Fed rate hikes. In our view, the improving outlook can justify four rate hikes by the Fed by the end of next year compared to just one implied by current market pricing.

Table 1: Financial market movements, 7 – 14 September 2017

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,495.6

1.2%

US

2.18%

14.6 bps

US Dollar Index (DXY)

92.12

0.5%

Nikkei 225

19,807.4

2.1%

Japan

0.05%

4.0 bps

USD-JPY

110.24

1.7%

FTSE 100

7,295.4

-1.4%

UK

1.23%

25.8 bps

GBP-USD

1.340

2.3%

DAX

12,540.5

2.0%

Germany

0.41%

10.6 bps

EUR-USD

1.192

-0.9%

S&P/ASX 200

5,738.7

0.9%

Australia

2.73%

9.3 bps

AUD-USD

0.801

-0.5%

Economic Update

United States / Canada

Inflation bounces back after months of disappointment in the US

  • Headline CPI inflation jumped higher in August after several months of weakness. Prices were 0.4% higher in August than in July, the biggest one-month gain since January, mostly driven by rises in petrol prices and accommodation costs. This brought year-ended inflation up to 1.9% in August from 1.7% in July. Without the boost from petrol prices, core inflation (which excludes food and energy) remained steady at 1.7% y/y for the fourth straight month, though accommodation costs helped to push the measure higher to 0.2% in monthly terms, also the biggest monthly increase since January. 

Euro area / United Kingdom

Bank of England sends strong signal on monetary tightening
  • Inflation has reaccelerated in the UK with headline and core measures rising in both monthly and year-ended terms. Headline inflation rebounded to 2.9% y/y on higher fuel and clothing prices, matching the rate reached in May 2017 after two months at 2.6%. This is the seventh consecutive month that inflation has run higher than the Bank of England’s 2% annual inflation target. Prices leapt 0.6% in August compared with the month before, after prices had fallen slightly in July in monthly terms. Core inflation is also running high, reaching 2.7% y/y in August, while annual retail price inflation has reached 3.9%.
  • In the days following the UK inflation data, the Bank of England’s Monetary Policy Committee (‘MPC’) met and decided to leave Bank Rate unchanged at 0.25%, with two of the nine MPC members voting for a rate rise. The MPC also went to further lengths to signal that the market was underestimating the future possibility of rate hikes. According to the summary of the policy decision, all MPC members held the view that monetary policy could be tightened by a greater extent over the forecast period than current market expectations if the economy continued as they expected. In addition, the summary noted that a majority of MPC members judged that a tightening of monetary policy could be appropriate over coming months, sending the currency and bond yields higher.
  • Industrial production in the euro area grew by 0.1% in July, following a -0.6% drop in June. Growth also picked up in year-ended terms, rising from 2.8% in June to 3.2% in July.


China / Japan

Momentum in China slows a little
  • There are some signs of slowing in China after a surprisingly strong first half of the year as annual growth in industrial production, urban fixed asset investment and retail sales all slowed for the second straight month in August. Year-ended growth in exports also slowed in August, though import growth and producer price inflation both picked up in the month.

Australia / New Zealand

Another positive month for the Australian labour market
  • The labour market has continued its run of strong employment growth in August, adding 54,200 jobs in the month, of which 40,100 were full-time. The unemployment rate remained steady at 5.6% due to a further improvement in the participation rate, which rose from 65.1% to 65.3% in August. 
  • Labour market conditions have been particularly positive in Queensland in recent months, with employment growing 0.7% in August after a 1.2% rise in July, bringing the unemployment rate down from 6.5% in June to 5.7% currently.

Sources: Thomson Reuters, ABS






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