Up until December, the Australian economy appeared to be growing at a rate that was in-line with the expectations of the Reserve Bank of Australia (RBA). In December, however, data indicating relatively weak Gross Domestic Product (GDP) was released showing that Australia’s GDP actually shrank by half a per cent in the September quarter – the first time it has fallen since March 2011. If GDP continues to decline over the next quarter, then Australia will have entered a recession, with the widely accepted technical definition of a recession being two consecutive quarters of declining GDP.
The significant drivers of the decline in GDP were reduced government consumption and reduced public capital expenditure. According to the Federal Government’s budget, this reduction is unlikely to be reversed quickly. While the RBA forecasts 2016 GDP growth to be between 2.5 and 3.5 per cent, the weak result experienced in the September quarter will likely push GDP growth to the bottom end of that range. Despite some investors’ concerns about Australia entering a technical recession, in March we expect the release of GDP growth data to show a rebound in the December quarter, when GDP, combined with a gradual rise in inflation, will likely see the RBA leave interest rates on hold during 2017.
European banks in focus
European banks have been in the limelight. One of Italy’s largest banks, which is also the world’s oldest surviving bank, Banca Monte dei Paschi di Siena, failed to raise €5 billion from investors to shore up its finances. This lack of interest from investors seems to stem from losses on non-performing loans as well as the level of investor caution about political risks in Italy. This was highlighted recently when the Prime Minister, Matteo Renzi, resigned after a referendum he proposed was defeated. The referendum aimed to make it easier to pass laws and sustain a stable government. In late December, the Italian parliament approved a €20 billion bail-out fund for Monte Paschi and other Italian lenders. However, investors remained concern and bought less risky German government bonds. In 2017, the general elections in France, the Netherlands and Germany, mean there are more political risks on the horizon for Europe which will increase the potential for volatility and significant market movements in the year ahead.
US interest rates begin to rise
At the outset of 2016, it was expected that the US Federal Reserve, commonly referred to as the Fed, would increase interest rates four times during the year. However, as 2016 drew to a close, December saw the Fed’s only rate rise of 0.25 per cent. Being widely anticipated, and effectively already priced into the share market, investor reaction was limited while economic data was supportive - job growth continued and unemployment fell to 4.7 per cent. The low inflation level has been one of the factors preventing a rate rise but, since September, the increasing inflation rate (as measured by the consumer price index) has allowed the rate to rise. The recent economic data, together with communications from the Fed, indicates rates are expected rise two or three times in 2017. By the end of the year, it’s expected that the US interest rate will be between 1.25-1.50 per cent by the end of the year.
Trump victory propels share markets
Donald Trump’s victory in the US presidential elections surprised both investors and political commentators alike. Share markets in the US rose strongly in the weeks following his victory as investors became more optimistic about the prospects for certain sectors of the US economy. President Trump has indicated he will aim to reduce banking regulations and increase infrastructure spending. Presuming that these aims are achieved, this could boost the prospects of some US companies.