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Chinese Economy Shows Resilience as U.S. & Eurozone Growth Lag Behind

Economic growth improved in the 2nd quarter (Q2) of 2017 in several countries, although not to levels suggested by the various confidence indicators. Inflation rates continue to decline and most central bankers have recently lowered their inflation forecasts and are showing concern that inflation will not return to target anytime soon. Meanwhile, financial markets continue to climb, a trend that is not without worrying central bankers, concerned about financial stability. The Chinese economy continues to show resilience and stabilized in Q2 2017 at 6.9% year over year (y/y). If domestic demand remains robust, especially investment, the improvement of foreign trade have been an important factor. Yet, for now, the consensus still anticipates that the 2nd half (H2) of 2017 growth could decelerate due to credit tightening and waning fiscal supports. As President Xi implied at the recent Financial Work Conference, the ongoing drive to strengthen regulation/supervisory tightening is not about to reverse anytime soon.

The Eurozone’s Q2 2017 GDP came in at 0.6 quarter over quarter (q/q). Expenditure breakdown of GDP will be published later, but the sharp rise in retail sales and the high level of consumer confidence suggest that household consumption was robust. In fact, June’s unemployment rate was the lowest since 2009 and the improvement was fairly broad-based, with not only Germany (3.8%) but also Spain (17.1%), Italy (11.1%) and Portugal (9%) seeing decline. However, this improvement does not, for the time being, translate into a fundamental movement in consumer prices and inflation is unlikely to substantially pick up soon. Indeed, wage growth remains subdued owing to weak productivity, underestimated labor market slack, a backward-looking wage setting process and previous downward wage rigidities. Moreover, the appreciation of the euro will likely start to have an impact in the coming months on the costs of imported goods, and consequently lower prices paid by the consumers. In addition, some recent indicators point to a certain slowdown in growth momentum in H2 2017. Indeed, the Markit index on business confidence fell for a second consecutive month in July. Bank lending growth also slowed in June and the credit impulse – i.e. changes in the flow of credit – has decelerated, which supports the slightly more downbeat message from latest’s ECB (European Central Bank) Bank Lending Survey.

In the United States, after a disappointing Q1 2017 (0.3% q/q), GDP picked up to 0.6% q/q in Q2, thus matching Eurozone’s Q2 GDP growth. On a y/y basis, both economies have expanded by 2.1%. The improvement was in part driven by a rebound in consumer spending. That said, growth in business investment spending remains modest, while residential investment has even declined. With wage growth remaining sluggish and job creation losing some momentum, there are concerns that consumer spending could slow in H2 while Republicans' struggles in Congress to pass a healthcare reform have reduced the prospects of fiscal stimulus. The July statement from the Fed acknowledged the improvement in Q2 economic growth but also pointed out the continuing slowdown in consumer price dynamics in recent months. The PCE inflation rate, which is the Fed's preferred measure of inflation, fell to 1.4% in June while core inflation was 1.5%, a low since December 2015. In fact, there are very few indications that wage pressures will lead to higher consumer prices. Indeed, the employment cost index – which is probably one of the best wage pressure measures in the United States – rose 2.4% y/y in Q2, confirming that despite a low level of unemployment, wage inflation is very limited. While the Fed may announce at its meeting on September 20 that it will cease reinvesting the full amount of maturing bonds, a third hike this year is therefore uncertain.

The Bank of England (BOE) published its Quarterly Inflation Report and revised downward its economic growth forecasts for this year and next. The contraction in activity in the construction and industrial sectors in Q2 2017 indicates that investment is losing momentum, probably linked to the climate of uncertainty. Infighting over the UK’s Brexit negotiating strategy has become entangled with a leadership struggle. At least three senior cabinet members are thought to be jockeying to replace Prime Minister Theresa May, whose position was severely weakened when she lost parliamentary majority in last June’s election. In a vote of 6 to 2, the BOE’s Monetary Committee decided to keep its key rate unchanged at 0.25%. Despite above target inflation, the majority of the BOE members felt that it was too early to tighten monetary policy. Still, if the pound were to depreciate too abruptly, the Monetary Committee could be forced to raise its key rate to support the currency.

CRN: 2017-0803-6080 R

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.