Cliff Notes: an event filled week
Key insights from the week that was.
This week, the second Australian Federal Budget for 2022 and the Q3 CPI report gave the market a lot to consider regarding Australia’s outlook. The same was true offshore, with the Bank of Canada and ECB respectively delivering ‘dovish’ 50bp and 75bp hikes as US Q3 GDP made clear US private demand growth is slowing rapidly.
Beginning with October Budget 2022. Our Bulletin and conversation with Chief Economist Bill Evans provides a full view of the new Government’s priorities and their economic expectations for the next four years. Most notable is that, while the starting point for October Budget 2022 is materially improved, the economy is expected to be weaken while spending grows rapidly, particularly interest costs and funding for the NDIS. As a result, net debt is forecast to continue rising to 2025/26, the last year of the forward estimates. Consistent with the policies Labor took to the election, October Budget 2022 focuses on providing cost of living relief for families through support for childcare; improving essential services, particularly aged care; and also commits to long-term investment in Australia’s capacity and productivity.
The day after Budget 2022, the Q3 CPI print came in well above the market’s expectation and our own. Critically, not only did headline inflation print at a challenging 1.8% (7.3%yr), so did the trimmed mean core (1.8%; 6.1%yr). Key contributors to the rise were housing (utilities and dwelling construction) and food. However, there was evidence of robust-to-strong inflation across the rest of the consumer basket.
In our view, it is therefore appropriate for the RBA to increase the cash rate by 50bps at the November meeting, and to follow that move with a further 75bps of cumulative tightening at the next three meetings to a peak of 3.85% in March (previously 3.60%). An on-hold posture will then be required over the remainder of 2023 to suppress inflation expectations and related risks. Chief Economist Bill Evans’ bulletin provides a detailed assessment of our expectations regarding the RBA.
Turning to the US. The Q3 GDP outcome was, more or less, as we anticipated, with a circa 3ppt contribution from net exports masking a continued deterioration in private demand growth. From 2.2% annualised in Q1, private demand growth has slowed to just 0.6%. As the service sector re-opening fades and durable purchases come under greater pressure from interest rates and cost of living, this downtrend will persist – note that in Q3, dwelling construction declined at a 26% annualised rate and business investment growth was sub-par.
We remain of the view that the US is likely to see cumulative GDP growth of only 0.5% through 2022 and 2023, with risks skewed to the downside. It will be interesting to see whether the FOMC take a more cautious view on the outlook for the economy at their November meeting next week as they deliver another outsized 75bp hike. For the US, inflation risks are still acute, but the probability of a hard landing in 2023 is on the rise.
Regarding the forward view for monetary policy globally, both the Bank of Canada and ECB delivered what were perceived to be ‘dovish’ extraordinary hikes this week, the Bank of Canada (BoC) raising 50bps and the European Central Bank (ECB) 75bps. For the BoC, growth in 2023 is clearly at risk, but excess demand remains and inflation is yet to show definitive signs of slowing. Ergo, further measured hikes are expected to prove necessary. Meanwhile in Europe, the ECB affirmed their resolve to combat inflation whilst being cognisant of the immediate and medium-term risks to growth. There is still a need to raise interest rates, but with domestic demand already showing clear signs of weakening in H2 2022 under the weight of historic inflation and collapsed confidence, a slowing in the pace of rate hikes is becoming increasingly likely. We expect another 75bp of rate hikes into early 2023, leaving the refi rate at a peak of 2.75% through the rest of that year and into early 2024.
Finally then to China. The end of the National Party Congress was as expected, with President Xi being confirmed for a third term and the Standing Committee re-shaped to cement his authority. The initial reaction of markets was unfavourable, though this has dissipated somewhat. The hold that President Xi has over the party, China’s development and COVID management is unnerving for many market participants. That said, the GDP and partial data for Q3 points to underlying economic strength.
In Q3, growth was more than a percentage point stronger than the market’s expectation, the 3.9% gain reversing Q2’s 2.7% loss. Year-to-date growth consequently bounced back to 3.0%, we expect on its way to 3.5% for the full year to be followed by 6.0% growth in 2023. From the GDP detail and monthly partial data, it is clear COVID management continues to pressure consumption and that residential construction is only starting to form a base after the provision of considerable stimulus. Supporting growth currently is fixed asset investment ex-housing and trade.
While trade with the US and Europe is under pressure as these economies stall and/or enter recession, Asia has capacity to offset. Not only does China stand to benefit from the region’s organic growth, they are also looking to take a greater share of these markets for both consumer and industrial goods. China’s decision to invest in and promote their own brands domestically over the past decade provides a strong foundation for their nascent Asian export expansion. So too the capital, production and know-how they are developing with respect to the green transition – a process Asia stands to benefit materially from. Of course, the greater China’s interest in Asia becomes, the stronger their footing on the global stage. Geopolitical uncertainty is then expected to persist and potentially escalate in the years ahead.
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