Cliff Notes: as global inflation risks recede, market expectations build
Key insights from the week that was.
This week, we received a set of downbeat updates on the consumer and housing in Australia. Meanwhile, a slew of rate hikes and updated policy guidance from across the US, Europe and the UK gave markets plenty to think about.
Beginning in Australia, the week began with a downside surprise for the consumer, December’s retail sales posting a sizeable 3.9% decline against the consensus estimate for a 0.2% fall. The decline was generally broad-based albeit with some seasonal volatility likely at play, with non-food retail, department stores and clothing all posting very weak reads. Having said that, December’s result more than reversed the upwardly revised gain of 1.7% in November, suggesting that an underlying down-trend in consumption is beginning to materialise in response to the rising interest rate burden. For a comprehensive update on the current state of the Australian consumer, see our January edition of the Red Book.
Developments on the housing front continued to point toward further weakness to come. CoreLogic’s home value index fell another 1.1% in January and, at -8.7%yr, the annual pace of decline has now exceeded that of the 2018-19 correction to be the weakest reading dating back to 1981. The current correction remains broadly-based and firmly entrenched, with all capital cities and major regional areas recording price declines and continued easing in turnover.
A similar theme was also present in December’s dwelling approvals release, with non-high rise approvals (a better gauge for underlying trends given the 90% spike in high rise approvals) posting a 2% decline in the month to be down 14.8% from its August peak. Given the extensive set of headwinds facing the construction sector and the broader housing market, further significant declines are expected in the period ahead, which will also feed through to demand for housing credit.
In a video update mid-week, Chief Economist Bill Evans outlined Westpac’s views on the outlook for Australian interest rates and the consequences for activity. In essence, our expectation for a 3.85% peak in the cash rate in May is reflective of robust wage pressures – a forecast 4.5%yr peak by end-2023 – and a slower retreat in services inflation. However, we do not expect this to result in a ‘classic’ recession as households are relatively well placed to weather these headwinds. Indeed, with a savings buffer of around $250 billion and a historically-tight labour market as supports, we anticipate a stalling in household consumption rather than an outright contraction in response to rising interest costs. If inflation recedes as we expect, there will be room for the RBA to deliver 100bps of rate cuts over 2024, easing the pressure on demand and facilitating a return to around-trend growth by end-2025.
Offshore, market participants were buoyed by the guidance given by key central banks this week. While the US FOMC raised by 25bps and the European Central Bank (ECB) and Bank of England (BoE) followed with 50bp hikes, the market took their data-dependent guidance on the outlook to mean the end of the tightening cycle is near.
After slowing the pace of hikes to 25bps at their January/February meeting, subtle but significant changes in communication highlighted the evolving balance of risks faced by the FOMC, with inflation having “eased somewhat” and the Committee now focused on the cumulative impact of policy versus the pace of meeting-by-meeting hikes. With annual headline inflation having slowed from 9%yr to 6%yr June to December 2022, and we might add the six-month annualised pace now back at the 2%yr target, the FOMC could have been more constructive on the outlook for inflation than they were. The reason they held back was made clear in the press conference, with Chair Powell highlighting that the deceleration to date has been concentrated in goods, with services inflation yet to ease.
Still, with market estimates of rent growth decelerating rapidly and wage gains slowing quicker than the FOMC anticipated, Chair Powell expressed growing confidence that disinflation will broaden in 2023. From the partial data and the trajectory of short-term momentum in service CPI components, this is our expectation too. Indeed, we remain of the view that the FOMC will on need to hike once more, taking fed funds to a peak of 4.875% at March. They may decide to continue to May; but, in either case, the US tightening cycle will conclude by June.
As expected, this week the ECB were decidedly more hawkish than the FOMC, with a 50bp hike delivered and a strong signal given that another 50bp increase will follow next month. The justification for doing so is that core inflation remains at peak levels in the Euro Area while both economic activity and the labour market continue to outperform, signalling a much-reduced chance of recession in 2023. It also has to be remembered that the ECB is a long way behind the FOMC, the current level of the ECB’s deposit rate being 2.50% versus US fed funds at 4.625%. Despite the ECB’s near-term hawkish resolve, the market still reacted favourably to the Governing Council’s guidance, taking “future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach” to signal that the ECB’s tightening cycle will also end by mid-year.
In the UK, the BoE’s 50bp hike to a bank rate of 4.00% with two dissenting opinions and a materially-improved outlook for inflation in 2023 (4.0%yr from 5.25%yr previously) has seen the market price an almost immediate end to the tightening cycle, with bank rate now forecast to peak circa 4.25% -- only +25bps from the current level. Arguably, the Committee’s expectation that inflation will be back below their 2.0%yr target in 2025 is providing the market with further confidence.
With each of these key central banks now more mindful of the outlook for activity and, while still risk aware, showing confidence over the outlook for inflation, the market is clearly now focused on the scale and timing of rate cuts. This is highlighted by the spread between 10 year yields and central bank policy rates. For the US, Euro Area and UK, the current market expectation for peak policy rates are approximately 4.875%, 3.25% and 4.25% whereas their 10 year yields are circa 3.40%, 2.10% (German Bund) and 3.00%. For risk assets, also critical is that these materially-lower term interest rates are paired with more favourable outlooks for growth than previously feared. Note that this week Euro Area GDP growth was reported to have remained positive in Q4; while, at February, the scale of the Bank of England’s recession forecast for 2023 and 2024 was materially reduced.
The US is the one jurisdiction in this group which has a deteriorating growth outlook, highlighted last week by the deceleration in domestic demand growth, and this week by weakness in the manufacturing sector (the ISM manufacturing survey pointing to a further decline in activity in January) and construction activity. We remain of the view that the US’ contraction will be shallow; but, given the much-improved outlook for the Euro Area and UK versus 2022’s expectations, this calls for further weakness in the US dollar to the end of 2024.
Another reason to expect continued weakness in the US dollar is that China and other developing markets are showing great promise at the start of 2023. Following December’s turmoil, this week a dramatic rebound in China’s official PMIs to near long-run average levels was reported. This signals that, not only has there been no lasting impact from the end of COVID-zero for manufacturing, but more importantly confidence amongst households has snapped back. In our view, Chinese consumers also have plenty of capacity to spend given accumulated savings and positive real income growth through 2022.
A final note on China. This week also saw authorities change their rules regarding tertiary education. To be recognised, students now need to undertake courses in person not online. As a result, in coming months Chinese students will need to quickly return to the countries in which their tertiary institutions are based, including Australia. As the visa and arrivals data allows, we will assess the implications.
Stay informed with Westpac IQ
Get the latest reports straight to your inbox.
Related articles
Browse topics
Disclaimer
©2025 Westpac Banking Corporation ABN 33 007 457 141 (including where acting under any of its Westpac, St George, Bank of Melbourne or BankSA brands, collectively, “Westpac”). References to the “Westpac Group” are to Westpac and its subsidiaries and includes the directors, employees and representatives of Westpac and its subsidiaries.
Things you should know
We respect your privacy: You can view our privacy statement at Westpac.com.au. Each time someone visits our site, data is captured so that we can accurately evaluate the quality of our content and make improvements for you. We may at times use technology to capture data about you to help us to better understand you and your needs, including potentially for the purposes of assessing your individual reading habits and interests to allow us to provide suggestions regarding other reading material which may be suitable for you.
This information, unless specifically indicated otherwise, is under copyright of the Westpac Group. None of the material, nor its contents, nor any copy of it, may be altered in any way, transmitted to, copied of distributed to any other party without the prior written permission of the Westpac Group.
Disclaimer
This information has been prepared by the Westpac and is intended for information purposes only. It is not intended to reflect any recommendation or financial advice and investment decisions should not be based on it. This information does not constitute an offer, a solicitation of an offer, or an inducement to subscribe for, purchase or sell any financial instrument or to enter into a legally binding contract. To the extent that this information contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs and before acting on it you should consider the appropriateness of the advice. Certain types of transactions, including those involving futures, options and high yield securities give rise to substantial risk and are not suitable for all investors. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. This information may contain material provided by third parties. While such material is published with the necessary permission none of Westpac or its related entities accepts any responsibility for the accuracy or completeness of any such material. Although we have made every effort to ensure this information is free from error, none of Westpac or its related entities warrants the accuracy, adequacy or completeness of this information, or otherwise endorses it in any way. Except where contrary to law, Westpac Group intend by this notice to exclude liability for this information. This information is subject to change without notice and none of Westpac or its related entities is under any obligation to update this information or correct any inaccuracy which may become apparent at a later date. This information may contain or incorporate by reference forward-looking statements. The words “believe”, “anticipate”, “expect”, “intend”, “plan”, “predict”, “continue”, “assume”, “positioned”, “may”, “will”, “should”, “shall”, “risk” and other similar expressions that are predictions of or indicate future events and future trends identify forward-looking statements. These forward-looking statements include all matters that are not historical facts. Past performance is not a reliable indicator of future performance, nor are forecasts of future performance. Whilst every effort has been taken to ensure that the assumptions on which any forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from any forecasts.
Conflicts of Interest: In the normal course of offering banking products and services to its clients, the Westpac Group may act in several capacities (including issuer, market maker, underwriter, distributor, swap counterparty and calculation agent) simultaneously with respect to a financial instrument, giving rise to potential conflicts of interest which may impact the performance of a financial instrument. The Westpac Group may at any time transact or hold a position (including hedging and trading positions) for its own account or the account of a client in any financial instrument which may impact the performance of that financial instrument.
Author(s) disclaimer and declaration: The author(s) confirms that (a) no part of his/her compensation was, is, or will be, directly or indirectly, related to any views or (if applicable) recommendations expressed in this material; (b) this material accurately reflects his/her personal views about the financial products, companies or issuers (if applicable) and is based on sources reasonably believed to be reliable and accurate; (c) to the best of the author’s knowledge, they are not in receipt of inside information and this material does not contain inside information; and (d) no other part of the Westpac Group has made any attempt to influence this material.
Further important information regarding sustainability-related content: This material may contain statements relating to environmental, social and governance (ESG) topics. These are subject to known and unknown risks, and there are significant uncertainties, limitations, risks and assumptions in the metrics, modelling, data, scenarios, reporting and analysis on which the statements rely. In particular, these areas are rapidly evolving and maturing, and there are variations in approaches and common standards and practice, as well as uncertainty around future related policy and legislation. Some material may include information derived from publicly available sources that have not been independently verified. No representation or warranty is made as to the accuracy, completeness or reliability of the information. There is a risk that the analysis, estimates, judgements, assumptions, views, models, scenarios or projections used may turn out to be incorrect. These risks may cause actual outcomes to differ materially from those expressed or implied. The ESG-related statements in this material do not constitute advice, nor are they guarantees or predictions of future performance, and Westpac gives no representation, warranty or assurance (including as to the quality, accuracy or completeness of the statements). You should seek your own independent advice.
Additional country disclosures:
Australia: Westpac holds an Australian Financial Services Licence (No. 233714). You can access Westpac’s Financial Services Guide here or request a copy from your Westpac point of contact. To the extent that this information contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs and before acting on it you should consider the appropriateness of the advice.
New Zealand: In New Zealand, Westpac Institutional Bank refers to the brand under which products and services are provided by either Westpac (NZ division) or Westpac New Zealand Limited (company number 1763882), the New Zealand incorporated subsidiary of Westpac ("WNZL"). Any product or service made available by WNZL does not represent an offer from Westpac or any of its subsidiaries (other than WNZL). Neither Westpac nor its other subsidiaries guarantee or otherwise support the performance of WNZL in respect of any such product. WNZL is not an authorised deposit-taking institution for the purposes of Australian prudential standards. The current disclosure statements for the New Zealand branch of Westpac and WNZL can be obtained at the internet address www.westpac.co.nz .
Singapore: This material has been prepared and issued for distribution in Singapore to institutional investors, accredited investors and expert investors (as defined in the applicable Singapore laws and regulations) only. Recipients of this material in Singapore should contact Westpac Singapore Branch in respect of any matters arising from, or in connection with, this material. Westpac Singapore Branch holds a wholesale banking licence and is subject to supervision by the Monetary Authority of Singapore.
U.S.: Westpac operates in the United States of America as a federally licensed branch, regulated by the Office of the Comptroller of the Currency. Westpac is also registered with the US Commodity Futures Trading Commission (“CFTC”) as a Swap Dealer, but is neither registered as, or affiliated with, a Futures Commission Merchant registered with the US CFTC. The services and products referenced above are not insured by the Federal Deposit Insurance Corporation (“FDIC”). Westpac Capital Markets, LLC (‘WCM’), a wholly-owned subsidiary of Westpac, is a broker-dealer registered under the U.S. Securities Exchange Act of 1934 (‘the Exchange Act’) and member of the Financial Industry Regulatory Authority (‘FINRA’). In accordance with APRA's Prudential Standard 222 'Association with Related Entities', Westpac does not stand behind WCM other than as provided for in certain legal agreements between Westpac and WCM andobligations of WCM do not represent liabilities of Westpac. This communication is provided for distribution to U.S. institutional investors in reliance on the exemption from registration provided by Rule 15a-6 under the Exchange Act and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors in the United States. WCM is the U.S. distributor of this communication and accepts responsibility for the contents of this communication. Transactions by U.S. customers of any securities referenced herein should be effected through WCM. All disclaimers set out with respect to Westpac apply equally to WCM. If you would like to speak to someone regarding any security mentioned herein, please contact WCM on +1 212 389 1269. Investing in any non-U.S. securities or related financial instruments mentioned in this communication may present certain risks. The securities of non-U.S. issuers may not be registered with, or be subject to the regulations of, the SEC in the United States. Information on such non-U.S. securities or related financial instruments may be limited. Non-U.S. companies may not be subject to audit and reporting standards and regulatory requirements comparable to those in effect in the United States. The value of any investment or income from any securities or related derivative instruments denominated in a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive or adverse effect on the value of or income from such securities or related derivative instruments.
The author of this communication is employed by Westpac and is not registered or qualified as a research analyst, representative, or associated person of WCM or any other U.S. broker-dealer under the rules of FINRA, any other U.S. self-regulatory organisation, or the laws, rules or regulations of any State. Unless otherwise specifically stated, the views expressed herein are solely those of the author and may differ from the information, views or analysis expressed by Westpac and/or its affiliates.
UK and EU: The London branch of Westpac is authorised in the United Kingdom by the Prudential Regulation Authority (PRA) and is subject to regulation by the Financial Conduct Authority (FCA) and limited regulation by the PRA (Financial Services Register number: 124586). The London branch of Westpac is registered at Companies House as a branch established in the United Kingdom (Branch No. BR000106). Details about the extent of the regulation of Westpac’s London branch by the PRA are available from us on request.
Westpac Europe GmbH (“WEG”) is authorised in Germany by the Federal Financial Supervision Authority (‘BaFin’) and subject to its regulation. WEG’s supervisory authorities are BaFin and the German Federal Bank (‘Deutsche Bundesbank’). WEG is registered with the commercial register (‘Handelsregister’) of the local court of Frankfurt am Main under registration number HRB 118483. In accordance with APRA’s Prudential Standard 222 ‘Association with Related Entities’, Westpac does not stand behind WEG other than as provided for in certain legal agreements (a risk transfer, sub-participation and collateral agreement) between Westpac and WEG and obligations of WEG do not represent liabilities of Westpac.
This communication is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. This communication is not being made to or distributed to, and must not be passed on to, the general public in the United Kingdom. Rather, this communication is being made only to and is directed at (a) those persons falling within the definition of Investment Professionals (set out in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”)); (b) those persons falling within the definition of high net worth companies, unincorporated associations etc. (set out in Article 49(2)of the Order; (c) other persons to whom it may lawfully be communicated in accordance with the Order or (d) any persons to whom it may otherwise lawfully be made (all such persons together being referred to as “relevant persons”). Any person who is not a relevant person should not act or rely on this communication or any of its contents. In the same way, the information contained in this communication is intended for “eligible counterparties” and “professional clients” as defined by the rules of the Financial Conduct Authority and is not intended for “retail clients”. Westpac expressly prohibits you from passing on the information in this communication to any third party.
This communication contains general commentary, research, and market colour. The communication does not constitute investment advice. The material may contain an ‘investment recommendation’ and/or ‘information recommending or suggesting an investment’, both as defined in Regulation (EU) No 596/2014 (including as applicable in the United Kingdom) (“MAR”). In accordance with the relevant provisions of MAR, reasonable care has been taken to ensure that the material has been objectively presented and that interests or conflicts of interest of the sender concerning the financial instruments to which that information relates have been disclosed.
Investment recommendations must be read alongside the specific disclosure which accompanies them and the general disclosure which can be found here. Such disclosure fulfils certain additional information requirements of MAR and associated delegated legislation and by accepting this communication you acknowledge that you are aware of the existence of such additional disclosure and its contents.
To the extent this communication comprises an investment recommendation it is classified as non-independent research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and therefore constitutes a marketing communication. Further, this communication is not subject to any prohibition on dealing ahead of the dissemination of investment research.