Cliff Notes: the end of the global tightening cycle
Key insights from the week that was.
The FOMC and Bank of England both delivered 25bp rate hikes at their March meeting, bringing their respective tightening cycles to an end – in our view. The RBA’s policy tightening is also near its end, with one final 25bp move to occur in May.
The March RBA meeting minutes gave a detailed assessment of only one policy option, their decision to hike by 25bps. Though discussion of a pause at the March meeting was not evident, the Board “agreed to reconsider the case for a pause at the following meeting, recognising that pausing would allow for additional time to reassess the outlook for the economy”. It was also interesting to see the Board’s in depth assessment of market pricing, particularly as their commitment to considering a pause in April pre-dated current developments in the global banking sector, which have seen market pricing flip from hikes to cuts offshore and in Australia.
As discussed by Chief Economist Bill Evans in a video update midweek, the minutes support our view of a pause from the RBA in April; however, we do not believe this will mark the end of the tightening cycle. By May, we expect the Board will be presented with a strong Q1 CPI report and an updated set of economic forecasts that justify one final 25bp rate hike, raising the cash rate from 3.60% to a peak of 3.85% in order to fully ensure that inflation risks are contained. Developments thereafter will be centred on the abrupt slowing of growth and easing inflation over the second half of 2023, warranting the RBA remain on hold over the rest of the year to assess before easing in 2024, with 150bps of rate cuts through to mid-2025. For an in-depth summary and state-by-state breakdown of the growth outlook, see the latest edition of Westpac’s Coast-to-Coast.
Before moving on, a quick note on Australian manufacturing. The latest ACCI-Westpac Business Survey reported that manufacturing conditions, after having stalled flat in Q4 2022, posted a modest improvement in Q1 2023. That said, the overall tone of the survey is still downbeat, with expectations for future activity moderating amid broadening headwinds for the sector. Most notably, Australian manufacturers are facing acute cost pressures – a net 70% reporting an increase in input prices in the period – as surging energy costs continue to impact, resulting in margin squeeze and a loss of competitiveness. With regards to production, not only is labour still being cited as a major limiting factor, but evidence is also beginning to emerge that manufacturers are facing pressures in sourcing financing.
Turning to the US, at their March meeting, the FOMC kept the immediate focus on the fight against inflation by hiking 25bps to a mid-point of 4.875% while also recognising the tightening of financial conditions to come as a result of this month’s Silicon Valley Bank and Signature Bank failures. While uncertain in time and scale, the inclusion of “Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation” makes clear the Committee’s expectation that the cost to the economy from this crisis of confidence in US regional banks will prove significant. The FOMC could certainly justify hiking once more in May to a peak of 5.125%. However, given the risks around financial conditions and confidence, holding off to assess would be the prudent course, particularly given policy is already contractionary and forward indicators for inflation and the labour market were pointing down ahead of this shock. Accordingly, we confirm our view that the federal funds rate has now peaked for this cycle.
Against market expectations of 3-4 cuts by January 2024, we also confirm our view that the federal funds rate is likely to remain on hold through the remainder of 2023, with a clear need to guard against inflation risks over the period. It is only once inflation is back near target that the FOMC will be confident to cut and, at that time, we believe they will do so aggressively, by 200bps in 2024 and a further 75bp in 2025, back to 2.125% -- a broadly neutral policy level. In assessing the risks to this view, it is important to emphasise as Chair Powell did in the press conference, that there are now multiple financial condition dynamics to assess in real time, each with its own timeline and risk profile. Even as rates are cut in 2024, a tighter regulatory focus on regional banks with less than $250bn in assets will likely continue to constrain lending and consequently investment and employment. It is only after the regulatory regime is reset and confidence fully restored that easier policy will bring growth back above trend on a sustainable basis. This is unlikely before late-2024, at the earliest.
Over in the UK, the Bank of England (BoE) also delivered a 25bp hike, albeit with two members voting instead for no change. In the communications from the meeting, there was little concern over the recent upside surprise for inflation which came as a result of core goods inflation, primary clothing and footwear “which tend to be volatile”. Services inflation meanwhile had proven to be marginally weaker than forecast in February, and the MPC anticipate that Q2 2023 will see a significant deceleration to a rate lower than forecast in February given falls in wholesale energy prices and a three-month extension of the Government’s Energy Price Guarantee from April. It is notable that this confidence in the outlook for inflation comes despite the economy continuing to outperform expectations and the Government giving additional modest support to the economy in the Spring Budget.
Like in the US, another 25bp hike could certainly be justified by the BoE in coming months, though it would come with the risk of a swift reversal. To us, the prudent course for the BoE is instead to remain on hold, providing stability and confidence while the already-contractionary stance of policy and global uncertainty works to cool inflation pressures. Albeit with one more hike to go, on our expectations, the ECB clearly finds itself in a similar position. This week, it was constructive to see ECB speakers much more conscious of the broad array of risks they face for the remainder of 2023 and into 2024.
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