Cliff Notes: hawkish bias to remain as inflation risks abate
Key insights from the week that was.
The near-term path for interest rates was in the spotlight this week. For Australia, it was chiefly through the lens of the labour market; in the US, the rhetoric of policymakers was the focus.
The May RBA meeting minutes provided a fairly mixed assessment of what was labelled a ‘finely balanced’ decision between a pause and the eventual outcome of a 25bp rate hike. It was interesting to note renewed concern around the medium-term path for inflation, specifically the upside risks – persistent services inflation, strong population growth (as evinced by ongoing strength in permanent and long-term net arrivals) and pressure on rents. Also noted was that, having inflation return to the top of the target range by mid-2025 leaves “little room for upside surprises… given that inflation would have been above the target for around four years by that time”.
The data that followed the minutes however eased expectations of further increases in interest rates, at least for the near-term.
The 0.8% gain in the wage price index over the three month to March raised the annual rate of wage inflation to 3.7%, a level which can still be viewed as relatively comfortable for the RBA. The underlying detail was also constructive, particularly the trend moderation in private sector wages growth (from 1.2% in September to 0.9% in December and 0.8% in March) as well as the fact that the proportion of those getting a wage rise under individual bargaining arrangements in March – which represents the majority of wages growth – was no larger than it was last year.
Meanwhile, the April labour force survey provided the largest surprise in the week, with employment declining by 4.3k and the unemployment rate rising from 3.5% to 3.7% (3.54% to 3.66% at two decimal points). The unique seasonality issues around the timing of Easter holidays and the survey reference period makes it difficult to interpret the underlying trend clearly. Nevertheless, this still represents a shift in tone following robust strength through February and March.
Taken together, these updates are likely to ease the Board’s immediate concerns around upside risks to inflation. Note, the chief risk for policy is centred on the August Board meeting when the next quarter of CPI data will be assessed. We continue to believe the cash rate is sufficiently restrictive to ensure inflation’s return to target, allowing the RBA to remain on hold over 2023 and cut in 2024. But momentum in price and labour data requires continued careful assessment.
Highlighting the impact of recent policy announcements, Westpac-MI Consumer Sentiment fell 7.9% to 79.0, a deeply pessimistic level. While the RBA’s surprise rate hike in May certainly played a role, the Budget also had an adverse effect, with sentiment amongst post-Budget respondents 7.4% lower than those sampled prior. The detail was more positive though, with the difference between self-assessed ‘budget losers’ and ‘budget winners’ favourable versus history, perhaps suggesting that households believe the Government’s measures will deliver some relief on the cost-of-living.
This week in New Zealand, there have been two key releases, our Economics team’s latest Quarterly Economic Overview and the Government’s 2023 Budget. The Overview updates on our New Zealand team’s latest expectations for the economy and the RBNZ, the take-home being that New Zealand’s economy is now expected to avoid recession thanks to resurgent population growth. Tight supply and the increase in demand to come as a result of migration will require the RBNZ to increase rates a little further to a peak of 6.0% at September, with rates then on hold until mid-2024.
This week’s US data was of limited significance. Total advance retail sales surprised to the downside, rising 0.4% in April against an expectation of 0.8%; however, part of the March decline was revised away, from -1.0% to -0.7%, leaving the two-month movement in line with expectations. Control group retail sales meanwhile surprised to the upside, gaining 0.7%; but this beat was partly offset by a negative revision to March, to a decline of -0.4%. Overall, nominal retail sales growth remains positive but modest. April’s housing data was meanwhile decidedly mixed, starts up 2.2% after a 4.5% decline in March as permits fell another 1.5% following a 3.0% decline in March. Constructively, the NAHB housing index provided evidence of a stabilisation in home builder confidence at weak levels, the index rising from 45 to 50 in May.
The focus for market participants was instead on a slew of comments from FOMC members. Each speaker brought their own perspective and degree of hawkishness, but their collective intent was clear: to keep financial conditions contractionary while upside inflation risks linger. In our view, the FOMC does not need to hike again to get inflation back near target over the coming year; but it does need to hold policy at a restrictive setting for the remainder of 2023. If the leading indicators for shelter prove correct, then annualised inflation will be back around 2.0% by December as slack builds in the labour market. From then on, the focus of the FOMC will pivot to the weak state of activity and downward skew of risks. From December 2023 to December 2024, 225bps of rate cuts are expected.
Also of note this week was China’s activity data for April. As was the case last week, the market was looking for weakness and found it in disappointing industrial production and fixed asset investment, respectively 3.6% and 4.7% year-to-date versus 2022. A degree of disappointment is unsurprising for investment in early-2023, with private investment yet to fire and the pipeline for housing construction only beginning to build, residential sales having risen 11.8% year-to-date against 2022. However, the strength of exports to Asia; China’s continued structural development; and the capacity of Chinese consumers, retail sales up 8.5% year-to-date, give us confidence that GDP growth can print above 6.0% in 2023 and hold between 5.0% and 6.0% in 2024 and 2025. At a time of weakness for the developed-world, this would be an exceptional result.
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