Westpac Market Outlook May 2023
Our latest thinking on Australia, markets and the global economy.
Read full report 'Westpac Market Outlook May 2023' (PDF 424KB)
The global interest rate tightening cycle that began in 2022 is now at or very near its peak. The US FOMC has established a conditional pause following this month’s 25bp hike. The RBA has adopted a softer tightening bias, and we expect the ECB, Bank of England and RBNZ to all follow suit after final 25bp hikes at their next meetings. In all cases, pausing is still highly conditional on the data–flow, the evolution of inflation in particular, but also how the growth and labour market conditions that feed into this unfold. As we have seen with the RBA’s surprise move in May, settings also remain dependent on how central banks assess risks to the outlook, and their tolerance for any delays in returning inflation to target.
As the year progresses, we will see more evidence of growth slowing materially in response to the rapid monetary tightening, and overlaid with some additional tightening in credit conditions associated with strains in the banking system. In the case of the US, the slowing in both growth and inflation is expected to be relatively rapid, opening the door for rate cuts by December. That process is expected to be slower elsewhere, reflecting the absence of banking-related issues and a variety of other factors and considerations. Across most jurisdictions, prospects of more persistent high services inflation amid still tight labour markets and low productivity growth is the key consideration.
These themes are still largely absent across most of Asia where inflation has tended to be more benign and, in China, where post–COVID reopening dynamics are helping to generate strong growth momentum. While there will be some spillovers from slowdowns in the major developed economies, this divergence in performance is set to become stark.
Australia: A slowdown of the Australian economy is underway, as evident from key partial indicators for the December and March quarters. Household incomes are under intense pressure from high inflation and sharply higher interest rates. We continue to expect growth to slow to a well below trend pace in 2023, a forecast 1%. This includes consumer spending increasing by only 0.7%, as well as declines in home building activity and business investment. It is against this backdrop that the Federal Treasurer will release the annual Budget on Tuesday May 9. The Budget is likely to provide some relief for the most vulnerable households, as well as showing restraint by banking the majority of the revenue windfall from stronger than forecast national income associated with higher commodity prices.
Commodities: Commodities had a meaningful correction through April with the broad index down almost 8%, led by a 22% fall in met coal prices (US$204/t), 13% fall in iron ore (US$107/t) and a 5% fall in Brent (US$79/bbl). Our end–2023 forecast for iron ore remains US$100/t but there are clear downside risks emerging. We have marked down our met coal forecast to US$206/t but held thermal coal flat at US$185/t for while prices are likely to be volatile, overall they should track broadly sideways through the remainder of the year.
Global FX markets: Conflicting forces have seen the US dollar trade a tight range over the past month. Ahead, as inflation risks continue to subside and contractionary monetary policy impacts activity, another leg lower will be seen. Importantly, the deterioration in the USD’s standing comes at a time of outperformance against expectations for Europe and the UK and with nascent strength evident in Asia. As the latter accelerates and broadens, and sentiment recovers, Asian currencies should outperform.
New Zealand: Inflation was weaker than we and other analysts expected in the early part of this year. Crucially, it has fallen well short of the Reserve Bank of New Zealand’s forecasts for a second quarter. This still leaves us with a picture of strong price pressures, including strong domestic inflation. However, inflation has now peaked and signs that rate hikes are weighing on demand are mounting. Against this backdrop, we expect only one more 25bp rate hike from the RBNZ, but interest rates will need to remain high for some time yet.
United States: At their May meeting, the FOMC raised the fed funds rate by 25bps to 5.125% but also signalled a conditional pause. From their communications, it is clear they believe that risks are tilting down for inflation and activity. We expect the first 25bp cut in December followed by 50bps per quarter through 2024. Critical to the outlook for activity and policy are conditions in banking.
China: As occurred previously in the West, consumers in China have relished an opportunity to be free of restrictions and spend. Their financial position and sentiment supports continued gains in coming months, an indeed into the medium term. However, a transition needs to be seen in fixed asset investment, with private business investment and residential construction needing to take the lead. Bumps are likely near–term, but time should justify a significant expansion of capacity and productivity, and bring with it income.
Europe: The ECB opted to slow the pace of rate hikes from 50bps to 25bps in May, reflecting a data–driven approach but also a clear concern over inflation. In particular, the stickiness of core inflation presents an ongoing challenge, but the risks to growth from contractionary policy are material. We believe the end to tightening is near, with only one more 25bp rate hike anticipated in June.
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