Cliff Notes: enduring pressures risk longer cycles
Key insights from the week that was.
In Australia, the June RBA meeting minutes confirmed that, when it comes to achieving the inflation target, the Board views the risks as having shifted to the upside. The arguments made in favour of the two policy options of a pause or 25bp rate increase were largely familiar: the slowing in activity and uncertain duration of policy lags versus the current strength of domestic inflation indicators, particularly the stickiness of services inflation. However, the Board also expressed specific concern over the risk of a wage-price spiral and a de-anchoring of inflation expectations, noting the possibility of “implicit indexation of wages to past high inflation” and firms “indexing their prices, either implicitly or directly, to past inflation.”
As discussed by Chief Economist Bill Evans in a video update mid-week, the minutes are consistent with our view that, despite policy’s goal to retain the labour market’s recent gains, the inflation challenge is the RBA’s focus. Hence, we continue to expect the Board to raise the cash rate in both July and August to a peak of 4.60%. This will certainly have an impact on households, with consumption expected to stall and GDP growth slowing to a negligible pace this year and early next. For more information on our broader views, see our latest Market Outlook In Conversation Podcast.
As detailed by Chief Economist Bill Evans today, it is not only the RBA that is facing these challenges. The developed world over the legacies of the pandemic and capacity constraints means central banks have more work to do before they can rest confident inflation is sustainably trending back to target. Note though, this only means the impact of policy tightening has been delayed not neutralised. In 2024, a more aggressive easing than the market has priced will prove necessary.
The UK and Bank of England are a case in point. The BoE surprised markets in June, raising the bank rate by 50 basis points to 5%. The minutes noted that the outsized hike came because of stronger than expected inflation and wage data. Seven members voted in favour of a 50bp hike; however, two members voted to keep rates steady at 4.5%. The May CPI ticked up to 8.7%yr, exceeding the bank’s forecast for an 8.2%yr lift in the second quarter. Services inflation, of particular importance to the BoE, also accelerated for the fourth month in a row to 7.3%yr. Price pressures remain broad with 89% of the CPI basket running hotter than the BoE’s 2% inflation target. The Bank no longer expects services inflation to abate this year; but, albeit more slowly, headline inflation is still expected to temper by the end of the year.
According to the Bank, a higher proportion of fixed rate mortgages have kept mortgage repayments lower than they otherwise would have been. This has prolonged the monetary policy lag with the committee noting “the full impact of the increase in Bank Rate to date will not be felt for some time”.
Looking ahead, the BoE will be taking a data-dependent approach. Further tightening has not been ruled out, noting “If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required”. It remains to be seen if the Bank will feel it is necessary to hike by another 50bps or can (again) slow the pace of tightening.
In the United States, members of the FOMC were active this week, with Chair Jerome Powell speaking before the House and Senate and notable comments made by Austan Goolsbee and Raphael Bostic.
Chair Powell highlighted while before Congress that this meeting’s pause was part of a necessary deceleration to a “careful pace” as they approach their destination – a metaphor also used by ECB’s Lagarde. Powell’s comments also highlighted that the FOMC’s concern over inflation risks will dissipate as inflation returns to target and be balanced with activity risks as labour market slack increases. Implicit is that rate cuts will occur when perceived activity risks are greater than those for inflation – this is unlikely until early-2024.
Consistent with this timeline and nascent shift in risks, Atlanta Fed President Bostic assessed that policy had only been restrictive ‘for less than a year’ and called for the pause to remain for the rest of the year, to account for the lag in monetary policy transmission. Chicago Fed President Goolsbee described the pause as a ‘reconnaissance mission’; but on a less dovish note, called the decision a ‘close call’. Taken together, these comments suggest the path ahead for policy will depend on how data prints.
Also for the US this week, housing indicators surprised to the upside. Building permits were up 5.2%mth in May and housing starts a staggering 21.7%. Optimism over a floor in activity for the sector is also picking up amongst builders, as captured by the NAHB Index which rose 5 points to an expansionary 55. Supply remains the chief concern for existing sales (0.2%;-20%yr), highlighting the opportunity for new construction.
Assessing the composition of the pipeline, while single and multi-family dwellings have both been supportive of late, over the year, multi-family has shown considerable strength, the number of units under construction at more than 50-year highs. This feature of the sector highlights the impact of affordability and the interest of institutional investors in expanding rental capacity in regions experiencing an imbalance between demand and supply. Eventually, this should help stop the extreme rent inflation experienced over recent years. Though it must be recognised that commercial-scale investors require competitive returns, so robust rent increases will be sought and contribute meaningfully to total consumer inflation into the medium term.
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