Cliff Notes: shifting risks and rhetoric
Key insights from the week that was.
Beginning in Australia, the August RBA meeting minutes underscored the Board’s growing confidence in charting a ‘narrow path’ to the inflation target, in step with their decision to leave the cash rate unchanged for a second consecutive month. This was highlighted by a more constructive tone around recent data developments, the Q2 CPI outcome considered “reassuring” and discussions of an emerging “turning point” in labour market conditions being had. While the lingering risks around the inflation and labour market outlooks were acknowledged, it is clear the Board view policy as “working as intended”, with “a credible path back to the inflation target with the cash rate staying at its present level.” Data must now arguably surpass a much higher hurdle to warrant further rate hikes.
Against that backdrop, the wage price index once again printed on the soft side, rising 0.8% (3.6%yr) over the three months to June, a rate broadly consistent with monetary policy’s objectives. Adding further support to the view is the broad-base underlying the moderation in wage inflation, both by sector and bargaining arrangement. A large increase in aggregate wages growth is anticipated in September given the 5.9% increase in the minimum wage; but the Q2 update makes it difficult to argue for a sustained lift in wage inflation beyond Q3.
The July labour force survey subsequently provided an even larger surprise as employment declined 14.6k and the unemployment rate rose from 3.5% to 3.7%. However, the signal from this update is not clear cut, with the ABS providing a partial explanation for the surprise: “July includes the school holidays, and we continue to see some changes around when people take their leave and start or leave their job.” At the outset, this context is very similar to April and May, when the survey also exhibited significant volatility. Whether July is a turning point or merely monthly volatility is yet to be determined; but, based on recent experience with the survey, the latter serves as a more consistent explanation, at least at this stage.
Regardless of the minutiae, these updates will likely ease the Board’s concerns and give credence to their on-hold policy position. With the cash rate at a sufficiently restrictive level and GDP growth likely to remain well below-trend through 2023 and 2024, inflation’s return to target looks more assured, providing scope to begin easing policy in the second half of 2024.
Offshore, it was a fairly busy week.
Across the Tasman, the Reserve Bank of New Zealand kept the OCR steady at 5.50%. This stance is considered sufficiently restrictive to bring inflation back to target. The projections, however, show that rate cuts are now expected to occur further out, from end-2024/early-2025. This change is supported by stronger near-term growth, a better-than-expected rebound in house prices and higher June quarter non-tradeable inflation which has led the RBNZ to upgrade their inflation forecast. The statement also revealed a 25bp rise in the RBNZ’s estimate of NZ’s 'neutral' rate to 2.25%, suggesting current policy settings are less restrictive than previously believed. We maintain our view for an additional rate hike at the November meeting to 5.75%. The RBNZ put a 40% probability on this additional hike, but view the most likely timing as the first half of 2024.
Moving to the US, the FOMC released its minutes for the July policy meeting. “Almost all” participants were in favour of the 25bp rise. And “most” continued to see “significant upside risks to inflation” while “Some” saw downside risks to activity and employment and a “number” believed that the risks to achieving their aims had become “more two sided”. Each subsequent decision on rates will be data dependent, with “further evidence… required… to be confident that inflation… [is] clearly on a path toward the Committee's 2 percent objective”.
Clearly on the minds of the Committee is the tension between the economy’s resilience to date, highlighted in these minutes by the staff revising away their recession forecast and a stated belief that the housing sector’s response to rate rises has peaked, and the long and variable lags with which policy and credit conditions impact -- the latter tight and getting tighter. Occurring after the July meeting, the material rise in term interest rates on both a nominal and real basis should give the FOMC greater comfort over the outlook for inflation, financial conditions becoming more contractionary as a result. We continue to believe that the next move in fed funds is down, but this requires recent trends in inflation, wages and employment to be sustained.
In the UK meanwhile, the ILO unemployment rate ticked up to 4.2% in June from 4.0% in May, above the BoE's projection of 4% for Q2 2023. However, wages ex. bonus rose 7.8%yr, a new high for the cycle. And, including bonuses, wages were up 8.2%yr, well above the Bank of England's estimate of 7.6%yr. The July CPI print was more constructive. Headline CPI printed at 6.8%yr versus June's 7.9%yr, in line with the BoE's projections. Services inflation remained robust rising 7.5%yr, but this was expected by the BoE. The proportion of the CPI basket that grew faster than the 2% target also declined to 86%, the lowest share since March 2022.
While the BoE will be pleased that inflation has not upstaged their forecasts, as has been common in the past, wages pressures remain a worry. Ahead, the BoE will need to determine whether their estimate of the unemployment rate required to bring inflation back to target needs to be upgraded. If unemployment needs to rise further than previously expected, rates will likely need to be higher for longer. This contrasts with current expectations that, once inflation is contained, rate cuts will be swift.
Back in Asia, China's July partial activity data continued recent trends. Fixed asset investment ex. rural was up 3.4%ytd, the resilience as a result of tech manufacturing, utilities, and other infrastructure. Much of the strength, however, came from investments by state-owned enterprises and local government authorities, with private investment –0.5%ytd. Weak private sector investment is a symptom of the poor confidence plaguing China's businesses/consumers and the structural change underway in China’s economy – i.e. old large industry shrinking as up-and-coming higher-tech production expands.
Poor consumer confidence also clearly resulted in the lower than expected 7.3%ytd growth in retail sales. This concern won't abate until the labour market strengthens and the property market turns decisively – authorities deciding to suspend the youth unemployment rate to improve its statistical foundations definitely won’t help the situation. A dwindling pipeline of uncompleted projects and weak housing sales and starts meanwhile led to an 8.5%ytd fall in property investment. While recent RRR cuts and authorities encouraging banks to lend is helpful in building a base for activity, a rebound requires deposit requirements for home purchases to be eased further and confidence in the broader outlook. The latter can, in time, be fostered by local governments and associated entities sustaining their investment drive.
Japan's Q2 GDP surprised to the upside, rising 1.5%qtr, driven by an increase in net exports which contributed 1.8ppts. This likely came as a result of an uptick in exports of cars as manufacturers clear backlogged orders. Also note the Yen saw a significant depreciation through Q2, making Japanese exports cheaper. Domestic demand remains weak however -- household consumption contributing –0.3ppts to GDP and imports declining. Non-residential investment was also tepid. The Q2 result is a strong start for fiscal 2024 (Japan’s fiscal year begins in April), with the Bank of Japan forecasting GDP growth to sit between 1.0% and 1.3% for the year as a whole. That said, the retreat in domestic demand is in line with the Bank's view of simmering growth and the enduring need for accommodative policy. As such, we can expect the BoJ to persist with current policy settings as long as domestic demand lacks capacity to sustain robust momentum in consumer inflation.
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