Cliff Notes: mixed signals keep central banks data dependent
Key insights from the week that was.
In Australia, the October RBA meeting minutes provided a detailed outline of the Board’s considerations for policy. The case to raise rates centred on the outlook for inflation and potential upside risks. The argument for remaining on hold rested on the fact that the full impact of policy tightening is still to be felt while inflation, labour market tightness and economic activity are all moderating (as discussed below). The arguments behind both options were familiar; with few material developments over the month, remaining on hold was, once again, recognised as the stronger policy option.
That said, there were some important shifts in rhetoric, most notably the assertion that “The Board has a low tolerance for a slower return of inflation to target than currently expected.” As outlined by Chief Economist Luci Ellis, this implies that if a significant upside surprise were to occur with regards to inflation, the Board is willing to respond by tightening. The RBA Board’s November discussion will benefit from a detailed update on inflation, with the Q3 CPI report due next week and new RBA staff forecasts to be tabled. As detailed in our Q3 CPI preview (available later today on WestpacIQ), considerable uncertainty remains over the inflation outlook, particularly the competing impacts of rising childcare costs and recent changes to childcare rebates. If inflation prints as we anticipate (1.1%qtr/5.3%yr for Q3), we believe the RBA will remain on hold through year end and well into 2024.
Moving on, the September Labour Force Survey provided a fairly mixed read on current labour market conditions. Broadly, the results did not shift the overarching view that the labour market is at a turning point -- no longer tightening, but yet to materially soften. This is highlighted by the gradual moderation in the pace of employment growth – which we currently judge as modestly below trend – in addition to two consecutive monthly declines in hours worked. However, that the participation rate fell sharply (–0.3ppts) whilst employment rose modestly serves as a reminder of the survey’s volatility month-to-month. We expect labour market conditions to continue cooling into year-end and slack to build more materially through 2024 as economic growth holds well below trend.
In Asia, Chinese Q3 GDP surprised to the upside coming in at 4.9%yr and 5.2% year-to-date, putting the 5% full-year growth target well within reach. Looking at the September monthly data, industrial production (IP) remains a bright spot, rising 4.5%yr with strength most apparent in materials. Strong export demand also continues to support IP as China expands the array of manufacturing components it produces.
Fixed asset investment rose 3.1%yr, held up by non-property related investment. The authorities' focus on productivity and efficiency is clear. Key sub-categories of high-tech investment continue to grow at between 10% and 40% even as their combined size nears that of property investment. Utilities investment is also up 25% year-to-date and other infrastructure around 6%. Unlike property, these sub-categories of investment are income and efficiency producing; hence their completion is just the start of their contribution to the economy. If China’s success with trade continues, further robust investment growth can easily be justified.
However, the property market remains a heavy weight -- property investment down 9.1% year-to-date in September, extending 2022’s decline. Recent stimulus measures, including cuts to the reserve requirement ratio and deposit requirements for homebuyers, are yet to take full effect and may be hindered by persistent pessimism around the property market, whether it be uncertainty around completion or future price increases.
The effectiveness of policy for property also threatens consumption via wealth. The September retail sales data highlight this risk. Total sales rose 5.5%yr, robust 13.8%yr growth in catering services a stark contrast to modest 4.6%yr growth in goods, implying households are financing higher spending on services by limiting or delaying discretionary spending on goods. The urban/rural split also suggests households in major cities remain cautious on the outlook.
Overall, Q3 GDP and the September monthly data imply current momentum in China’s economy is stronger than the market had anticipated, and there is no obvious reason why it will fail immediately. But risks around the consumer remain, particularly for young workers. So, while we have revised up our 2023 forecast from 5.0% to 5.3%, we have also lowered our 2024 forecast from 5.5% to 5.3% after which a deceleration to around 5.0% is likely in 2025.
There was also plenty for the Bank of England to ponder this week. Wages grew 8.1%yr, down from 8.5%yr previously. Private sector wages led the deceleration, easing to 7.1%yr from 7.7%yr. While the BoE has indicated that they are looking at measures beyond Average Weekly Earnings, a downshift should give them comfort that emerging labour market slack is cooling wages.
September's CPI in contrast remained steady at 6.7%yr, much to the disappointment of markets, but still below the BoE's 6.9%yr forecast. Goods disinflation persisted but was compensated for by services. The October result, out before the November meeting, ought to show a substantial easing in inflation coming off a high base caused by a spike in electricity prices in 2022. Easing wages and CPI trending down should give the BoE enough confidence to remain on hold at the November meeting.
Over in the US, retail sales surprised to the upside, total sales rising 0.7%mth and the control group 0.6%mth in September. August's figures were also revised up 0.2ppts for headline and 0.1ppt for the control group. The health of the labour market and long-term fixed rate mortgages continue to provide households with capacity to spend, even as already-weak consumer expectations for the economy deteriorate further. Providing an additional buffer, recent data revisions imply consumers have more pandemic savings left than previously thought.
FOMC Chair Powell’s appearance at the Economic Club of New York closed out the key economic events for the week. The focus of his prepared remarks was policy’s progress to date and a belief that there are risks in both tightening “too little” and “too much”. The extended Q&A that followed covered an array of possibilities and uncertainties for the outlook, but overall made clear that the FOMC are broadly comfortable with the current stance of policy as long as it continues to prove effective – i.e. inflation continues to trend down towards 2%yr. Also front of mind for the Committee is the potential impact on financial conditions of rising term interest rates which are assessed to be a consequence of an increased term premium, not fed funds rate or inflation expectations.
This rise in yields is having a similar effect to further increases in the fed funds rate, at the margin increasing the probability of inflation staying on course. The FOMC therefore looks set to remain on hold in November and thereafter will continue to assess conditions. We expect a further softening of the labour market and a sharp pullback in aggregate growth from Q4, which should justify the FOMC also remaining on hold in December and January. The degree of further improvement in inflation will subsequently dictate the timing and scale of cuts in 2024 and beyond.
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