Cliff Notes: considering near-term risks
Key insights from the week that was.
This week, the RBA decided to leave policy unchanged for a fourth consecutive month. Given that it was Governor Bullocks’s first meeting at the helm, market participants were eager to dissect the decision statement for any changes in rhetoric or perceived risks. In the event, the decision statement was little-changed from August, apart from refreshed observations on the Monthly CPI Indicator, including “fuel prices have risen notably of late”. The RBA is certainly justified in highlighting near-term momentum in inflation. Indeed, we have upgraded our own inflation forecasts for Q3 and Q4 in light of the stickier services detail in the Monthly CPI Indicator, recent strength in crude oil prices and the languishing Australian dollar. These developments will be incorporated into the RBA’s staff forecasts next month following the more comprehensive Q3 CPI report of late-October. We expect their revisions to also be contained to the near-term, leaving intact inflation’s path back into the target band in 2025.
As such, we remain of the view that the RBA will keep the cash rate unchanged in coming months. Looking to 2024, as economic growth remains weak, labour market slack will build. With inflation maintaining its downtrend towards target, the RBA will have sufficient evidence to begin easing from September quarter 2024, delivering 25bps of cuts per quarter through to mid-2025.
For more detail on our views on the outlook for the RBA and global central banks, our latest edition of Market Outlook is now available. The RBA also released their latest Financial Stability Review today, highlighting the resilience of Australia’s economy and financial system amid considerable uncertainty.
Turning then to the housing data, the CoreLogic home value index posted another broad-based gain in September (0.9%) with solid increases reported in most of the major capital cities. Despite clear evidence of robust momentum in house prices, housing finance approvals point to low transaction volumes, with the total value of new loans still 27% below 2022’s peak. A sizeable pipeline of work is currently holding up the level of housing construction, abstracting for high-rise volatility; but, as highlighted by dwelling approvals, the pulse of new activity is soft. Elevated construction costs and widespread capacity issues will continue to weigh on housing construction activity over the coming year, providing support to both house prices and rents.
Before moving offshore, a quick note on trade. Australia’s trade surplus bounced notably in August, rising from $7.3bn to $9.6bn. This was largely a consequence of strength in gold exports which nearly doubled in the month as imports essentially halved, leading to a remarkable $2.4bn improvement in the gold balance. Excluding gold, the detail was broadly as expected, exports rising 0.3% as imports gained 0.7%. The latter in part reflects the impact of a weaker Australian dollar and higher global oil prices.
Turning to New Zealand, the RBNZ kept rates steady at 5.50% at their October meeting and their statement did not carry as hawkish a tone as Westpac and others forecasters had expected. Inflation continues to show persistence in New Zealand, while the impact of current policy settings has been blunted by strong migration and expansionary fiscal policy. As such, we maintain our call for an additional rate hike in November and now expect the cash rate to remain on hold at 5.75% until early 2025. A slow decline in the cash rate to 4% in 2026 and 3.5% from 2027 onwards is then anticipated.
Further afield, the ISM manufacturing PMI rose for a third consecutive month, albeit only to a still-contractionary 49. The lift was broadly supported by new orders, production, and employment. Despite the stronger pulse of activity, prices paid fell, leaving the sub-index 12pts below its 5-year pre-COVID average. Both from a demand and supply perspective, manufacturing sector inflation pressures seem benign.
The September non-manufacturing PMI report was mixed. The headline index fell in the month, but at 53.6 is still expansionary. Looking ahead, the decline in new orders and employment point to a belief amongst service providers that discretionary spending is losing steam across the economy.
Focusing in on the labour market, the manufacturing and non-manufacturing ISM employment components together with the JOLTS survey’s hiring and quit rates, which are now back at pre-pandemic levels, suggest labour demand and supply are near balance. If GDP growth settles below trend in coming quarters as we expect, then a further deceleration in job creation is likely.
Several FOMC members also spoke this week. Of most significance were the comments of San Fransisco Fed President Mary Daly. President Daly described holding nominal rates steady as an “active policy action” because declining inflation expectations will see the real stance of policy “grow increasingly restrictive”. With real term interest rates already at deeply contractionary levels, and given our expectation that GDP growth and the labour market will disappoint the FOMC, we continue to believe rate cuts will be appropriate from March 2024 and that 100bps of cuts will be required over the year versus the Committee’s current median estimate of just 50bps (from a higher peak).
Over in the UK, the Bank of England released its Decision Maker Panel (DMP) survey results for September. Of note, 3-year ahead inflation expectations rose to 3.2%. Realised wages increased to 7.1% and expected wages to 5.2% after two months at 5%. In the most recent meeting, the BoE indicated that wage growth was “stable” according to broader measures of wage growth, setting aside the rapid gain in headline average weekly earnings. The DMP is one of the broader measures that the BoE is referring to. An uptick in expected wages (albeit a modest one) increases the risk of another rate hike for the BoE. It is worth noting that the survey closed a day after the most recent meeting, potentially supporting the survey’s outcomes.
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