Cliff Notes: constructive policy developments
Key insights from the week that was.
In Australia, the Monthly CPI Indicator fell 0.3% in October, pulling the annual rate of inflation down from 5.6%yr to 4.9%yr; encouragingly for policy, there were no convincing upside surprises within the detail. Indeed, goods prices – which constitute the bulk of the new information at this point in the quarter – reportedly fell 0.1% in the month, with weakness across household contents (–1.6%mth) and certain footwear/garment prices that are measured quarterly. The main driver of the headline result was a decline in services inflation (–0.7%mth); note though, a partial reversal could be seen next month when a larger portion of the services basket is surveyed.
Other consumer data received this week was also on the softer side. Nominal retail sales declined by 0.2% in October after September’s 0.9% gain. Abstracting from inflation and population growth, real per capita retail spending is experiencing a sharp decline in the realm of –4.5%yr to –5.0%yr. Another ‘noisy’ month for dwelling approvals did little to shift the underlying narrative: approvals are holding at weak levels and signs of a sustainable recovery are limited, suggesting that housing availability and affordability will continue to have a significant bearing on prices and rents. For a comprehensive update on the current state of Australia’s housing market and its prospects, see the latest edition of Westpac’s Housing Pulse.
As discussed by Chief Economist Luci Ellis, the data flow since the RBA’s November meeting has not provided any further material upside surprises. But, over the last few weeks, RBA Governor Bullock has devoted much effort to explaining the nuances around Australia’s inflation outlook. The take-away message is that if inflation threatens to take any longer to return to target than currently expected, the RBA Board would respond by tightening policy further. Such risks will certainly be front-of-mind early next year, though we still believe inflation will most likely decelerate through year-end and 2024, removing the need for further increases in the cash rate. Once inflation is convincingly heading towards target, there will be room to begin easing policy, most likely from Q3 2024. Over this period and into the medium-term, labour and capital’s cost and productivity will remain critical for policy.
In the lead-up to the Q3 GDP report, this week the ABS also released two partial indicators of investment.
It was revealed that construction activity lifted by 1.3% in the quarter, spot on Westpac’s forecast. The detail continues to highlight a growing contribution from public works (+4.2%qtr), centred on infrastructure projects; while private construction is tracking a flattening trend at an elevated level (–0.7%qtr). Housing activity continues to experience mixed fortunes, with new dwelling construction still 0.7% below its pre-COVID level while renovation activity is 16.1% higher.
The Q3 CAPEX survey subsequently delivered an upside surprise relative to our expectations, with a 0.6% lift in current activity. The 0.5% gain in aggregate equipment spending was constructive, though the mining and non-mining sector performances were distinct (+5.9% vs. –0.5%). On spending intentions, the fourth estimate for 2023/24 CAPEX plans remained optimistic, up 10% compared to the fourth estimate a year ago. In our view, that implies a 9% rise in nominal CAPEX spending over the financial year. However, momentum is likely to fade as the impetus from tax incentives wanes and the drag from softer demand becomes increasingly evident.
Following the stronger result on equipment spending, we have lifted our Q3 GDP forecast slightly to 0.4% (1.8%yr).
In the US, anecdotes from the 12 Federal Reserve districts were captured in the latest Beige Book. On activity, goods demand was perceived to have weakened, but services held up. Scaling the turn in aggregate momentum, “two [Districts indicated] conditions were flat to slightly down, and six [noted] slight declines in activity” compared to only “four Districts reporting modest growth”. Signs of labour market cooling were also evident with applicants more readily available and firms comfortable letting go of weak performers. Businesses also sought fewer loans while consumer credit remained robust; that said, delinquencies among consumers ticked up according to some banks. In this context, FOMC members' comments through the week indicated optimism that a soft landing was being achieved and that present policy settings were sufficient to rein in inflation.
Adding weight to this view was October’s PCE deflator which came in flat month-on-month, 3%yr. The components were in line with the recent CPI outcome and suggest that inflation’s next leg down will need to come from the shelter component. Personal income and spending both rose 0.2%mth; but over the year, income growth has outpaced spending, highlighting consumer restraint. The pace of real income growth will be critical in determining the degree to which consumption and GDP fall below trend in 2024 and the likely recovery thereafter. Significant job shedding, which the Beige Book hints is a risk, would destabilise income growth and lead to much weaker GDP outcomes. Financial and credit conditions are also critical.
Over in Europe, the flash CPI slowed to 2.4%yr in November from 2.9%yr, the core measure also improving materially to 3.6%yr from 4.2%yr. The deceleration was driven by a surprisingly large slowdown in services inflation from 4.6%yr to 4.0%yr. While on the surface the result supports the case for a near-term pivot to rate cuts, the European Central Bank's Nagel made clear that risks remain “skewed to the upside” and would not rule out further hikes if inflation accelerated once more.
In Asia, China's NBS PMIs were broadly unchanged in November. Manufacturing input prices declined 1.9pts, reflecting the impact of excess capacity in the economy alongside easing global supply pressures. Output prices improved, but the index remained below 50. Further downward pressure on prices will support global goods deflation; it is important to recognise that this trend stems as much from increased capacity, productivity and efficiency as it does soft demand. The non-manufacturing PMI meanwhile held just above 50. Helpfully, employment and new orders look to be stabilising, albeit at a weak level.
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