Cliff Notes: an abrupt change in expectations
Key insights from the week that was.
The latest edition of the Westpac-Melbourne Institute survey pointed to consumer sentiment remaining near its historic lows in December, the index rising just 2.7% to 82.1 compared to a long-run average of 100.8. The probability of further rate hikes may be dwindling, but consumers find themselves under considerable financial pressure as a result of the tightening experienced to date; the cumulative hit to real incomes from inflation; and a rising tax take, the latter principally a consequence of bracket creep and a topic discussed in depth by Westpac Chief Economist Luci Ellis. From the survey, the persistence of these factors is as significant as their scale: 2023 being the second weakest year ever for consumer sentiment overall; and assessments of family finances versus a year ago and for the year ahead respectively 23% and 15% below average.
The consequence for spending of this entrenched weakness is not only apparent in our consumer sentiment survey, but also the spending data. Last week’s Q3 GDP report estimated that real consumption was essentially flat over the six months to September and down around 2% over the year on a per capita basis. Available data for the current quarter is also poor, Westpac’s Card Tracker reporting a 5.9pt fall over the fortnight to December 9, unwinding the prior boost from Black Friday and taking the index back to its lowest reading since July 2022.
Challenges for the financial position of households were also on display in the November labour force survey, which showed a well above trend gain for employment of 61.5k but also a further lift in the unemployment rate from 3.8% to 3.9%, the mix made possible by a further rise in the participation rate to a new record high. While the cost of living squeeze appears to be encouraging those outside the labour force to join and those already engaged to remain, weak end-demand is starting to see businesses reduce hours worked by individual staff. The pattern would be consistent with workers seeking additional hours having to look for a second position rather than taking up overtime offers from their primary employer.
The improving availability of labour argues for limited upside risks to wages growth and the totality of the report points to upside risks for unemployment should the economy disappoint through 2024 and 2025. Our baseline expectation remains a gradual lift in the unemployment rate to 4.7% at end-2025 as population growth outpaces job gains. In assessing the risks for employment, it is important to closely assess the evolution of business conditions and confidence. While the NAB survey (PDF 162KB) again reported robust conditions in late-November, business confidence fell to its third weakest reading for the monthly series back to 1997, outside the GFC and the 2020 covid outbreak. Highlighting businesses’ growing concern over the outlook, the capital expenditure index from the survey has fallen 8pts over the past four months to +4, the lowest reading since the delta outbreak.
The benefit of record employment was on display this week in the Government’s Mid-Year Economic Update (PDF 269KB), with a $66bn upgrade to expected receipts over the four years to 2026-27 and a consequent $40bn benefit to the Budget’s bottom line. The Government’s expectations for the labour market are relatively similar to our own, but the combination of population growth; bracket creep; and commodity price outperformance points to additional upside for receipts.
Over in New Zealand, two data releases indicated the economy is in a much weaker state than previously estimated. GDP not only contracted 0.3% in the September quarter, but heavy downward revisions to prior quarters left the annual rate at -0.6%yr and the level of GDP 1.8% lower than the RBNZ estimated for the November Monetary Policy Statement. Given population growth of 2.7%yr, per capita GDP has declined more than 3% over the 12 months to September – a very weak result. Statistics NZ’s update on consumer price movements in November was also softer than anticipated and resulted in our NZ economics team lowering their Q4 CPI forecast from 0.6% to 0.3%, a long way off the RBNZ’s forecast of 0.8%. If our team is correct, annual inflation will be 4.5%yr at December. There remains a degree of uncertainty about the persistence of disinflation. And so, with inflation still a long way from target, a need for careful monitoring of inflation dynamics.
Further afield, the FOMC’s December meeting was the highlight for market participants. The communications did not disappoint, with the Committee responding to success with inflation and balance in the labour market by not only removing the additional hike forecast at September for 2023, but also adding a cut to their 2024 view – 75bps of cuts are now projected by the Committee for 2024 to 4.6% followed by 100bps to 3.6% in 2025 and another 75bps to 2.9% in 2026. To end-2025, the revised FOMC view is broadly in line with our established view of 100bps of cuts in both 2024 and 2025 to 3.375% at end-2025.
During the post-meeting press conference, Chair Powell was balanced in his assessment of the risks noting that, despite the revisions to their forecasts, the Committee is willing to tighten policy further if appropriate (i.e. demand and inflation surprise materially to the upside). However, he also recognised the risk of recession with the full effects of monetary tightening still to be felt. Late in the press conference, he also cited a belief that the Committee needed to be “reducing restriction well before [inflation reaches] 2%”. Contrasting our own forecasts for the US economy as set out in the December/January edition of Market Outlook, we see downside risks to the FOMC’s activity views, forecasting two years of modestly below-trend growth in 2024 and 2025 and a lift in the unemployment rate to 4.7%. But we also expect inflation to surprise to the upside from H2 2024, with a 2.5% annualised pace anticipated on average to end-2025. This anticipated imbalance between growth and inflation is a consequence of enduring capacity constraints in the housing sector and the limited breadth of the business investment upswing.
The European Central Bank (ECB) and Bank of England (BoE) delivered their December decisions a day after the FOMC. Both sets of communications highlighted lingering inflation risks despite recognising success-to-date in bringing inflation towards their medium-term 2.0%yr target and with the activity outlook clouded. Given the rhetoric and assuming their forecasts prove accurate, both the ECB and BoE are set to follow the FOMC into rate cuts with a lag. This is part of the reason why we project a sustained uptrend in Euro and, to a lesser extent, Sterling over both 2024 and 2025. It is worth noting that both currencies have already jumped ahead to trade at levels we did not expect until mid-2024. There is therefore room for volatility around a steady uptrend. Full detail of our FX and interest rate forecasts can be found in Market Outlook.
Cliff Notes will return in mid-January 2024. We’d like to wish all our readers a Merry Christmas and happy new year.
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