Cliff Notes: balancing the risks
Key insights from the week that was.
In Australia, the week started with an encouraging development, the Westpac-MI Consumer Sentiment's headline index rose 6.2% to be at its highest level in over a year, albeit still almost 15% below the long-run average. A ‘trifecta’ of disposable income pressures – high inflation, elevated interest rates and a rising tax burden – have materially impacted household finances. But inflation’s ongoing deceleration towards target and the hoped-for consequence for interest rates – policy easing on the horizon – is now providing some relief.
In February alone, views on the near-term outlook for the economy and family finances have improved, up 8.8% and 2.4% respectively. ‘Time to buy a major household item’ also gained an appreciable 11.3%. However, the family finance and ‘time to buy’ indexes remain well below their long-run averages, highlighting the long recovery ahead for consumer finances and discretionary spending capacity.
While households’ views on the labour market remain sanguine, official labour market data points to a softening labour market. Overall, the January Labour Force Survey was a poor update, underlying weakness amplified by shifting seasonal patterns. The 2.5% decline in hours worked in January, following a downwardly revised 1.5% decline through H2 2023 was particularly striking. January’s outsized decline in hours worked is, at least in part, the result of more people taking holidays in January than has typically occurred through history. The decline in H2 hours points to downside risk to output growth for Q4 2023; January’s result, suggests this may persist into 2024.
With activity growth to remain below trend through 2024, a further deterioration in labour market conditions is likely, albeit only to a still-low unemployment rate of 4.5% by year-end. While abating, the pace and composition of inflation will remain a critical risk over the period as well. Chief Economist Luci Ellis’ essay this week digs into the complex dynamics underlying Australian inflation.
Before moving offshore, a quick note on business. The latest NAB business survey delivered another soft update on the state of the domestic economy in late-January. The business conditions index fell 2pts to +6, extending the downtrend in place since 2022. Unsurprisingly, business confidence remains fragile, the index registering a below-average reading of +1. The most notable development in this survey was with regards to CAPEX spending, now at a ten-year low outside the pandemic. Businesses are clearly responding to the weakness in household demand. Alongside the fading impetus around non-residential construction, this development points to a downbeat near-term outlook for total business investment.
In the US meanwhile, January’s headline CPI came in slightly above consensus at 0.3%mth, 3.1%yr. Given its high weight, growth in the shelter component contributed two-thirds of headline inflation, both in the month and over the year. Medical care services and motor vehicle insurance also saw strong gains, though comparatively small weights limited their contributions to the aggregate. Arguably each of these factors are a consequence of supply dynamics versus demand and are therefore not a material concern for the FOMC, particularly with inflation expectations in retreat. The main point to take from recent US CPI readings is that headline CPI inflation ex-shelter is now tracking below the FOMC’s 2.0%yr target on a one, three and six-month basis. By mid-year, the annual rate will likely be there too.
Retail sales subsequently undershot expectations, the headline measure down 0.8%mth and the control group, which better reflects consumer spending, 0.4% lower. Given inflation, real sales were weaker still. Part of this decline likely reflects a post-sales hangover, but more months of data are necessary before a view on the 2024 demand trend can be formed.
This week, the UK was confirmed to be in recession after GDP was estimated to have declined 0.3%qtr in Q4, the consequence of a decline in both household and government consumption. The January CPI, released earlier in the week, meanwhile grew 4.0%yr with services inflation contributing 80% of the aggregate rise. Creating additional risk for services inflation, wages grew 6.2%yr in December, only slightly below the 6.7%yr prior. Even with the UK economy in recession, these conditions make it difficult for the Bank of England to cut rates. We expect the first rate cut to come in June, but progress thereafter will be slow.
Japan also finds itself in a technical recession after GDP fell 0.1%qtr in Q4 2023 owing to declining household consumption and investment. A silver lining is the benefit Japan continues to receive from tourism, net exports partly offsetting the contraction in domestic demand. Of more concern than the technical result is that household consumption has now contracted for three consecutive quarters with services consumption, typically more affected by wages outcomes, down in Q4. This data strengthens the case for the Bank of Japan to keep policy settings where they are and to be particularly mindful of the strength of sentiment and inflation expectations, both critical to achieving 2.0%yr inflation sustainably into the medium term.
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