Cliff Notes: a game of patience
Key insights from the week that was.
In Australia, the RBA February Minutes put forward a familiar account of the Board’s deliberations and assessment of risks, providing more colour on the key themes presented in various communications since the decision. The case to raise the cash rate further – centred on the observation that it would take “some time” for inflation to return to target – is becoming increasingly improbable given continued progress on inflation which is broadly consistent with the Board’s central forecast.
Before rate cuts can be delivered however, the Board will need to be fully convinced that inflation’s return to target will be sustained. That is expected to take several months, with the most likely date for the first cut being September – a view discussed in depth by Chief Economist Luci Ellis. We expect that policy easing will be delivered at a measured pace thereafter, 25bps per quarter through to September 2025, supporting a gradual recovery in GDP growth towards trend while ensuring inflation remains in the target range.
The Wage Price Index – one of the broadest measures of wage inflation – lifted 0.9% (4.2%yr) in Q4, in line with Westpac’s forecast. Compositionally, the headline result looks to have been bolstered by recent changes to enterprise bargaining agreements in health care and education/training, seeing the pace of public sector wage inflation lift to its highest rate since December 2008 (1.3%; 4.3%yr). Westpac estimates that individual arrangements – the agreement type most responsive to current economic conditions – are currently tracking a much softer pace of wage inflation (3.4%yr) than enterprise arrangements (5.7%yr) and award wages (5.2%yr). We remain of the view that current dynamics – including labour market softening and inflation’s deceleration – will continue to drive a moderation in wages growth into year-end, to a forecast 3.2%yr.
Ahead of next week’s partials on business investment and the Q4 GDP release on March 6th, two perspectives on Australia’s investment outlook were published this week.
For mining investment, the concentrated “burst” over 2023 was caused by pandemic-related delays that disrupted the flow of project starts. This dynamic is expected to fade going forward and, given the lacklustre underlying trend in this sector since 2016, momentum in project starts is likely to recede over the course of the year.
In contrast, the pipeline of electricity supply projects is clearly progressing, with the value of projects moving from “potential” to “committed” or “under construction” lifting from $27bn in 2022 to $38bn in 2023. While this may be, in part, a result of rising costs associated with Snowy Hydro, other renewable energy projects such as the $3bn Goyder South renewables zone are now beginning construction and will soon add to Australia’s electricity capacity. Investment into renewable energy projects and the evolution of Australia’s electricity supply will prove a vital determinant of Australia’s productive capacity and long-run economic success.
In a quiet week offshore, the FOMC’s January meeting minutes were of greatest significance.
The overall tone of the minutes suggest the FOMC are pleased with progress to date but believe “restrictive” policy has more work to do. Employment and inflation were characterised as ‘moving towards’ the FOMC’s goals, so too the overall balance between supply and demand. The FOMC continues to be concerned over inflation getting stuck above the 2% target however, owing to persistence in services inflation which the shelter component personifies.
The pace and scale of downward momentum in services inflation is critical to the aggregate outlook as the deceleration in goods prices that has come about because of normalising supply chains is likely to moderate going forward. Helpfully, regional indicators suggest businesses are finding it harder to pass on higher costs to consumers. Our recent analysis of the CPI also highlights that price growth across the CPI basket excluding shelter is now comfortably below target on an annualised basis from 1 to 11 months. Risks remain, but patience to mid-year should deliver annual inflation at, or very near, target and justify the beginning of the next easing cycle. Note though that our rate cut profile from June 2024 to December 2025 is only 200bps in total; that will leave the fed funds rate at a modestly contractionary level of 3.375% relative to FOMC’s longer run 2.50% ‘neutral’ view.
In Europe meanwhile, the January CPI final release confirmed that goods prices continue to weigh on aggregate inflation, the annual rate 0.1ppt lower at 2.8%yr. Energy prices are reaccelerating in monthly terms however, and could pose an upside risk to headline inflation as Europe enters winter. This development could partially account for the reacceleration in input prices, and subsequently selling prices, as measured by the Eurozone PMIs. While prices charged by manufacturers for their output fell in the month, services prices saw a sharp increase, the fourth increase in a row. Further outlining the divergence between manufacturing and services, the employment sub-index was strong for services, but manufacturers further reduced their demand for labour.
To date in 2024, ECB speakers have highlighted services inflation and strong wage growth as key factors in deciding when to cut rates. The data so far suggests they will need to balance a diverging outlook across countries and industries when making their decisions. We continue to expect a modest easing cycle by the ECB from mid-year, largely in sync with the US FOMC’s cycle.
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