Cliff Notes: short-term risks and long-term opportunity
Key insights from the week that was.
On Budget 2024-25, our bulletin and conversation with Chief Economist Luci Ellis provides a full view of the Government’s fiscal position and economic plan to 2028. In terms of policy initiatives, the focus was split between immediate cost of living relief for households and long-term plans to expand Australia’s productive capacity. While these policies will see spending exceed revenue across the forward estimates, the Federal Government projecting a return to deficits from 2024-25 to 2027-28, it is not a given that inflation risks will increase, with current momentum and the degree of spare capacity at the time the policy initiatives become active to determine the consequence for inflation. This is a topic taken up by Chief Economist Luci Ellis in her weekly essay.
In terms of the week’s data, a below expectations Q1 WPI of 0.8% was constructive, seeing annual wage inflation moderate from 4.2%yr in December to 4.1%yr in March, ahead of the RBA’s expectation (growth or 4.2%yr through mid-2024). Last year’s strength in public wages – associated with new enterprise agreements and changes to wage caps – is cycling out. Private sector wage growth is also moderating, in line with the gradual easing of labour market conditions evident in April's Labour Force Survey.
At 2.8%yr on a three-month average basis, employment growth is slowly tracking towards the more typical 2.0-2.5%yr pace observed pre pandemic. Individuals remain eager to enter and participate in the labour force, but securing a job is becoming more challenging, seeing the unemployment rate edge higher. This trend is expected to continue through the remainder of the year to a quarter-average unemployment rate of 4.3% at year end.
Over in New Zealand, ahead of the RBNZ meeting next week and Budget 2024 at month end, our New Zealand team released their latest quarterly, providing an in-depth assessment of current conditions and the outlook.
Further afield, comments by US FOMC members through the week, including from Chair Powell, reiterated the need for patience and thorough analysis of price risks. Having experienced a strong first quarter of 2024, a number of months of data signalling further progress towards the 2.0% inflation target needs to be seen for the Committee to be comfortable easing.
The price data for April began this journey, the headline CPI printing below expectations at 0.3%, allowing the annual rate to edge down to 3.4%. More importantly, the detail of the release showed inflation is being driven by supply constraints and historic inflation – rents and motor vehicle insurance being the clearest examples. Meanwhile, goods inflation is absent, and discretionary demand driven components such as accommodation away from home and airfares are benign or in retreat.
Notably, annual headline CPI inflation excluding only shelter has been around 2.0% for 12 consecutive months, printing a range between 0.7% and 2.3% and averaging 1.7% over the period. Annual shelter inflation has also decelerated from 8.0% at May 2023 to 5.5% in April 2024. Although the PPI surprised to the upside in April, revisions to March offset; also, the components of PPI used as inputs for PCE inflation, the FOMC’s preferred measure of consumer inflation, were broadly neutral. Taking both the CPI and PPI detail into consideration, April’s PCE result will likely be benign.
US retail sales for April were also constructive for the inflation outlook, headline sales flat in the month and the control group down 0.3%. More importantly, both benchmarks are essentially flat over the first four months of this year, pointing to a stalling out of consumer goods demand. Services demand still has momentum, but its slowing. This sets the scene for a gradual deceleration in GDP growth over the course of 2024 to around trend, our baseline view. Such an outturn will allow the FOMC to begin cutting in September and continue doing so through to mid-2026, albeit to a still mildly-contractionary 3.375%. If the labour market suddenly deteriorates, the FOMC can accelerate or lengthen the cutting cycle; but this is a risk not our baseline view.
Data and policy guidance out of both Europe and the UK were also constructive for the price and activity outlook this week. Both the ECB and BoE look to be on track to cut in June, though the timing and pace of easing thereafter is yet to be determined with growth to pick up and inflation risks to persist. Conversely, the growth outlook for Japan remains challenged. This week, GDP was reported to have contracted in the March quarter by a larger than expected 2.0% annualised. That is the second contraction in three quarters, and there is a clear risk of further weakness given the consumer is financially constrained after a sustained decline in real incomes. The BoJ continues to anticipate an acceleration in consumer demand through mid-year as the latest wage increases take effect and inflation continues to abate. But consumer confidence and the health of small business pose significant risks. Japan is also arguably not in as strong a position as China, Korea and developing Asia to benefit from global growth in investment. While another small increase in Japan’s policy interest rates has to be expected in 2024, the end-point of this tightening cycle is likely within a 0.0-0.5% range versus 1.0% or above. The US dollar and US interest rates are therefore likely to dictate the Yen’s path rather than Japan’s domestic situation.
Finally to China, the April data round again highlighted that authorities are achieving on their objective to increase industrial capacity and, through trade, national income. However, also evident in the disappointing retail sales result is that households are, in aggregate, yet to see material benefit. At the same time, there remains a need for additional policy support for the property sector, which reports this week suggest are under discussion. Chinese growth is set to remain uneven and susceptible to shocks. But authorities’ 5.0% growth guidance for 2024 is certainly achievable; and, looking to the long-term, all the investment being undertaken is developing a strong foundation for a sustainable robust uptrend in national income.
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