Cliff Notes: responsive policy
Key insights from the week that was.
In Australia, Q1 GDP confirmed that the economy started the year on a weak footing, rising just 0.2% to be up 1.3% over the year. Compositionally, the roll-off of energy rebates saw a portion of spending re-allocated from governments to households; but overall, the pulse in the domestic economy remains faint. Having just experienced one of the most prolonged and deep contractions in real per capita disposable incomes on record, households continue to preference rebuilding savings buffers over discretionary spending. While public spending remains elevated, the support it offers to economic growth is starting to wane as large infrastructure projects move towards completion. Growth in housing construction was a bright spot amongst the GDP detail, but new business investment was mixed – non-residential construction accelerating as equipment spending fell to its lowest level in two years.
Prior to the GDP release, the RBA Minutes made clear that current trends in domestic economic conditions alone justified a further reduction in policy restrictiveness in May, with the added downside risks from global developments raising the possibility for a 50bp cut (which was ultimately dismissed). With growth now having stalled at 1.3%yr over the past six months, it is important to consider how the RBA might reach its terminal policy rate and where that terminal policy rate might be. This week’s essay from Chief Economist Luci Ellis explores these questions.
Coming back to the GDP detail, the external sector proved to be a slight drag on activity, with real net exports detracting –0.1ppts from Q1 GDP. Highlighting the volatility at present, weather-related disruptions to coal production and port activity more than offset the gold export rush, while travel-related services exports surprised materially to the downside. Some of these goods trade dynamics started to unwind over April, but we are likely to see further volatility in coming months.
Before moving offshore, it is worth noting that the latest Cotality (formerly CoreLogic) data showcased another bumper gain in house price growth, up 0.5% in May. Seasonality may be overstating the scale of recent gains; regardless, the data reflects a clear rapid response to RBA rate cuts which will be tested against affordability in coming quarters. For more detail on our views around the housing market, see our latest Housing Pulse.
In the US, the May ISM reports painted a sombre picture of the economy. The manufacturing index fell 0.3pts to 48.5pts, with most components below the 50 expansion/contraction divide. Of particular note, the production and new export orders sub-indexes both posted sizeable falls and remain more than 10pts below their pre-COVID 5-year average. Both the prices and supplier deliveries sub-indexes rose strongly, however, reflecting the impact of tariffs – increased import costs and a hoarding of inputs ahead of feared tariff escalation. On the services side, the headline index surprised, falling from 51.6pts to 49.9pts. In the detail, there was a substantial drop in the new orders, order backlog and export components. On the bright side, the services employment index regained momentum to 50.7, consistent with balance between labour demand and supply. The Federal Reserve’s latest Beige Book highlighted similar concerns over prices and uncertainty regarding the outlook for both activity and the labour market.
Further north, the Bank of Canada maintained its policy rate at 2.75% at their June meeting, seeking further information on the implications of US trade policy for the Canadian economy. Post-meeting communications noted that the labour market has weakened, particularly in trade-related sectors; however, inflation has been modestly stronger than anticipated. Activity growth has shown resilience amid uncertainty, however; although this is partly due to exports and inventory building to avoid tariffs. The Bank of Canada noted they intend to be less forward looking in the months ahead, amid considerable uncertainty over trade policy and with the policy rate near neutral.
Also facing considerable uncertainty from offshore, the European Central Bank cut its deposit rate by 25bps to 2.0%. Revised forecasts show inflation is now anticipated to be 2.0% in 2025 then 1.6% in 2026 (both 0.3ppts below the prior forecast) and 2.0% in 2027. Their GDP forecasts were broadly unchanged, with growth expected to come in at 0.9% in 2025, 1.1% in 2026 and 1.3% for 2027. Accompanying these baseline forecasts were staff scenarios. A “further escalation of trade tensions over the coming months would result in growth and inflation being below the baseline projections. By contrast, if trade tensions were resolved with a benign outcome, growth and, to a lesser extent, inflation would be higher than in the baseline projections.”
In terms of the path ahead, President Lagarde emphasised the uncertain terrain the ECB are navigating and consequently that they will “follow a data-dependent and meeting-by-meeting approach” in determining policy. That said, President Lagarde mentioned the central bank was in a "good place" and that "they were getting to the end of a monetary-policy cycle". On balance, the hawkish tone on the inflation outlook increases the probability of a pause in interest rate cuts at the next meeting in July, but it does not rule out a further cut in September or later in the year, particularly if near term uncertainty and tariff effects prove to be a bigger issue than the ECB expects.
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