Cliff Notes: into 2026, a broad array of risks remains
Key insights from the week that was.
Australia’s key release for the week was the Westpac-MI Consumer Sentiment Index which, after November’s ‘net positive’ read, fell 9% to 94.5 in December – a ‘cautiously pessimistic’ level. Responses to questions on news recall suggest consumers were shaken by recent inflation results, the tone of related coverage now viewed as decisively negative versus somewhat mixed three months ago. This has sparked one of the sharpest turnarounds in consumers’ mortgage rate expectations on record, 86% of those with a view now anticipate mortgage rates to be the same or higher in a year’s time.
This has fed into renewed concerns over the economy, the one-year and five-year ahead sub-indexes falling 9.7% and 11.7% respectively. Buyer sentiment also looks to have been crimped, the ‘time to buy a major household item’ sub-index shedding 11.4% to be well below average. Official data is pointing to a genuine consumer upswing, driven by a recovery in real household disposable incomes; however, higher inflation, interest rates and bracket creep threaten the outturn. As a result, the year-ahead outlook for family finances fell 6.1% to be modestly below average.
The RBA has also taken signal from the recent lift in inflation, with only some of the pressures deemed temporary. As detailed by Chief Economist Luci Ellis earlier this week, Westpac continues to believe inflation will moderate through 2026, but the Monetary Policy Board’s more hawkish assessment has pushed back the timing of further policy easing into 2027. There are risks to both sides of our view for policy to remain on hold in 2026 and two cuts in H1 2027. If inflation continues surprising meaningfully to the upside in the near term, a rate hike could become a possibility. But, if the labour market weakens more than expected, the cuts now forecast for 2027 may need to be brought forward.
Fiscal policy developments are also worth monitoring vis a vis inflation and growth. The Federal Government’s MYEFO revealed an $8.7bn improvement in the budget’s bottom line over the forward estimates due to a tax windfall associated with higher commodity prices and a firmer-than-expected economic upswing. If the government elects to save the bulk of the windfall, it would ease near-term inflationary pressures – at the margin.
Before moving offshore, a final note on the local manufacturing sector. The latest Westpac-ACCI Survey of Industrial Trends revealed that the long-awaited improvement in conditions is finally starting to materialise, the Actual Composite bouncing from a broadly neutral read to a solid 55.1 in Q4. The Expected Composite meanwhile continued to lift to fresh cycle highs. Some of the hallmark challenges facing the sector, such as elevated costs, skilled labour shortages and material constraints, has restricted the ability for some manufacturers to respond to firmer demand. Solid investment intentions and plans for hiring, if realised, should go some way to alleviating capacity constraints.
Over in the UK, the Bank of England cut rates by 25bps to 3.75% in a narrow 5-4 vote. Those voting for a cut emphasised the downside risks to growth; those for a pause that inflation, which came in at 3.2%yr earlier in the week, could show greater persistence. On the outlook, Governor Bailey noted that “judgements around further policy easing will become a closer call” suggesting that the BoE is nearing the end of its easing cycle. With GDP growth expected to be only slightly above 1% in 2026 and inflation trending down, we maintain a view of further gradual BoE easing in H1 2026, by 25bp per quarter. However, the committee may proceed more cautiously, delaying cuts to the second half of next year.
Across the English Channel, the European Central Bank kept rates steady at 2.0% with President Lagarde noting once again that "policy is in a good place". Inflation was revised up for 2026 due to a slower descent in services inflation (core inflation now 2.2%yr), but it is still expected to stabilise at target in 2027/2028 (1.9% and 2.0%). The economic growth projections have also been revised up to 1.4% in 2025, 1.2% in 2026 and 1.4% in 2027, where growth is expected to remain in 2028. The statement made clear the "Governing Council is not pre-committing to a particular rate path", highlighting that policy will be fine-tuned depending on how the risks evolve.
In the US, November's inflation read surprised to the downside, the core measure rising 2.6%yr while headline prices rose 2.7%yr, both down from 3.0%yr in September. However, with the government shutdown precluding an October report and essentially no month-to-month detail provided for November, the FOMC is unlikely to take signal from this inflation read. Earlier in the week, non-farm payrolls rose 64k in November after a 105k decline in October, both released at the same time. Average job gains over the last 3 months are circa 20k, towards the bottom of the range estimated to be consistent with balance between labour demand and supply. It is unsurprising then that the unemployment rate edged up 0.2ppts between September and November to 4.6%.
In Asia meanwhile, Chinese partial data came in softer than expected in November. Retail trade was up just 4%ytd, weighed down by persistent weakness in consumer prices, but more significantly weak sentiment and declining wealth. Equities are now trending higher, but house prices continue to decline. Industrial production grew 6%ytd, however, highlighting that the capacity investment of recent years is earning a return. Fixed asset investment fell 2.6%ytd though, as high-tech manufacturing retraced some of its rapid gains of prior years, and property construction continued to contract. Clearly, pro-active stimulus in scale is necessary to put a floor under activity and, in time, see sentiment move back up.
Further east, the Q4 Tankan survey showed conditions improved by two points to 17pts, supporting views for a rate hike later today by the Bank of Japan. The output prices measure remained broadly steady, with one-year, three-year and five-year ahead projections all consistent with at-target inflation. Investment plans remain high, albeit with a slight downgrade from last quarter's expectations. Software investment is anticipated to increase 12.2%, while R&D investment is expected to rise 4.6%. All this is consistent with reports of firms investing to reduce their demand for labour and in pursuit of productivity. Employment conditions remained consistent with a tight labour market; firms expect to hire more new graduates in the following financial year. Overall, the survey points to a tight labour and historically elevated inflation expectations, which should aid workers case for higher wages in FY26 (ending in March 2027).
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