Cliff Notes: policy matters
Key insights from the week that was.
The RBA Monetary Policy Board (MPB) unanimously decided to leave the cash rate unchanged at 4.35% this week, as widely expected. However, in the subsequent communications, the MPB clearly leaned against the idea that the hiking cycle is definitively over. After emphasising that both headline and underlying inflation is “too high” and warning that “[t]here are signs that some firms experiencing cost pressures are increasing the prices of their goods and services and others are looking to do so”, the MPB explicitly signalled that it will not rule out “increasing the cash rate target further if required” in order to achieve its objectives.
As discussed by Chief Economist Luci Ellis in a video update midweek, markets have recently taken a larger cue from a softer run of data around consumer spending, housing and the labour market. Some of the weakness in the labour market reflected ‘abnormal seasonality’ which we expect will revert in May. But the important point is that Governor Bullock framed a weaker economy as an intended consequence of tighter monetary policy – slowing demand growth enough to squeeze inflation out of the system and prevent it from becoming embedded in expectations. With upcoming inflation data likely to show further persistence, we think the MPB will feel compelled to respond with further rate hikes in August and September.
Before moving offshore, a final note on local manufacturing. The latest Westpac-ACCI Survey of Industrial Trends revealed that momentum stalled heading into mid-year, the Actual Composite falling from a robust 57.6 in Q1 to a neutral reading of 50.5 in Q2. Underpinning the result was a flattening in new orders, a deceleration in output growth and a decline in employment. This comes as the Middle East conflict compounds the cost-of-living pressures households face, weighing on demand. It has also reignited cost pressures within manufacturing, a net 51% of firms reporting a rise in average unit costs. Firms expect further material increases in selling prices as a result, suggesting the pass-through of higher costs will persist into the second half. What was once budding optimism on the general business outlook has now collapsed to deep pessimism, leading many firms to delay or cancel plans to increase investment and hiring over the coming year.
Before moving further afield, New Zealand received an update on economic activity this week, the 0.8% rise in Q1 GDP a little less than we expected, though revisions meant the annual growth pace came out ahead of our forecasts. The pick-up in momentum evident over recent quarters likely came to a halt in Q2 due to the Middle East conflict, but this week’s apparent resolution (see below) could see the economy pick up again sooner than we had assumed.
In the US, the first FOMC meeting with Kevin Warsh as Chair was largely as anticipated. Notably, Chair Warsh focused on the practices of the Committee and the Federal Reserve as much as the economic outlook, announcing the formation of five separate task forces. On the current state of the economy, the labour market was characterised as largely in balance. The message on inflation was blunt, Chair Warsh making clear the Committee “will deliver price stability”.
Regarding the near-term policy outlook, the market showed concern over 9 of 18 respondents expecting at least one rate hike by year end. However, in the press conference, Chair Warsh made clear the degree of uncertainty participants wrestled with in coming to these views. Also, at least with respect to energy prices, in recent days risks have begun to recede. If the US/Iran deal holds over coming months, we expect the FOMC to remain on hold.
The Bank of England also marked time in June, with seven of the nine Monetary Policy Committee members voting to keep Bank Rate unchanged at 3.75%. The minutes showed that Chief Economist Huw Pill and external member Megan Greene preferred a 25bp hike as a risk-management response given the possibility of material second-round effects from energy inflation. Other members took comfort from the recent fall in energy prices. The latest labour market and inflation prints were meanwhile interpreted as evidence that disinflation was well underway before the Middle East conflict. Nonetheless, the statement carried a hawkish tone, signalling the Committee still sees price risks as the dominant concern.
In Asia, the Bank of Japan raised its policy rate by 25bps to 1.0%. This follows strong wage outcomes earlier this year and growing evidence of pass-through to domestic inflation, particularly for services. In Governor Ueda’s absence, Deputy Governor Uchida signalled further rate hikes ahead. We expect that productivity gains and sustained domestic inflation pressures will support the BoJ reaching a terminal rate of around 1.5% in mid-2027.
The Policy Board also confirmed that it will continue tapering JGB purchases, albeit at a slower pace. Importantly, the Bank retains the flexibility to scale up purchases in the event of disorderly moves in yields and will continue to pre-commit to purchase amounts on a quarterly basis.
On the data front, Chinese activity disappointed again in May. Retail sales contracted over the year, -0.6%yr, as soft income growth, declining wealth and an absence of confidence weighed. Fixed asset investment fell 4.1%ytd, driven by declines in sectors including property, health and education, but also owing to a lull in previously strong areas of the economy, namely manufacturing and utilities. Industrial production growth of 5.4%ytd shows the effective use of current capacity to meet strong growth in external demand, however. Aggregate growth in the economy is largely dependent on net exports’ contribution at present. This is unsustainable given the record-high level of the trade surplus, hence the need for material and urgent stimulus for the domestic economy.
Finally, to the Middle East conflict. A resolution now looks to be in effect, at least for the next 60 days after a 14-point Memorandum of Understanding was signed by both the US and Iran. On day 1 of the Strait’s re-opening, several VLCCs, which each carry 2 million barrels of oil, were seen transiting the Strait as others readied at port. Further, not only will shipments from other Middle East countries now come to the global market, but also from Iran – waivers allowing the nation to freely sell into the global market without delay and, as conditions are met, the removal of sanctions should confirm long-term access. Negotiations over Iran’s nuclear program are still necessary, and until agreed there is risk of further conflict. Also, it will take time for damaged infrastructure and global inventories to be rebuilt. Still, the initial market reaction has be positive, the price of Brent oil falling from a recent peak near USD110 per barrel to USD79, compared to an average of USD63 in Q4 2025.
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