Cliff Notes: searching for signal
Key insights from the week that was.
In Australia, this week’s main event was the RBA Monetary Policy Board’s (MPB) decision to raise the cash rate by 25bps to 4.60%. This outcome was universally expected given Governor Bullock had already communicated that upside risks to inflation had materialised – the conditionality established by the MPB back in August for considering another rate hike.
Governor Bullock made explicit note of three upside risks. The Middle East conflict was emphasised as the risk that had “materialised”, given the re-escalation and renewed surge in crude oil and refined product prices over recent months. The RBA’s liaison warns this could lead to further pass-through of costs and more persistent inflation pressures. On top of this, domestic capacity pressures and the data centre/AI investment boom were also noted as upside risks that the MPB remain alert to.
In a video update mid-week, Chief Economist Luci Ellis explains why the bar for a follow-up rate hike in November is low. We now expect a 25bp increase in November, provided there is no sudden resolution of the Middle East conflict beforehand, or some other event that significantly lowers the outlook for energy-related costs.
Subsequently, the August CPI revealed that underlying (trimmed mean) inflation rose 0.2% (3.4%yr), which was slightly below the market’s expectation but spot on Westpac’s forecast. As usual, the monthly detail was mixed, but the key drivers of underlying inflation remain centred on housing-related components, particularly rents and new dwelling purchases. Headline inflation remained volatile, with the unwind of the fuel excise cut causing another spike in fuel prices. We have maintained our forecast for a 0.9% lift in trimmed mean inflation in Q3, and with upside risks building for Q4, a follow-up rate hike in November appears most likely.
Regarding the current growth pulse, household spending surprised with a flat reading in August. Services spend fell back following recent strength that was driven by major sporting events, but this was offset by an increase in goods spend, particularly in fuel and electric vehicles. Together with our latest card data for early September, the consumer spending pulse is shading a touch softer. However, another solid outcome for business investment could once again be on the cards for Q3. August’s goods trade data showcased another significant spike in data centre-related equipment imports, up $4.3bn, similar in scale to Q1. While clearly import-driven, our modelling suggests that the local economic impact of such investment is likely to be around half of the total investment.
Before moving offshore, a final note on housing. Cotality’s latest update revealed that dwelling prices fell another 1.1% nationally in September. While Sydney and Melbourne have led the correction to date, the fact that the other capitals are also reporting price declines clearly indicates that the correction is deepening and broadening, as higher interest rates collide with the tax policy changes announced in May’s budget. Sentiment effects indeed remain at play, as evinced by the continued pull-back in investor credit growth. Westpac anticipates a peak-to-trough decline of around 7%, with tight on-market supply limiting the extent of the correction. For more, see our latest Housing Pulse.
Offshore, there was plenty of data to dissect.
In the US, inflation eased in August despite ongoing strength in household demand and higher energy prices. Headline PCE inflation rose 0.3%mth and 3.4%yr, while core PCE increased 0.2%mth and 3.0%yr. Encouragingly for the FOMC, the share of PCE components rising by more than 3% over the past year, a measure frequently cited by Fed Chairman Kevin Warsh, declined to 45% from 49%, suggesting some easing in broad-based inflation pressures. At the same time, household spending remained robust, increasing 0.9%mth, equivalent to around 0.6%mth in real terms. That said, personal income growth was soft, rising 0.2% in the month, signalling households opted to draw down savings.
The ISM manufacturing survey was stronger than the headline suggested. While the index edged down 0.1pt to 54.5, manufacturing has now expanded for nine consecutive months. There were some signs of capacity constraints emerging, with production softened in the month but backlogs up 4.6pts to 56.4, suggesting that firms struggled to keep pace with demand. New orders rose 1.6pts to 55.3, primarily due to domestic demand as new export orders eased, backlogs increased. Firms responded by lifting employment, 1.5pts to 52.7. Against this backdrop manufacturers saw a renewed acceleration in cost pressures, with the prices paid index jumping 6.8pts to 77.9. Firms cited higher steel and aluminium prices, elevated energy costs, rising freight charges and ongoing semiconductor shortages, with every major industry reporting higher input costs during the month.
The past week’s data will have done nothing to bridge the clear divide across the FOMC, as evident in this week’s busy Fedspeak. Some participants argued for further rate hikes, citing strong inflation, diminished supply capacity and policy that is not yet restrictive. Others counselled patience, pointing to progress on inflation and that September’s hike buys time to assess upcoming data. The one thing both agree on is that inflation will be the primary determinant of the timing and extent of further rate hikes. Our view remains that one further hike is likely this cycle to bring policy closer to neutral.
In China, policymakers announced another round of targeted support measures aimed at stabilising growth and supporting the struggling property sector. The PBOC lowered rates on its Pledged Supplementary Lending facility by 25bps to 1.5% and expanded quotas for targeted lending programs. Authorities also introduced subsidies for eligible first-home buyers. The subsidy applies to homes with a floor area of 120m² or less and a value below CNY1.5mn, with support capped at 1ppt of mortgage costs, up to CNY10,000 and for a maximum term of five years. The measures complement reforms announced in August to improve developer financing conditions and support housing completion. However, weak credit demand and confidence remains a significant constraint, suggesting policy transmission is still limited.
The September PMI data pointed to a modest improvement in activity, although the details were less convincing. Manufacturing returned to expansionary territory, rising 0.9pts to 50.1, supported by stronger production and new orders. Much of the improvement, however, reflected a rebound in prices, with the raw materials price index rising 7.6pts and producer prices increasing 6.2pts. Labour market conditions remained weak, with the employment index falling a further 0.6pts and remaining below 50 for almost four years. Conditions in the non-manufacturing sector also improved, with the services PMI lifting from 49.0 to 50.2, driven largely by stronger construction activity. Input and output prices moved higher, selling prices returned back above 50, export orders improved to 48.5 and employment increased 0.5pts, although at 45.9 it remains firmly in contractionary territory. Overall, the surveys suggest activity is stabilising and policy support is gaining some traction, but weak labour demand, subdued credit growth and soft domestic demand indicate the recovery remains fragile.
In Japan, the September Tankan survey delivered another constructive signal on the economy and reinforced the case for further policy normalisation. Business conditions improved by 2pts for large manufacturers and 5pts more broadly, while profitability indicators strengthened and capital expenditure intentions remained elevated. Large manufacturers expect fixed investment to increase by 11.6% in FY2026, while large non-manufacturers expect investment growth of 11.2%, pointing to continued confidence in the medium-term outlook.
Capacity indicators improved further across both manufacturing and non-manufacturing sectors, with measures of excess production capacity becoming less negative and indicating that demand remains sufficiently strong to keep pressure on existing capacity. Labour shortages also intensified, with employment conditions becoming more negative across most industries and firm sizes, pointing to a progressively tighter labour market. Inflation expectations remained anchored around 2%, providing further evidence that Japan is moving towards a more sustainable inflation environment. Overall, the survey was consistent with an economy operating close to capacity and supports the view that a December rate hike remains a realistic possibility.
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