Macro (Re)view (1/11) | US FOMC signals pause; Australian CPI soft

For the third consecutive meeting, the US Federal Reserve's policy-setting Committee (FOMC) announced a 25 basis point rate cut that lowered the range for its benchmark interest rate to between 1.5% and 1.75%. Back in July, the FOMC delivered its first rate cut since late-2008, described at the time by Committee Chair Jerome Powell as a "midcycle adjustment to policy" as insurance from the risks posed by weakening global growth, US-China trade tensions, and muted inflation. Since then, the guidance has been that the Committee would "act as appropriate to sustain the (economic) expansion", though the decision statement at this meeting altered this to read: "The Committee will continue to monitor the implications of incoming information for the economic outlook as it assesses the appropriate path of the target range for the federal funds rate". Then, in his post-meeting press conference, Chair Powell described the current interest rate setting as "in a good place", indicating the Committee will pivot from its proactive stance to a more reactionary framework.

At this juncture, the Committee's baseline outlook remains constructive seeing the continuation of the 11-year long economic expansion, a strong labour market and inflation near the 2% target as "the most likely outcomes". However, risks around global growth prospects and trade uncertainty still attend this outlook and as such Chair Powell noted; "if developments emerge that cause a material reassessment of our outlook, we would respond accordingly". Data this week showed that GDP growth in the US slowed from an annualised 2.0% pace to 1.9% in Q3 and continued to highlight an economy being driven by consumer spending against broad-based weakness from business investment and net exports in response to the uncertainties over trade and global demand conditions. Support for the consumer continues to come from the labour market, with non-farm payrolls rising by 128k in October against expectations for an 85k increase, while there were also sharp upward revisions for the previous two months. In line with expectations and with a rise in workforce participation from 63.2% to 63.3%, the unemployment rate ticked back up to 3.6% from 3.5% but remains around its lowest levels since the late 1960s. Meanwhile, October's read on the ISM survey for the manufacturing sector at 48.3 showed there had been some improvement in conditions after a precipitous decline in September to 47.8. However, new orders, production, and employment contracted for the third consecutive month, with firms noting global trade uncertainty as a key concern. 

Over in Europe, the European Commission's Economic Sentiment Indicator weakened in October to its lowest level since early-2015 as confidence among industrial firms, which are exposed to the global trade and economic headwinds, slipped further below the long-term average level, while there were signs this pessimism is now spilling over into the broader services sector and is also dampening consumers' perceptions of conditions placing at risk the outlook for retail spending. The preliminary estimate of GDP growth in the euro area in Q3 was in line with consensus at 0.2%, which saw the annual pace ease from 1.2% to 1.1% to be at its slowest since Q4 2013. Economic activity in the bloc has slowed markedly from a 3.0% annual pace at the end of 2017 and has been heavily impacted by external weakness as well as Brexit-related and US-China trade uncertainty. In contrast, domestic demand has been more resilient and September's update of the labour market was consistent with this as the unemployment rate held at 7.5% to be at its equal-lowest since mid-2008. However, core inflation at 1.1% over the year to October remains soft relative to the European Central Bank's (ECB) target of below, but close to, 2% as outgoing ECB President Mario Draghi made one final call to fiscal authorities to step up stimulus during his farewell speech in Frankfurt to conclude his 8-year tenure. 

In the UK, Brexit developments saw the EU agree to an extension of the withdrawal date (previously October 31) to January 31. However, PM Johnson was successful in gaining Parliamentary approval for a general election on December 12, which he hopes will result in a working majority to facilitate the passage of his withdrawal agreement through the House.

Closer to home, the Bank of Japan left its monetary policy settings on hold but there was an alteration made to its forward guidance to indicate that interest rates, which are already negative, could be lowered further, or left at their present levels for longer, as it closely monitors the risks from abroad that could derail the moderate expansion underway in the domestic economy and hinder progress towards meeting the 2% inflation target.  

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In Australia this week, events were highlighted by the Consumer Price Index (CPI) report for the September quarter. Overall, the nation's inflation pulse remains soft on both a headline and underlying basis, though Q3's update was broadly in line with market estimates and contained few surprises (see our full review here). Headline CPI increased by 0.5% in Q3 as the annual pace lifted slightly from 1.6% to 1.7%. The quarterly figure was driven mostly by higher overseas travel costs associated with the peak seasons in the northern hemisphere and an increase in the federal excise tax on tobacco. Outside of these influences, there were further signs of drought-related impacts on meat and bread prices and modest increases in retail prices due to the pass-through from a weaker Australian dollar. A 2% fall in petrol prices was the main weight on inflation in Q3, while weakness in rents and new dwelling costs remain notable constraints given their high weightings in the CPI. Underlying inflation, which excludes the impact of extreme price changes, was unchanged at 0.4% in Q3 and 1.4% over the year, based on the average of the weighted median and trimmed mean measures (see chart of the week, below). The latter is the Reserve Bank of Australia's preferred index, with this measure coming in at 0.4% in the quarter keeping the annual pace steady at 1.6%. As such, inflation has now undershot the 2-3% range targeted by the Bank for 15 consecutive quarters dating back to Q4 2015. 

Chart of the week

In a speech in Canberra earlier this week, RBA Governor Philip Lowe gave significant focus to the inflation target and emphasised the flexibility the Bank has in pursuing this aspect of its triple mandate, which also includes full employment and economic prosperity and welfare. In the global context of financial stability shocks and structural changes associated with rising competition and technological advancements that have occurred over recent years, the governor argued that having this flexibility has allowed the Bank to set policy in a way that better acknowledges these complexities. In contrast, many central banks in other jurisdictions have more rigid inflation targets and it is worth noting that the Federal Reserve and ECB have recently hinted at moving towards similar approaches following years of undershoots. Highlighting the welfare aspect, the governor made the comment; "I also see longer-term benefits in terms of the standing of central banks in the community if they explain their decisions in terms of jobs and incomes, not just short-run variations in inflation rates". This comment is consistent with the communications from the June, July and October meetings where the RBA Board announced rate cuts, which all contained references to offering support to employment growth and incomes. Governor Lowe did not dismiss the importance of inflation targeting, but his comment that "it is a means to an end, and that end is welfare maximisation" was a fairly conclusive reinforcement of what the current reaction function is. Markets are now giving next to no chance of a rate cut at next week's meeting and have somewhat surprisingly priced out expectations for another cut in this cycle, though the risks remain clearly to the downside. 

Housing was also a key focus this week, with CoreLogic's Home Value Index showing a fourth consecutive monthly rise in national property prices with a 1.2% lift in October to now be down by just 2.3% through the year compared to an earlier trough of around -9%. Momentum continues to build in the Sydney (+1.7%m/m) and Melbourne (+2.3%m/m) markets — the latter seeing its strongest monthly rise in nearly a decade — and while the tone appears to be improving across the other capitals the performances remain mixed. Yet to convey this turnaround, housing credit growth to owner-occupiers remained at its 5-year low of 4.8%Y/Y and slipped into contraction (-0.1%Y/Y) for the investor segment, though these measures can be expected to pick up over the months ahead. Meanwhile, the outlook for the residential construction cycle remains weak in spite of a sharp 7.6% increase in dwelling approvals in September (see our review here). In Q3, approvals fell by 7.4% to their lowest quarterly aggregate in more than 7 years, driven predominantly by weakness in the unit segment, though the detached segment also softened further. Based on these indications, residential construction activity is likely to remain a drag on national GDP growth until well into 2020.