This week's US inflation data saw markets turning more hawkish, bringing forward rate hike expectations to the extent where a 50bps move from the Fed in March is now seen as a genuine possibility. Despite repricing for a more front-loaded hiking cycle, markets have been reluctant to shift from their view that the Fed's policy rate will peak at around 2%, a broadly similar level to at the start of the year. This has seen the yield curve flatten to mid-2020 levels, weighing on US equities over the week. A firmer US dollar and push back from ECB officials on rate hikes saw the EUR decline. Elevated commodity prices and a more open view from the RBA on hiking rates in 2022 continue to see the AUD rise from its recent low at the end of January.
High and rising US inflation has turned up the pressure on the Fed...
An upside surprise in January's data left US inflation up at 40-year highs as the headline CPI lifted from 7% to 7.5% and the core rate turned out at 6% from 5.5% (year-over-year rates). Amid supply constraints and strong demand, durable goods inflation remains extraordinarily high increasing to 18.4%, while energy prices are up by 27% over the year even after cooling a touch over the past couple of months. Pressure on the cost of living is also coming through from food (7%) and housing as owners' equivalent rent reached a near 15-year high (4.1%). Following the release, comments from the St. Louis Fed President James Bullard that he would support rates rising by 100bps by July drove a sharp repricing of rate hike expectations, with a larger-than-usual 50bps increase to start the tightening cycle in March now seen around a 50/50 prospect.
while in Europe, the ECB pushed back on early rate hike calls...
After opening the door to rates rising this year at last week's meeting, ECB President Christine Lagarde cautioned in an interview that hiking early would do little to curb high inflation and would also risk slowing growth and employment. In a similar tone, ECB Chief Economist Philip Lane in a blog post argued the case for a measured response to high inflation given that it was being driven by external supply issues and would likely be temporary, while Executive Board member Isabel Schabel said in a Twitter Q&A that adjustments to policy would be made in a gradual manner. This all came as the European Commission's Winter 2022 Economic Forecasts sharply raised the inflation outlook for this year from 2.2% to 3.5% due to persistent increases in energy prices and a broadening of prices pressures before easing back to 1.7% (1.4% previously) and below the ECB's target in 2023.
UK economy was still in the recovery phase as Omicron emerged...
UK GDP expanded by 1%q/q in Q4, broadly in line with consensus and matching the pace seen in the prior quarter. Overall, this still left the UK economy 0.4% below its pre-Covid level from Q4 2019. Monthly estimates highlighted the Omicron effect as activity turned from growth of 0.7% in November to a 0.2% contraction in December; the decline being driven by a 0.5% fall in service sector output as concerns over the virus hit the retail (-3.7%) and hospitality industries (-9.2%). Similar to the Fed, the Bank of England was last week grappling with the idea of a larger-than-usual hike in rates but ultimately settled for a 25bps hike. The BoE's Chief Economist Huw Pill used a speech this week as justification, putting forward that taking measured steps was the most prudent approach to normalising policy.
In Australia, the RBA maintained its patient message on policy...
Reaffirming the key themes from last week's Board meeting and 'Year Ahead' speech, RBA Governor Philip Lowe told the House of Representatives Standing Committee on Economics that given the uncertainty around wage and inflation dynamics, there were risks to tightening monetary policy too quickly, principally in hindering the effort to drive the unemployment rate down even further to generational lows. Flexibility to keep pushing the full employment side of the mandate comes from an RBA yet to be convinced that the recent return of underlying inflation to the middle of the 2-3% target for the first time in 7 years can be sustained, particularly as pandemic-related supply issues had contributed strongly to the rise in inflation even though their effects had been more pronounced in economies offshore. Confidence in meeting the inflation target requires a stronger pace of wages growth, which is currently only running around pre-pandemic rates. However, the RBA acknowledges there could be more upward pressure on pay rates than implied by the Wage Price Index, and with the QE program coming to an end this week, Governor Lowe said it was plausible that the cash rate may need to rise in 2022.
but expectations of 2022 rate hikes are weighing on consumer sentiment...
Certainly, households sense RBA rate hikes are nearing with a deterioration in assessments of family finances driving a 1.3% fall in consumer sentiment in February, taking the Westpac-Melbourne Institute Index back to a neutral level. In this latest survey, two in three respondents with a mortgage thought rates would rise this year. Post the Delta lockdowns, consumer sentiment was elevated in the optimistic range and that helped drive a record increase in retail sales volumes of 8.2% in Q4, rebounding from Q3's 4.4% record fall (reviewed here). Discretionary consumption across the non-food categories surged by 15.7%, with clothing and footwear (43.1%), department stores (25%), and cafes and restaurants (18.8%) benefitting from eased restrictions.
while Omicron disruptions are impacting businesses and the labour market
Though the impact of Omicron on the economy will be less severe than earlier waves of the virus, it is still is causing significant disruptions. The NAB Business Survey for January reported a sharp fall in overall conditions for firms, from a +8 to +3 reading, as the trading, profitability and employment components all weakened. However, confidence rebounded from the month prior (-12 to +3), indicating many firms thought the disruptions would be temporary. In the labour market, a slower post-holiday rebound compared to 2021 in the latest high frequency payrolls data pointed to the effects of Omicron as the ABS's business survey highlighted the significant extent of staff shortages in January due to isolation requirements.
