In the week of Royal Ascot, a race of a different kind went up a notch as central banks sped up the normalisation of policy settings. This was headlined by the Fed's 75bps hike but extended as far as the SNB, surprising markets with a 50bps hike. The BoJ remains the outlier keeping policy unchanged. An aggressive hiking cycle poses major risks to global growth prospects, leading equity markets to reprice accordingly and yield curves to flatten.
Labour market data supports a 50bps RBA rate hike in July
The Australian labour market continued to tighten in May, with this week's data set to keep the RBA normalising rates at an accelerated pace. Employment more than doubled the expected figure to advance by 60.6k in May, a result strong enough to hold the national unemployment rate at its 48-year low of 3.9% amid a surge in participation to a new record high at 66.7%. Full time employment continued to rise at pace lifting by a further 69.4k in the month, supporting the ongoing expansion in hours worked to 4.9% above pre-Covid levels. The rate of underemployment now has a 5 in front of it for the first time since 2008 (5.7%) and total underutilisation in the labour market is at a 40-year low (9.6%). My full review of the May Labour Force Survey can be accessed here.
Although the pace of wages growth remains modest (2.4%Y/Y in Q1), the NAB Business Survey continues to indicate that labour costs are on the rise, while this week's decision by the Fair Work Commission to raise the national minimum wage by 5.2%, a tick above the rate of inflation (5.1%), will provide a boost. Appearing in a TV interview, RBA Governor Philip Lowe reiterated that the strength of demand was putting pressure on the capacity of the economy and, together with global factors, was contributing to high inflation. This has led the RBA to forecast a higher peak for inflation at 7% (from around 6%) by the end of the year, further supporting the case for a follow-up 50bps rate hike in July. While consumer sentiment has weakened sharply, Governor Lowe continued to remain upbeat on the economic outlook pointing to the strength of household balance sheets and the labour market.
Fed accelerates tightening with a 75bps rate hike
With May's CPI report showing US inflation lifting to 8.6% and concerns this was feeding into higher inflation expectations, the Fed responded by dialling up the pace of its tightening cycle with a 75bps rate hike at this week's meeting that takes the policy rate to 1.5% to 1.75%. Furthermore, members on the FOMC have significantly lifted their expectations for the scale of tightening required, signalling its policy rate will rise into a restrictive range for economic activity by the end of the year. In the post-meeting press conference, FOMC Chair Jerome Powell said a 50 or 75bps rate "seems most likely" at the July meeting.
Upward revisions to the inflation outlook in 2022, with the headline PCE gauge rising to 5.2% and the core PCE rate at 4.3%, have prompted a more forceful reaction from the FOMC. The Summary of Economic Projections pushed the median estimate for the fed funds rate this year to 3.4% from 1.9%, with further hikes in 2023 taking the terminal rate to 3.8% (from 2.8%). The by-product of a more aggressive and frontloaded hiking cycle is lower output, with GDP growth revised down from 2.8% to 1.7% in 2022 and from 2.2% to 1.7% in 2023 before levelling out to a pace around trend in 2024 (1.9%). Despite these growth downgrades, unemployment is projected to rise only modestly across the projection period from 3.7% to 4.1%. This is a vastly more sanguine view on the economic outlook compared to the repricing that occured in markets this week that reflected expectations for a sharp slowdown and runs the risk of deteriorating into a downturn on the back of aggressive monetary policy tightening.
BoE resists pressure hiking rates by another 25bps
As other central banks are in the process of speeding up the return to more normal settings, it remained business as usual for the Bank of England this week as it hiked rates by another 25bps to 1.25%. The MPC's decision was sealed by a 6-3 vote (as it was in May), with the minority (comprising Haskel, Mann and Saunders) again calling for a larger 50bps hike. While sticking with 25bps hikes for now, the MPC appeared to position for greater optionality by replacing its previous policy guidance with a commitment to "act forcefully" in response to inflationary pressures.
The situation for the BoE is finely balanced. On the one hand, it lifted its forecast for peak inflation to above 11% in October (currently running at 9%), which allows for another large increase in the energy price cap, but on the other, the growth outlook is deteriorating and it now expects GDP to contract by 0.3% in Q2. For the time being, households appear to be holding up still increasing spending despite a large squeeze on real incomes and very weak sentiment. A tight labour market has been a key support, with the unemployment rate at 3.8% and below its pre-pandemic level. The BoE also noted that cost of living support measures by the UK government would bolster households.
ECB makes plans to deal with fragmentation
After limited details emerged from the ECB's meeting last week on how it planned to contain peripheral yield spreads as it begins hiking rates from next month, the Governing Council went to the unusual step of calling an "ad hoc" meeting to discuss the matter. The meeting statement reported that reinvestments from its maturing PEPP holdings will be applied with "flexibility", allowing the ECB to purchase more Italian and other nations' bonds.
Although it is unclear how much PEPP redemptions would amount to, analyst estimates suggest this could be in the order of €200bn through the remainder of the year. The statement then went on to confirm that the Governing Council had tasked its committees with accelerating the preparatory work for a new "anti-fragmentation" tool. Earlier in the week, the ECB's Isabel Schnabel in a speech said there were "no limits" to the central bank's commitment to ensuring the smooth transmission of its monetary policy stance across the euro area.
