The week brought to a close a tough quarter and first half of the year as markets worked through the risk of recession coming down the line in response to aggressive hiking cycles to curb high inflation.
The ECB's Forum in Sintra highlighted events this week, with the standout being the panel featuring ECB President Lagarde, Fed Chair Powell and Governor Bailey of the BoE. A united front was presented, prioritising the need to bring inflation under control over the risks posed to growth outlooks. Although there is confidence their course of action will work, the heads of all three central banks thought that it was unlikely the world would return to the low inflationary environment that characterised the previous cycle post the financial crisis. The push toward deglobalisation and the green transition were contributing factors cited, while Governor Bailey highlighted structural changes to the labour market coming out of the pandemic.
Australian retail sales continue to defy weak sentiment
National retail sales lifted for the 5th month running with a stronger-than-expected 0.9% rise posted in May, defying the sharp fall in consumer sentiment over recent months. Through the first quarter of the year, retail sales lifted by 2.9% supported by resilient demand (contributing 1.2ppts) as inflation started to ramp up (1.7ppts). So far in Q2, retail sales have risen by 1.8% with the largest increases coming in food (2.4%) and cafes and restaurants (5.1%), categories which the ABS noted are being boosted by rising prices (note fuel is not included in national retail sales). Spending has advanced in clothing and footwear (1.7%), department stores (2.5%) and other categories (2%) but declined in household goods (-2.3%). Overall, while slower volumes are likely for Q2, the data still suggest demand has been broadly resilient to the effects of inflation and weak sentiment.
The strength of the labour market looks to be a key factor supporting that resilience. Labour demand continues to surge with a further 58.2k job vacancies posted over the 3-month period to May. That brings total vacancies to 480.1k, equivalent to 3.4% of the labour force. The labour market has been the major beneficiary of the economic recovery from the pandemic. Currently, there are 25% of businesses with at least one vacancy, well up from only 11% prior to the onset of Covid. With the labour market to keep tightening, the RBA will be increasingly confident of wages growth rising into the 3s, the level it views as consistent with sustainable 2-3% inflation, which speaks to the idea discussed at Sintra of a departure from low inflation dynamics.
US tracking towards a slowdown in Q2 GDP
Market concerns around slowing US growth were encapsulated by the deterioration in the latest reading of the Atlanta Fed's GDPnow model and by the ISM manufacturing index softening to a 53.0 reading in June, its lowest since June 2020. The GDPnow model has the US economy on track to contract by 1% in the June quarter (downgraded from -0.3%), though this is more pessimistic than most analyst forecasts.
The outlook for consumption is being revised with households facing cost-of-living pressures and rising interest rates. Data for May showed growth in real personal consumption declined by 0.4% in the month, its weakest outcome since December, while revisions reduced the pace of growth in April. The decline in May was driven entirely by falling goods consumption (-1.6%m/m), which is unwinding from the elevated peaks reached during the pandemic. The rotation back towards services continued with a 0.3% rise, though the rebalancing of consumption patterns is proving to be much more drawn out than many expected.
Meanwhile, inflation on the key core PCE deflator moderated from 4.9% to 4.7%yr in May, a 6-month low. Although inflation on this measure is on the way down, it's too early to call the peak on the headline rate, which is yet to roll over holding steady at 6.3%yr.
New high for euro area inflation
Euro area inflation continues to push new record highs as June's preliminary readings came in above expectations. Headline inflation was posted at 0.8% month-on-month, which left the annual rate up at 8.6% from 8.1% in May. The spillover effects from the war in Ukraine saw energy prices surge 3.3% in the month (41.9%yr) and food prices pushed up by 1.1% (8.9%yr). With these two components the major drivers of inflation, there remains a large wedge to the core rate, with its pace easing from 3.8% to 3.7%yr, defying expectations for a lift to 3.9%, partly reflecting the impact of government support measures in Germany. Core inflation is unlikely to have peaked yet, and with the euro area unemployment rate falling to a new low at 6.6% in May wage pressures are likely to be building.
