The data flow gave markets and policymakers alike plenty to think about this week. The expectation for further rate hikes remains intact, maintaining the upward pressure on bond yields and gaving support to the US dollar. But there is increasing recognition that the lagged effect of monetary policy tightening has yet to play out in economies, which is limiting visibility around the outlook.
More work ahead of the RBA...
Although there was much focus on RBA Governor Lowe's appearances at the Senate and House of Representatives, little new information came from his Canberra visit. In short, the RBA has more work to do with rates to lower inflation, which it sees as requiring a softening in the demand side of the economy and for the easing in global supply constraints to work their way into Australian prices. In balancing up the risks of doing too much vs too little, it continues the judge the risks around the latter as more pressing. Governor Lowe reiterated that the RBA is aiming for a soft landing but the path has become narrower due to the uncertainty around the economic outlook. Interestingly, the tone from Governor Lowe wasn't all hawkish saying that market pricing for interest rate cuts to next year was "a plausible scenario". This somewhat contrasts with the higher for longer pushback that has been coming from most other central banks of late.
... as the data complicates the picture
Consumer sentiment according to the Westpac-Melbourne Institute Index showed a predictably sizeable post-RBA meeting fall in February (-6.8%) to a 4-month low. The NAB Business Survey, however, indicated demand conditions from the consumer had been robust in January. This week's key release on the labour market came in weak across the key details; employment declined by 11.5k (vs 20k expected), its second consecutive fall as the unemployment rate lifted from 3.5% to 3.7%. As covered in my detailed review (see here), this weakness looks attributable to seasonal volatility rather than signalling a turning point in the labour market, and employment appears likely to rebound sharply in February.
US data gives louder voice to Fed hawks
Strong US data continued this week and led Fed hawks Mester and Bullard to put the idea of 50bps rate hikes back on the table. Compared to recent months, inflation showed more modest signs of easing in January, with headline CPI coming in at 6.4% (vs 6.2%) and 5.6% (vs 5.5%) on core CPI, both measures 0.1ppt softer from December. The resolution of supply chain pressures and switching demand patterns continued to see durable goods prices fall (-1.3%yr); however, services inflation ticked higher overall (7.6%yr) and was elevated even after removing the housing components (4%yr).
Retail sales posted very strong rises in January, potentially boosted by pent-up demand from weather-related disruptions in December. Headline sales surged 3% in the month, their strongest rise in nearly two years while the control group, which feeds into GDP calculations, advanced by 1.7%, a 12-month high.
Improving outlook in Europe but ECB remains on guard
The odds of Europe falling into recession look to have lengthened with the economy showing its resilience over the winter. The European Commission lifted its forecast for growth in 2023 from 0.3% to 0.9% and cited the risks to the outlook had become more balanced with energy prices falling and China reopening earlier than expected. Inflation is now expected to decline more quickly to 5.6% in 2023 (from 6.1%) and 2.5% in 2024 (from 2.6%).
However, that is still too high to comfort the ECB, with Executive Board member Schnabel warning against complacency saying that the restrictive effects of the tightening cycle so far were difficult to judge. Two of the more dovish members of the Governing Council in Chief Economist Lane and Executive Board member Panetta spoke of the lags in monetary policy transmission and how that will need to come into consideration as rates continue to rise.
UK inflation eases but wage pressures rise
January's inflation readings for the UK were softer than expected as headline inflation declined from 10.5% to 10.1%yr (vs 10.3% expected) and the core rate came in from 6.3% to 5.8%yr (vs 6.2%). Inflation pressures are easing due to a disinflationary pulse coming through in energy and goods prices. Against this, services inflation has been on the rise, though it posted a surprise fall to 6%yr from 6.8% with airfares moderating.
The Bank of England's Chief Economist Pill indicated in a speech this week that the pace of rate hikes was set to slow but that the MPC needed to remain attentive to the risks of inflation persistence. In this respect, Pill highlighted that the labour market "remains tight in an absolute sense" and this is contributing to rising wages growth. Data this week showed annual wages growth (ex-bonuses) firmed from 6.5% to 6.7% in December on the back of a 74k increase in employment that held the unemployment rate steady at the historical low of 3.7%.
