Following the likes of the Reserve Bank of Australia and the Bank of Canada, the Federal Reserve and the European Central Bank increased the hawkish volume of their messaging on policy at their respective meeting this week. But this proved no match for the rally in global risk sentiment. The expectation is that further rate hikes will be required in the US and euro area as the risk of persistent inflation pressures remains present. Markets are unconvinced the Fed will hike again while they took the ECB's messaging in their stride. The Bank of Japan also met this week, leaving all settings unchanged. Attention shifts to the Bank of England's meeting next week, a 25bps hike considered a lock on the back of a strong labour market report and rising wages growth. Given the forward profile for UK rates is aggressive, with 4 additional hikes expected to a peak of 5.5%, it may be harder for the MPC to deliver a hawkish surprise.
Fed hawkishness falls flat as inflation decelerates
The Federal Reserve's FOMC delivered the 'skip' it had guided markets to expect at this week's meeting, the fed funds rate remaining steady in the 5-5.25% range. Cautioning against extrapolating this week's decision into a more extended pause, the FOMC raised its projection for the peak rate to 5.5-5.75%. However, markets are unconvinced an additional 50bps of rate hikes will be forthcoming given the disinflationary pulse working through the US economy. Headline CPI fell from 4.9% to 4% in May - its slowest since March-21 - and this was backed up by a continued easing in pipeline price pressures in producer (1.1%yr) and import prices (-5.9%yr). The core CPI softened to 5.3%yr but is still elevated and as Chair Jerome Powell highlighted in the post-meeting press conference, the FOMC has been frustrated by the slow pace of progress on this front.
Speaking to this, FOMC members raised their outlook for the core PCE deflator - its preferred gauge of underlying inflation - from 3.6% to 3.9% this year; the projection for 2024 was left unchanged at 2.6%, with a return close to the target anticipated in 2025 at 2.2% (from 2.1%). Chair Powell also made the point that the FOMC continues to see that the balance of risks to its inflation outlook remain to the upside, justifying the expectation for a higher peak rate. This comes amid renewed confidence in the resilience of the economy; forecast GDP growth was upgraded from 0.4% to 1.0% in 2023, which lowered the outlook for the unemployment rate to 4.1% from 4.5% previously.
ECB recalibrates as inflation risks persist
In addition to announcing a 25bps hike to its key rates this week, the ECB signalled rates were set to rise further in July, developments that were expected by markets. The depo rate now stands at 3.5%, up from -0.5% this time last year. Uncertainty remains over how close the ECB is to the peak rate. In the post-meeting press conference, ECB President Christine Lagarde said an outlook for higher inflation than previously expected meant that rates had yet to reach their destination, remaining short of a sufficiently restrictive level.
ECB staff macroeconomic projections raised the inflation profile to 5.4% on a headline basis in 2023 (from 5.3%) and to 5.1% on the core rate (from 4.6%). Inflation is then anticipated to decline at a slower pace through the projection horizon, remaining firm to its 2% target come 2025: headline at 2.2% (from 2.1%) and core at 2.3% (from 2.2%). The drivers of inflation - previously caused by the shock to food and energy prices stemming from the war in Ukraine - are switching to labour cost pressures, which the ECB says carries upside risk to its outlook. That portends higher rates but at the cost of a more forceful headwind to the economy. Euro area growth has contracted slightly over the past couple of quarters, resulting in the ECB lowering its growth outlook from 1% to 0.9% this year and to 1.5% from 1.6% in 2024.
Australian labour market rebounds strongly
A strong rebound in the Australian labour market from the slowdown over the Easter holiday period has put a hawkish and data-dependent RBA back in focus. Pricing for a July rate hike has pushed up to 50% from 25% as employment surged above expectations rising by 75.9k in May - its strongest increase in 11 months - after declining by 4k in April (full review here). Attesting to the strength of labour demand, the unemployment rate fell back from 3.7% to be close to its lowest since 1974 at 3.6%. While this will keep the RBA alert to wage pressures, labour supply in Australia remains highly dynamic - as it was through the pandemic - with the participation rate rising to a new record high of 66.9%.
Surveys on households and businesses continued to report that confidence remains weak. For households, the Westpac-Melbourne Institute consumer sentiment index was broadly unchanged in June (-0.2%) but remains in deeply pessimistic territory, largely reflecting the impacts of cost-of-living pressures and rising interest rates. A weak confidence reading for businesses in the NAB survey (-4) appears driven by the expectation that conditions - while still above average for now despite softening in May (+8) - are set to weaken materially amid an outlook for economic growth to slow as consumers pull back.
