Australian Q2 Wage Price Index; 0.6%q/q, 2.3%Y/Y

Growth in Australia's Wage Price Index (WPI) lifted by a stronger-than-expected 0.6% in the June quarter, though the annual pace remained subdued at 2.3% consistent with a labour market operating with a considerable level of spare capacity. Growth in public sector wages in Q2 and over the past year outpaced the private sector, boosted by a strong increase in Victoria. 

Wage Price Index — Q2 | By the numbers

• The headline WPI (total hourly rates of pay ex-bonuses) increased by 0.61% in Q2 to outpace the median forecast for +0.5%. Q1's initially reported increase of 0.54% was revised lower to 0.46% in today's report. 
• In annual terms, growth in the WPI lifted from 2.26% (revised from 2.34% in Q1) to 2.33%  

Wage Price Index — Q2 | The details 

The ABS's Wage Price Index (WPI) is a measure of the change in price of wages and salaries paid by all employer types for a fixed group of jobs unadjusted for compositional characteristics of employees (role responsibilities, experience, qualification levels, hours worked etc). Thus the WPI reflects underlying factors driving wages growth and can be influenced by changes in individual and enterprise bargaining agreements and in minimum wage settings and awards. 

The headline WPI increased by 0.61% over the 3-month period ending June, which saw the pace over the past 12 months rise gently from 2.26% to 2.33%. Breaking these results down, the WPI for the public sector increased by 0.82% in Q2 -- its fastest quarterly rise in more than 5 years going back to Q1 2014 -- with the annual pace rising from 2.37% to 2.58%. The private sector WPI posted a 0.54% rise in Q2 to match the outcome in Q1, though the pace through the year eased from 2.35% to 2.26%. 

Adjusting for inflation as measured by the Consumer Price Index, real growth in the WPI over the year slowed from 0.96% to 0.73%, though if adjusted by the trimmed mean measure of inflation, real growth picked up from 0.66% to 0.73%. Either way, real wages growth remains very subdued -- though it is at least on an improving trajectory. 

The WPI inclusive of bonuses (not seasonally adjusted) softened in the June quarter rising by 0.38% compared to 0.46% in Q1, while the annual pace slowed from 2.64% to 2.47%. There were contrasting moves across the sectors with the private sector slowing to 0.38%q/q and 2.41%Y/Y (prior: 0.46%q/q, 2.66%Y/Y) as the public sector lifted to 0.6%q/q and 2.51%Y/Y (prior: 0.45%q/q, 2.37%Y/Y). 

On an industry basis, the healthcare sector led the way over the past year rising by 3.7% to match strong employment growth. An additional 6 industries recorded wages growth above the national average of 2.33%, including utilities (2.84%), arts and recreation (2.79%), public administration (2.54%), other services (2.44%), education (2.41%) and professional services (2.36%). The transport industry (2.33%) was in line with the national average. 

That meant wages growth lagged in 10 industries; accommodation and food services (2.31%), finance and insurance (2.3%), real estate (2.3%), mining (2.16%), administration (2.02%), manufacturing (2.01%), retail (1.92%), construction (1.86%), telecommunications (1.83%) and wholesale trade (1.71%).      

The chart (below) shows the quarterly outcomes for WPI growth in each state and sector. Growth in Victorian public sector wages was the clear standout here rising by 1.48%. 

  

The next chart shows the state and sector outcomes over the past year, which was also led by the Victorian public sector at 3.7%. Private sector wages growth in New South Wales was noticeably soft at 2.19%, which lagged the national average for the sector (2.26%) and the headline WPI (2.33%). Conditions are comparatively stronger in the Victorian private sector (2.64%). Softness remains notable in the private sectors in Queensland (2.11%) and Western Australia (1.65%). Surprisingly, given the employment data, the strongest market for private sector wages growth was Tasmania (3.18%). 

From an overall perspective, while most states languish Victoria pulled further away over Q2 to 2.9% in annual terms in response to an underutilisation rate that has fallen by around 2ppts over the past 2 years.  

Wage Price Index — Q2 | Insights 

Australian wages growth remains subdued at around a 2.3% pace in annual terms. As the chart (below) highlights, an elevated level of spare capacity is a strong headwind to wages growth, though there are also other structural influences at play, such as low growth in productivity, a more globally mobile workforce and the increased use of technology. The detail in today's report showed subdued wage pressures continue to be broad-based across most industries and states. There is little to suggest a near-term acceleration in national wages growth is likely, though Victoria offers some optimism where momentum continues to build with its annual pace lifting to a near 6-year high at 2.9%.  

Preview: Wage Price Index -- Q2

Australia's Wage Price Index (WPI) for the June quarter is due to be released by the ABS at 11:30am (AEST) today. The WPI measures the change in price of wages and salaries paid by employers of all types for a fixed group of jobs keeping constant all compositional factors, such as responsibilities, experience, qualifications and hours worked. Wages growth has a key influence on growth in household disposable income, which in turn drives the outlook for household consumption; the largest component of the domestic economy and the area currently identified by the Reserve Bank of Australia as posing the most uncertainty for its outlook.     


As it stands | Wage Price Index

The pace of wages growth remains subdued after the headline WPI increased by a softer-than-expected 0.5% in the March quarter to keep the annual pace at around 2.3%. Both outcomes were unchanged from Q4 in 2018. At the sector level, private sector wages growth came in at 0.5% to lift the annual pace from 2.3% to 2.4%, and while the quarterly pace in the public sector was also 0.5% growth through the year eased from 2.5% to 2.4%. 

Including bonuses, growth in the headline index posted a 0.5% rise in Q1 slowing the annual pace from 2.8% to 2.6%. For the private sector, growth in Q1 at 0.5% was noticeably softer than in the previous quarter, which resulted in the through-the-year pace falling from 2.8% to 2.6%. In the public sector, Q1's outcome of 0.5% saw the annual pace slow to 2.4% from 2.5%. 

To read our full review of Q1's report see here

  

Market expectations | Wage Price Index

Today's report is expected to show the WPI made little progress over the June quarter. According to Bloomberg, the median forecast is for the index to rise by 0.5% in Q1 between a tight range of estimates from 0.5% to 0.6%. The annual pace is expected to remain at 2.3%, though individual estimates vary between 2.1% and 2.4%. 

The economy added a net 87,700 jobs in Q2 -- a decent increase from Q1's total of 67,400 -- with the annual pace of employment growth remaining the same as it was at the end of the March quarter at a robust 2.4%. However, workforce participation continued to rise over the quarter reaching its highest level on record at 66.0% in June. As a result, the unemployment rate drifted up from 5.1% at the end of March to 5.2%, while over that time the underemployment rate remained at 8.2% and the underutilisation rate lifted from 13.3% to 13.4%. Aside from spare capacity in the labour market, the pace of wages growth has also likely been restricted by structural factors, such as subdued productivity growth and the increased digitalisation and globalisation of the workforce. The recent decision from the Fair Work Commission to raise the national minimum wage by 3.0% takes effect from the start of Q3 so will not be reflected in today's report.


What to watch | Wage Price Index

The state-level data are always worth watching in this release. Labour market conditions vary considerably across the nation, with the two most populous states of New South Wales and Victoria leading the way over the past year or so in terms of employment growth and progress in reducing their unemployment rates, though that has failed to rev up wages growth. More recently, the unemployment rates in those states have lifted and noticeably so in New South Wales. In the other states, labour market conditions have been on the improve in Western Australia but have weakened in Queensland, South Australia, and Tasmania. Given these dynamics, it is difficult to see an acceleration in national wages growth for the foreseeable future, as highlighted by last Friday's Statement on Monetary Policy from RBA which forecasts growth in the WPI remaining at 2.3% in 2019 and 2020, rising only to 2.4% in 2021 (see here). 

Macro (Re)view (9/8) | Trade tensions continue to concern markets; RBA downgrades outlook

Another escalation in US-China trade tensions saw volatility and risk aversion sweep across markets this week. Following last Friday's announcement from US President Trump that a $300bn tranche of consumer-related imports from China would face a tariff of 10% (with the potential to rise to 25% or higher) effective from September 1, the People's Bank of China on Monday announced a much weaker-than-expected fix for the Yuan against the US dollar linking the decision to "trade protectionism measures and the imposition of tariff increases". With the Yuan subsequently weakening to an 11-year low against the US dollar, fears were sparked that currency devaluation was a sign of things to come from China in its retaliation, while there were also reports that state-owned enterprises had been directed to curb purchases of agricultural products from the US. Tensions elevated further when the US Treasury Department labeled China as a currency manipulator for the first time since 1994, while President Trump expressed his grievances via Twitter.

Suffice it to say risk appetite, notably for equities, evaporated sending government bond yields to even lower levels. Germany, an economy at notable risk from a further downturn in global trade, saw its 10-year yield tumble to a new record low of -0.58% accentuated by data that showed industrial output fell by 5.2% over the year to June -- its worst outturn since 2009. Whereas in recent times falling bond yields had driven equity prices higher, sentiment appeared to be turning to the view that it was now a clear signal for a worsening economic outlook across the globe in which the actions of central banks (or perceived lack thereof in the case of the US Federal Reserve) might only have limited impact.

In that context of increasing trade tensions, fears of currency devaluations and a deteriorating global outlook, no fewer than 4 central banks in the Asian region, including India, Thailand, Philippines and New Zealand delivered interest rate cuts. Across the Tasman, the Reserve Bank of New Zealand cut its Offical Cash Rate by 50 basis points to 1.0%, which was deeper than the 25 basis point cut the markets had anticipated. The accompanying statement outlined that the Bank's policy-setting committee debated the relative merits of a 25 or 50-basis point cut and ultimately reached the determination that the latter was necessary "to continue to meet its employment and inflation objectives". The decision was made particularly notable by the latest employment data that showed the nation's unemployment rate defied expectations for a rise to 4.3% by instead falling from 4.2% to an 11-year low of 3.9% in Q2.

Also helping to improve market sentiment, China trade data for July came in stronger than anticipated on Thursday. Exports swung from -1.3% to +3.3% through the year, perhaps reflective of a bringing forward in demand ahead of the introduction of new tariffs, while imports contracted by 5.6% against expectations for a much more sizeable decline of 9.0%. However, risk aversion came back on Friday as President Trump said he could cancel trade talks with China that are due to take place in September sending equities lower to lock in losses for the week.  

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Domestically events this week were heavily focused on the Reserve Bank Australia. As expected, the Board held the cash rate steady at 1.0% on Tuesday (reviewed here). In his decision statement, Governor Philip Lowe highlighted that "increased uncertainty" surrounding trade tensions kept the risks to the global economic outlook "titled to the downside", while downgrades to the domestic outlook were signaled thus resulting in the Board firming its easing bias by noting a preparedness to "ease monetary policy further if needed" to support its inflation-targeting objective. 

On Friday, the RBA published its Statement on Monetary Policy for August in which its updated set of forecasts confirmed a deterioration in the Bank's outlook for the domestic economy. For 2019, GDP growth was lowered to a below-trend pace of 2.5% from 2.75%, though it is still expected to return to trend (2.75%) in 2020 before lifting again to 3.0% in 2021. Little progress is expected to be made in reducing the spare capacity in the labour market that the Board has been discussing over recent months with the unemployment rate remaining around its current 5.2% level out to the end of next year, whereas in May its forecast was for a decline to 5.0%. With the unemployment rate now not expected to fall to 5.0% until mid-2021, headline inflation is not seen hitting 2.0% before then, with the outlook for 2019 and 2020 lowered by 0.25ppts to 1.75%. The forecast for the Bank's preferred inflation measure (trimmed mean)  in 2019 was lowered from 1.75% to 1.5% and was downgraded from 2.0% to 1.75% in 2020, meaning that it is not expected to reach to the lower band of the target range before mid-2021. It is important to highlight that these downgrades come despite incorporating an additional two 25 basis point rate cuts (cash rate of 0.5%) as implied by market pricing (the first by November 2019 and the second by February 2020) and a lower Australian dollar in both trade-weighted and US dollar terms. 

Also on Friday, Governor Lowe, his deputy and assistant governors appeared before the House of Representatives' Standing Committee on Economics for the Bank's semi-annual testimony. In his opening statement, the governor highlighted while the Board was now in wait-and-see mode given it cut the cash rate in June and July, the downgrades in August's quarterly statement meant that "the possibility of lower interest rates will remain on the table". To that end, when questioned, the governor said that while unlikely "it's possible that we end up at the zero lower bound" before going on to say "we are prepared to do unconventional things if the circumstances warranted it". Discussions within the RBA on what form those measures could potentially take appear to be only at a very early stage, though the governor outlined that the unconventional measures taken by other central banks across the world had been examined to try and identify what actions could work within an Australian context. 

In terms of data this week, Australia's trade surplus surged past $8.0bn in June to a new record high (shown as our chart of the week, below) driven by the tailwind from an escalation in iron ore prices (note prices retraced sharply over the past week) and weakness in imports (reviewed here). Meanwhile, there were early signs that the recent pick up in sentiment in the housing market following May's federal election is flowing through to demand for housing finance with lending commitments the owner-occupier and investor segments rising together in June for the first time since May 2018 (reviewed here). 

Chart of the week

Australian housing finance and approvals rise in June

Australian housing finance approvals to owner-occupiers lifted for the first time in 4 months in June, while the total value of lending committed across the segments increased at its strongest month pace since February earlier this year. The activity indicators have highlighted that sentiment in the housing market has clearly picked up since May's federal election result, supported also by the Reserve Bank of Australia announcing consecutive cash rate cuts in June and July and by an easing in credit assessment criteria signaled by the banking regulator, APRA. 

Housing Finance — June | By the numbers

• Housing finance approvals to owner-occupiers (excluding refinancing) posted a 0.4% month-to-month rise in June to 30,894, though that was softer than the 0.5% lift expected by markets (prior rev: -0.3%). The decline in approvals over the year moderated to -13.6% from -15.0%.

• The total value of housing finance commitments (excluding refinancing) increased by 1.9% in the month to $A16.82bn (prior rev: -2.7% from -2.4%) to be 17.6% lower than a year earlier (prior rev: -20.9%). 

Housing Finance — June | The details 

For the first time since May 2018, lending to both the owner-occupier and investor segments posted monthly increases. Excluding refinancing, commitments to owner-occupiers lifted by 2.4% -- its strongest rise since February 2019 -- to $12.4bn, easing the annual decline from -18.2% to -14.8%. Commitments to investors excluding refinancing increased by 0.5% in June -- its first monthly gain since July 2018 -- to $4.4bn, which slowed the decline over the year from -27.7% to -24.8%. 

The total value of refinancing commitments fell by 1.9% in June and by 7.5% through the year to $8.1bn. Within that result, refinancing from owner-occupiers declined by 2.9% in the month to $5.6bn (-7.8%Y/Y), while it lifted by 0.4% in the investor segment to $2.4bn (-6.7%Y/Y). Lending to the owner-occupier segment for renovation work increased by 2.7% to $278m, with the annual decline slowing to -8.8% from a low of nearly -34% last September. 

Over Q2, lending to owner-occupiers fell by 1.7% and by 4.8% to investors, though as the chart (below) shows, the pace of the declines is reducing. 

In terms of loan approvals to owner-occupiers, there was a 1.2% rise for approvals to purchase established properties (-13.7%Y/Y), which is in contrast to a 2% fall for construction-related approvals (-13.2%Y/Y), with loans for construction -2.3% (-8.7%Y/Y) and newly constructed dwellings -1.2% (-23.0%Y/Y). 

   

The state detail for owner-occupier approvals was largely positive in June but still weak for Q2 overall; New South Wales +0.7% (-1.7% qtr), Victoria -0.6% (-1.7%), Queensland +0.3% (-3.7%), South Australia +2.0% (-4.4%), Western Australia +1.1% (-2.9%) and Tasmania +2.1% (-8.4%). 

   

Approvals details are not produced for the investor segment, though the ABS does provide value estimates. Here, lending in New South Wales increased by 2.4% in June -- its first monthly rise since April of last year -- while Victoria (+0.6%) also posted its first month-to-month rise since February 2019. Investment lending fell for the other states in June. 

The summary table, below, shows the full breakdown of results across the segments on a state-by-state basis in June and over the past year. 

One area worth highlighting is a pick up in activity from first home buyers in New South Wales and Victoria that has occurred over recent months (see chart, below), likely reflecting some improvement in affordability conditions.

Housing Finance — June | Insights

There were early signs in today's report that the recent improvement in the activity indicators, such as auction clearance rates and prices, are starting to flow into the hard data. Consecutive interest rate cuts from the RBA as well as indications for an extended period of low or even lower rates (see here) and less onerous credit assessment criteria are likely to support further improvement in demand for housing finance in the months ahead. 

RBA on hold at 1.0% in August

The Reserve Bank of Australia (RBA) Board kept the cash rate unchanged at 1.0% at its August meeting in Sydney today, in line with expectations of economists and markets. The cash rate was cut by 25 basis points at each of the Board's past two meetings in June and July.

In today's decision statement, Governor Philip Lowe started by acknowledging that the global trade tensions that are rattling markets at the moment had "increased uncertainty" and meant that the risks for the global economy "remain tilted to the downside". Against that negativity, labour market conditions abroad are strong referencing low unemployment rates and rising wages growth, though notably "inflation remains low". Due to concerns around the global economic outlook and low inflation, the governor highlighted the recent easing in policy from other central banks and noted that "further monetary easing is widely expected". In recent appearances, Governor Lowe has stated that exchange rate depreciation is the primary mechanism by which the recent rate cuts are expected to support the Australian economy. 

Focusing domestically, the governor conceded that economic growth through the first half of 2019 was lower than had been anticipated, due to slowing growth in household consumption in response to low income growth and declining property prices. Ahead of this Friday's quarterly Statement on Monetary Policy, the governor stated that the Bank's GDP growth forecast for 2019 would be lowered from 2.75% to 2.5%, though it still expected it to return to a trend pace of 2.75% in 2020 supported by its cuts to the cash rate, tax cuts, infrastructure investment, a stabilisation in the housing market and a more optimistic resources sector. 

Despite the recent lift in the unemployment rate to 5.2%, the Bank will continue to forecast a decline over the next couple of years to 5.0%. Spare capacity remains persistent highlighted in today's statement by the line that "wages growth remains subdued and there is little upward pressure at present, with strong labour demand being met by more supply".

Turning to inflation, the governor noted that Q2's Consumer Price Index data (see here) were broadly in line with what the Bank had expected and confirmed that "inflation pressures remain subdued across much of the economy". However, the Bank will downgrade its inflation forecasts from those it published in May, which had inflation rising to the 2% lower band by mid-2020. It now expects both headline and underlying inflation "to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021".

In concluding, the governor stated very clearly that policy will be lower for longer to support its objectives in reducing spare capacity in the labour market and lifting inflation back to its 2-3% target range. Given that the Bank's updated forecasts on Friday will show some deterioration in growth and inflation relative to what was anticipated in May's quarterly statement, an easing bias was made explicit with the closing line that "The Board will continue to monitor developments in the labour market closely and ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time" (our emphasis). 

Australia's trade surplus surges to $8.0bn in June

Australia posted its highest monthly trade surplus on record in June at $8.0bn to surge past the previous record mark set a month earlier at $6.2bn. The June quarter was an unprecedented one overall, with the total of the trade surpluses from the 3-month period exceeding $19.0bn -- well above the previous highest of $15.1bn from Q1 earlier in the year. 

International Trade — June | By the numbers

• June's trade surplus was $A8.036bn and well ahead of the $6.0bn forecast by markets. May's initially reported surplus of $5.745bn was revised up to $6.173bn in today's release. 
• Export earnings increased by 1.4% in June to a record $42.378bn, with growth over the year tracking at a strong 15.5% pace (prior rev: +4.2%m/m, +16.9%Y/Y)
• Import spending fell by 3.6% in the month to $34.342bn, which saw the annual rate turn negative to -1.3% (prior rev: +0.9%m/m, +2.2%Y/Y)

• The 3-month total for the trade surplus in the June quarter was $19.021bn, which the ABS estimates increases to $19.719bn after seasonal adjustments, or by 35.7% above Q1's surplus.   

International Trade — June | The details 

The trade surplus increased by $1.86bn over the month of June to the new record high mark of $8.036bn. That increase was the result of export earnings rising by $576m (+1.4%) and import expenditure declining by $1.29bn (-3.6%). 

Starting with exports, total earnings lifted to their highest on record at $42.28bn in the month. That was driven predominantly by the non-rural goods category rising by $758m (+2.7%m/m), in which metal ores and minerals (mostly iron ore) contributed $554m reflecting higher prices and coal lifted by $232m on a rise in shipments. Over the year, earnings from metal ores and minerals are up in the order of 50% after iron ore prices escalated in response to supply disruptions caused by the tailings dam disaster in Brazil.   

Meanwhile, services exports increased by a modest $26m (+0.3%) in June but have risen at a robust pace over the past year boosted by areas such as tourism from Asia and education. Rural goods earnings fell by $170m in June (-4.3%) reflecting weakness from cereals as drought conditions continue to impact. The normally volatile non-monetary gold category showed a contained move in June falling by $37m (-2.2%). 

For imports, expenditure contracted at its sharpest monthly pace (-3.6%) since December of 2018 to a total of $34.342bn, which is 1.3% lower than a year earlier. June saw broad-based weakness across the categories; consumption goods -$450m (-5.1%), capital goods -$600m (-8.7%), intermediate goods -$366m (-3.3%) and services -$2m (0.0%). The result for consumption goods was impacted notably by weakness in vehicles (-$260m), while capital spending declined on falls from civil aircraft (-$307m) and industrial transport equipment (-$213m). The decline from intermediate goods can largely be explained by fuels and lubricants (-$367m) driven by lower oil prices. 

International Trade — June | Insights

Strength in commodity prices continues to provide a tailwind for the domestic economy, with the terms of trade anticipated to show another decent rise in Q2. That will assist in boosting the Federal government's tax receipts and leaves the door open for further fiscal stimulus measures. That could well be needed given that the weak signals from imports in this report indicate that domestic demand continues to soften. However, looking towards Q2's GDP growth outcome, strength from commodities exports and weakness from imports suggests that net exports will add economic activity in the quarter.  

Preview: RBA August meeting

The Reserve Bank of Australia's (RBA) latest monthly policy meeting takes place in Sydney today, with the decision to be announced at 2:30PM AEST. After lowering the cash rate by 25 basis points at each of its past two meetings, indications are that the Board will stay on hold today at 1.0%. It is an important week for watchers of Australia's central bank, with Governor Philip Lowe to provide his semi-annual testimony to the House of Representatives' Standing Committee on Economics on Friday (9:30AM), while later that morning (11:30AM) the Bank will release its quarterly Statement on Monetary Policy.    

  

At the June meeting, the Board resumed their easing cycle by lowering the cash rate for the first time since August 2016 in order to "support employment growth and provide greater confidence that inflation will be consistent with the medium-term target". That reasoning was then repeated in July when the Board delivered a follow-up rate cut to take the cash rate to a new record low of 1.0%. 

Last week, Australia's Consumer Price Index data for Q2 showed that inflation on the Bank's preferred trimmed mean measure was steady at 1.6% over the year, meaning that it has now been below the 2-3% target for 3½ years (see our review here). That outcome was consistent what the Bank had forecast in May's quarterly statement. As the governor highlighted in his most recent speech ("Inflation Targeting and Economic Welfare") a key factor for this was that workforce participation had risen sharply over the past couple of years in line with strong employment growth, thus the labour market had operated with persistent spare capacity restraining wages growth and, in turn, inflation. 

The Bank has concluded that for inflation to return to target, conditions in the labour market will need to tighten considerably to be consistent with an unemployment rate of around 4.5%. Since the previous meeting, June's Labour Force Survey showed that workforce participation touched a new record high of 66.0% and with employment rising by a softer-than-expected net 0.5k the unemployment rate remained at 5.2% (see our review here), which is a deterioration on the 5.0% outcome the Bank had forecast in May.

Given the importance of labour market conditions to the inflation target, it is not surprising that the governor in his speech on 25/7 made the comment that "the Board is prepared to provide additional support by easing monetary policy further". However, the governor preceded that statement by highlighting that the rate cuts from June and July "will support demand in the Australian economy" together with "recent tax cuts, higher commodity prices, some stabilisation in the housing market, ongoing investment in infrastructure and a lift in resource sector investment". But time will be needed to assess how the real economy is responding to its 50 basis points of cuts, and that was essentially the message the Board conveyed in the minutes from July's meeting where it noted it "would continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy and the achievement of the inflation target over time". (our emphasis).  

Thus the Board is expected to remain on hold today, with all 24 economists surveyed by Bloomberg Australia in alignment on that view. The volatility of the past few days has seen markets bid up their expectation for another rate cut, though it is not fully discounted within pricing until November. In today's decision statement, the governor may offer some insight into the Bank's updated growth and inflation forecasts that will be included in Friday's Statement on Monetary Policy, which will be important in shaping expectations around the timing of any future easing. 

Macro (Re)view (2/8) | US FOMC cuts by 25bps as trade tensions escalate; Australian inflation subdued

The US Federal Reserve's policy-setting committee, the FOMC, cut its benchmark interest rate for the first time since December 2008 this week, lowering fed funds target range by 25 basis points to 2.0-2.25% (shown as the chart of the week, below). The Committee also announced it would be ending its balance sheet normalisation (quantitive tightening) process in August, two months ahead of schedule. These outcomes had been widely anticipated, though markets are now in the process of recalibrating expectations for the future path of rates, as the Committee was seemingly reluctant to meet the sort of aggressive easing of around 3 to 4 rates cuts that had been factored into pricing out to December 2020.

Chart of the week

In his post-meeting statement to the press, Committee Chair Jerome Powell said that the basis for July's rate cut was to "insure against downside risks from weak global growth and trade policy uncertainty", and then later described it as "mid-cycle adjustment to policy" in response to a reporter's question, which seemed to leave markets questioning their assessment. However, the point that Chair Powell reiterated throughout his press conference was that the Committee had become progressively more accommodative in their commentary since the turn of the year, with this rate cut seen as the next step in within that overall shift. Accordingly, Chair Powell outlined that this change in direction had allowed the Committee to retain a constructive outlook, notably for economic growth to remain around its current pace (described as "solid") to support a continuation of robust conditions in the labour market, which in turn will help lift inflation towards its 2% target.

With markets barely having had time to absorb the details from the FOMC's meeting, early on Friday morning US President Trump announced that a 10% tariff would be levied on a $300 billion tranche of Chinese imports effective from 1 September, which could then potentially escalate to a rate of 25% and above, after bilateral negotiations earlier in the week had failed to achieve any substantive progress on reaching a trade deal. This tranche will largely target consumer-related goods that have been excluded from previous tariff announcements. Once again, China has indicated it is prepared to retaliate. Given that household consumption strongly contributed to US GDP growth coming in at an above-trend pace of 2.1% annualised in Q2, this latest development will likely add to the risks to the FOMC's outlook, which to date have mostly been focused around business investment weakening (mainly in the manufacturing sector) in response to the uncertainty caused by trade tensions and slower global growth. In support of households, Friday's employment data provided another decent result with non-farm payrolls rising by 164,000 in June (expected +165,000) and the unemployment rate remaining at 3.7%. Meanwhile, the pace of wages growth lifted from 3.1% to 3.2% over the year. 

In Europe this week, the advanced read on GDP growth showed that output slowed from 0.4% to 0.2% in Q2. Annual growth eased from 1.2% to 1.1% to be tracking at a 5½-year low and half the pace from a year ago. That slowdown over the past year reflects weakness in external trade, which is a significant component of the euro area economy, impacted by US-China tensions and has notably impacted manufacturing firms. Domestic demand has been more resilient, with the household sector supported by strengthening labour market conditions wherein the unemployment rate fell to an 11-year low of 7.5% in June. However, core inflation remained very subdued at 0.9% year-on-year emphasising the tone from the ECB's meeting last week that renewed stimulus measures were likely to be forthcoming.

With the increasing risk of a no-deal Brexit, markets were closely watching the Bank of England's meeting for signs of a shift to more accommodative policy. While the Bank lowered its GDP growth forecasts for 2019 (from 1.2% to 1.0%) and 2020 (from 1.7% to 1.4%), due to the intensification of uncertainties regarding Brexit and a weaker global economy (see here), it retained its guidance for "gradual" and "limited" interest rate increases to maintain inflation at the 2% target. However, that remains conditioned on a smooth withdrawal process from the EU, which is in contrast with current market sentiment.   

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In Australia, the highlight this week was Q2's Consumer Price Index data in which headline inflation lifted by 0.6% in the quarter and by 1.6% through the year, with both outturns 0.1ppt above the market forecast. The main measure followed by the Reserve Bank of Australia, the trimmed mean, met consensus at 0.4% quarter-on-quarter and 1.6% year-on-year, though the latter remains well below the Board's 2-3% target (for a full review see here). Over half of the 0.6% quarterly rise in headline inflation was accounted for by a strong increase in petrol prices, while there were also indications that a weaker domestic currency was feeding through to higher prices as tradables inflation lifted by 1.2% — its fastest quarter-to-quarter rise in 4 years. However, outside of those influences, inflationary pressures remain well contained and are broadly indicative of elevated spare capacity in the labour market restraining wages growth. The RBA is expected to remain on hold next week at 1.0%, though it will almost certainly lower the cash rate again before year's end, with the market having a 25 basis point cut fully discounted by December. 

Adding to the likelihood of further RBA easing, consumer retail demand softened further in Q2. In nominal terms, retail sales growth was slightly above consensus at 0.4% in June and was up by 0.6% over the quarter. However, after adjusting for an overall price increase of 0.4%, retail volumes lifted by a softer-than-expected 0.2% in Q2, prompting a sharp slowdown in the annual pace from 1.1% to 0.2% — its weakest pace since 1991 (see our review here). Demand is likely to receive support going forward from the RBA's easing cycle and the Federal government's tax relief measures, as well as improving sentiment in the housing market. According to CoreLogic, combined capital city house prices across the nation lifted by 0.1% in July, which was the first month-to-month rise since September 2017. Prices in the two major markets of Sydney and Melbourne were both up by 0.2% in the month, though the declines over the past year are still significant at 9.0% and 8.2% respectively. The residential construction outlook continues to remain weak with data this week showing that building approvals fell by 1.2% in June and by 7.3% in Q2 (reviewed here). That accelerated the decline from a year earlier from -19.2% to -25.6%, with the slowdown driven mostly by a rollover in high-rise units, though house approvals have also weakened notably.

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Australian retail sales +0.4% in June; Q2 volumes +0.2%

Australian retail turnover posted a stronger-than-expected increase in the month of June, led by areas of discretionary spending and coincided with the Reserve Bank of Australia's first interest rate cut in nearly 3 years. However, conditions in the sector remain very soft given that real spending lifted by just 0.2% in the quarter and by 0.1% over the first half of the year. 

Retail Sales — June | By the numbers

• Retail turnover increased by 0.4% in June to $A27.45bn, which was stronger than the 0.3% forecast by markets and a solid improvement from May's outturn of 0.1%. 

• Annual turnover growth ticked up from 2.4% to 2.5% on a seasonally adjusted basis, though in trend terms the pace moderated from 2.8% to 2.7%.

• Retail volumes (nominal spending adjusted for price changes) lifted by 0.2% in Q2 to more than offset Q1's 0.1% fall, though today's outturn was softer than the 0.3% figure anticpated.   
• Annual volume growth slowed sharply from 1.1% to 0.2% 

Retail Sales — June | The details

On a nominal basis, spending in June lifted by an overall 0.4%, though excluding food (+0.1% in the month) which accounts for around 40% of all spending, turnover was up by 0.5%. Clothing and footwear led at +2.0%, followed by 'other' +0.6%, cafes and restaurants +0.5%, and household goods +0.2%. Department stores were the one area of weakness falling by 0.6% in June, although the category recorded the fastest rate of increase in spending over the quarter. Over the year, headline spending expanded by 2.5% outpacing the total ex-food at 2.2%, which was weighed by declines in household goods and department stores. 

The ABS reported that overall retail prices lifted by 0.4% in the June quarter, down from 0.8% in Q1. As the next chart shows, the 'other' category (which includes items such as pharmaceuticals) led in Q2 (+1.0%), though broadly speaking price increases continue to come mainly from food. Weakness remains notable in the discretionary areas, though the declines in clothing and footwear and department stores have ended, possibly reflecting the pass-through from a weaker domestic currency.   

 

Adjusting nominal spending for the above price changes, overall retail demand lifted by 0.2% in the quarter to be just +0.1% over the half-year. In annual terms, one has to go back all the way to 1991 to find a weaker outcome than Q2's 0.2% pace. Though, looking more closely, Q2's quarterly outcome (0.2%) is an improvement on the past two outturns from Q4 2018 (0.0%) and Q1 2019 (-0.1%). The sharp slowdown in the annual pace from 1.1% to 0.2% could potentially be overstated by a sizeable base effect as a strong 1.0% increase in Q2 last year fell out of the calculation, though there is no doubt that consumer demand is very soft. 

The underlying detail confirms broad-based weakness in demand over the past year, though there were some better signs in this quarter at least, notably for department stores given that prices were also up modestly. Clothing and footwear volumes also increased, even as prices lifted. Also worth highlighting, household goods posted its first increase in a year, and while that was on lower prices, perhaps that is an early sign of improved sentiment in the housing market.       

Across the states, nominal spending growth in June was led by Tasmania (+1.5%), followed by Western Australia (+0.8%), Queensland (+0.4%), New South Wales and Victoria (both +0.3%), while South Australia fell by 0.3%. Over the quarter, Queensland led (+1.5%), with South Australia next best (+1.2%), followed by Victoria (+0.9%) and Tasmania (+0.7%), while spending fell in Western Australia (-0.1%) and New South Wales (-0.2%). As can be seen below, Queensland comfortably tops the chart for annual spending growth, a position it has held since March of this year.  

Retail Sales — June | Insights

The key takeaway from today's release is that consumer demand is very soft given concerns around spare capacity in the labour market, slow wages growth and wealth effects from the housing market correction, which clearly justifies the RBA's June and July rate cuts and the fiscal stimulus from the Federal government through tax relief to low and middle income earners. More timely indicators highlight that the housing market is improving, which should also help to support demand. The quarterly volumes outcome of 0.2% was a soft lead for household consumption in the national accounts (see chart, below), though retail spending only accounts for around 30% of that component.