The Committee continues to hold underlying confidence in the outlook for the US economy and in the labour market, however; risks posed by slowing momentum in the global economy, notably in China, trade and political uncertainties, including the US government shutdown, and volatility in financial markets warranted the Committee being "patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate". Consistent with this, the line that "some further gradual increases" in the fed funds rate was removed from the statement.
The existing projections of the Committee point to 2 rate increases this year, but the risks appear to be slanted the downside given the caution around the outlook. Though the prospect of rate increases cannot be ruled out, the data — namely inflation — will need to provide the Committee with clear justification to do so. Financial markets have, however, priced out expectations for any further rate increases in this cycle, moving towards the chance of a cut in 2020. Sentiment was also buoyed by separate communication that indicated that the Fed would be prepared to adjust the pace of its monthly balance sheet run-off, providing more liquidity in markets, if economic conditions required a more accommodative policy stance.
In Europe, economic growth in the 19-nation euro area slowed in line with market expectations in the December quarter from 1.6% to 1.2% in annual terms. As yet, the detail was lacking given this was the first of three estimates, though it was confirmed that Italy — the third-largest economy in the euro area — had entered into a technical recession with growth contracting for the second consecutive quarter. Momentum in economic activity in the euro area has been slowing due to weakening business investment, impacted by Germany's auto industry facing major changes in response to stricter emissions standards, and external demand due to trade tensions, while a loss of confidence stemming from political uncertainties has also contributed. In spite of this, the euro area's unemployment rate held at a decade-low 7.9% in December, unchanged from the previous month.
Brexit was back in focus with a series of parliamentary votes taking place on Tuesday, though once again little substantive progress was made towards the UK securing a withdrawal agreement with the European Union. A proposal put forward by an opposition MP in an attempt to cede control of the Brexit process from PM Theresa May to the parliament, potentially giving rise to a delay in the withdrawal under Article 50, was rejected. A motion introduced by a conservative MP indicated that parliament would support PM May's Brexit proposal if the contentious Irish backstop was replaced by unspecified "alternative arrangements", however EU officials again rejected such a proposal. The Irish backstop intends to maintain an open border between Ireland (EU) and Northern Ireland (UK), but many MP's fear that it will lead to different trade regulations applying to Northern Ireland compared with the rest of the UK. In a non-binding vote, the parliament signaled their opposition to leaving the EU under a no-deal scenario, but this remains the default situation unless the impasse can be resolved before the March 29 deadline.
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The highlight from a local perspective this week was the Q4 Consumer Price Index data (see our note here). Australian inflation continues to remain subdued, with the core measure meeting expectations at 1.77% in annual terms in Q4 but has now tracked below the Reserve Bank of Australia's 2-3% target range for three years, as shown in our chart of the week.
Chart of the week
In Q4, the headline increase of 0.5% was stronger than anticipated for the first time in 2 years, though the detail indicated there was little sign of a shift in the inflationary pulse. The main contributor driving inflation remains tobacco, which is subject to legislated price increases, while seasonal impacts led to higher fruit prices in the quarter and drought conditions impacted meat prices. Inflation driven by market-based forces and impacting key areas such as rents, new dwellings, retail goods and household services remained broadly soft in the quarter.
From a policy perspective, the RBA has been prepared to be patient with below-target inflation, conditioned on the expectation that a tightening labour market will gradually lead to stronger wages growth and inflationary pressures. Next week, the Bank publishes its latest set of economic projections where it is likely to indicate a similar trajectory for inflation over the next couple of years to its previous forecasts from November, which point to a return to the target range by the end of 2019.
The NAB's Business Survey for December generated significant attention this week, which showed a dramatic fall in business conditions in the final month of 2018 to a below-average reading of +2 from +11 in November — the largest monthly decline since the financial crisis. Meanwhile, business confidence declined over Q4 and held at a below-average level of +3 in December.
Though the NAB highlighted caution given the timing of the survey, the declines in conditions had been broad-based across the sub-components (trading, profitability, and employment) and industries; part of a weakening trend since the start of 2018 and indicative of notable slowing in business activity from much higher levels over the second half of the year. The decline in the employment sub-component from +9 to +4 is particularly significant, with the NAB assessing this to be consistent with an easing in the pace of employment growth from around 22,000 per month to around 18,000 per month. The labour market requires the addition of around 20,000 jobs per month to prevent the nation's unemployment rate from rising, depending on changes in participation. Also important to highlight was that the forward orders component fell to -1 from 0, pointing to a slowing in demand and activity.
Lastly, property prices on a national capital-city basis contracted by a further 1.2% in January taking the annual decline to 6.9% according to CoreLogic's Home Value Index. Price falls continue to be led by Sydney (-1.3%m/m, -9.7%Y/Y) and Melbourne (-1.6%m/m, -8.3%Y/Y), though all other capitals excluding Canberra recorded declines in the month. An acceleration in price declines follows tightening lending standards, with data compiled by the RBA showing a further easing in the pace of housing credit growth in December to a 5½-year low.
