On the policy front, the recent meeting by the US Federal Reserve highlighted a divergence of views on the Committee regarding interest rate settings and that was evident again this week. Vice Chair of the Federal Reserve Richard Clarida assessed that inflation expectations "were consistent with our price stability mandate", while Chicago Fed President Charles Evans stated that the two previous rate cuts now have the Committee "well-positioned". In addition, Dallas Fed President Robert Kaplan and Richmond Fed President Thomas Barkin, despite noting trade and political headwinds, were non-committal that further cuts were needed. Those pushing the case for an easier policy stance were Minneapolis Fed President Neel Kashkari as he saw "no evidence that the US economy is running at capacity or beyond capacity" and noted dove James Bullard, President of the St Louis Federal Reserve saying; "I think we could do a little more".
On the US data front, GDP growth was confirmed at an annualised pace of 2.0% in Q2 and was unchanged from the previous estimate. The stated objective of the US Federal Reserve is to maintain its now 10-year long period of economic expansion and the consumer is key to this. Overall, US household consumption is still in robust shape supported by wage gains generated by a tight labour market, though there are reasons to be cautious. Growth in real personal spending on goods and services was softer than expected in August rising by just 0.1%, while the annual pace eased from 4.0% to 3.7%. Consumer sentiment according to the University of Michigan's index lifted off its 3-year low in the previous month to a stronger-than-expected 92.3 in September but is down noticeably over the past year impacted by economic uncertainty domestically and offshore. To date, this uncertainty has impacted mostly on business investment and while data for August was above expectations, durable goods orders have fallen by 3.0% in annual terms compared to a 12.4% pace a year ago, while the less volatile core orders (which exclude investment on transportation assets such as aircraft etc) have slowed to 0.2% from 7.5% in August 2018. Meanwhile, the Federal Reserve's preferred measure of inflation remained below target on a 12-month basis at 1.8% to August, though it lifted from 1.6% in the previous month.
Across the Atlantic, European Central Bank President Mario Draghi used his appearance before the European Parliament to outline that the 5-point stimulus plan announced by the Governing Council at its meeting two weeks ago was necessary due to "a more rapid and extended slowdown than previously anticipated, persistent and prominent downside risks to the growth outlook, and a further delay in the convergence of inflation towards our aim". Key will be developments around global trade, and by extension manufacturing, given the exposure of the euro area economy to the external sector. For now, the services sector remains resilient highlighted by this week's IHS Markit Flash PMI reading of 52.0 in September, though as President Draghi commented; "The longer the weakness in manufacturing persists, the greater the risks that other sectors of the economy will be affected by the slowdown". These risks are genuine considering that Eurozone manufacturing conditions according to Markit's flash PMI weakened to an 81-month low in September at a reading of 46.0, while in Germany — the bloc's largest economy — conditions are considerably weaker at 41.4, which is a 123-month low. While remaining open to further monetary stimulus, President Draghi reiterated his ongoing call for a more balanced policy mix featuring enhanced support from fiscal policy and structural reform.
Closer to home, the Reserve Bank of New Zealand elected to leave its benchmark interest rate on hold this week at 1.0%, with the Monetary Policy Committee (MPC) assessing that the economy was around full employment and inflation was within its target range. Following a 50 basis point cut at its previous meeting early last month, the Bank had observed a decline in borrowing rates and a depreciation in the domestic currency. While these factors, together with government spending, are anticipated to support domestic demand conditions over the next 12 months, the MPC does have scope to ease further "if necessary, to support the economy and maintain our inflation and employment objectives".
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Chart of the week
From a domestic standpoint, the governor highlighted that the extent of the slowdown in the Australian economy had been sharper than anticipated. To put this in perspective, in February's quarterly statement GDP growth over the year to the June quarter was forecast to be 2.4%, which was then cut to 1.7% in May and then subsequently retained in the Bank's August Statement on Monetary Policy. Ultimately, Q2's GDP growth outcome came in at 1.4% year-on-year (see here). The governor attributed this to slower global economic growth and rising uncertainty, weakness in household consumption growth and the impact of drought conditions weighing on farm output.
In looking ahead, Governor Lowe outlined that the economy had "reached a gentle turning point" with growth expected to pick up modestly to around trend by next year. That assessment is on based on a combination of factors including; lower interest rates and tax cuts, a weaker Australian dollar, an elevated pipeline of infrastructure projects, a stabilisation of the major housing markets and a more buoyant resources sector. However, as the governor acknowledged; "there are some obvious risks to this outlook", which continue to mainly be around prospects for household consumption growth.
Perhaps a more pressing concern for the Board at next Tuesday's meeting will be the state of the labour market. Once again, the governor highlighted that while employment growth has been robust it has been met with rising workforce participation and thus the labour market has not tightened sufficiently to generate a pace of wages growth that would assist in driving inflation back towards the target range. As such, the assessment was that there has been an "accumulation of evidence over recent times that the economy can sustain lower rates of unemployment and underemployment than previously thought likely". In this context and as covered last week (see here), August's Labour Force Survey contained several weak details; the unemployment rate lifted to its highest in 12 months at 5.3%, while underemployment and underutilisation also increased.
The other main consideration that points to a rate cut being delivered next Tuesday is the recent easing by other central banks, including the US Federal Reserve and European Central Bank. Governor Lowe outlined that in a global setting of lower interest rates, local resistance to this shift would place upward pressure on the exchange rate, which "would be unhelpful in terms of achieving both the inflation target and full employment". In closing, to achieve these objectives, the governor again reiterated that the Board stands ready to "ease monetary policy further if needed".