Markets waited all week for the speech by Federal Reserve Chair Jerome Powell at the Jackson Hole symposium. Overall, Chair Powell franked the views that many of his colleagues have expressed of late that tapering of its asset purchases from their current $120bn/month rate is nearing, though his assessment of the timing was less committal in light of the Delta variant, simply saying that it could be appropriate some time "this year". Importantly, he went on to emphasise that tapering would be disconnected from the eventual lift-off for interest rates, the latter having a "different and substantially more stringent test" attached to it. The key factor for the timing of taper depends on labour market; still seen as being very much in recovery mode. The FOMC will be weighing up the strength in job gains — averaging around 830k per month over the past 3 months — against the headwinds associated with Delta and spare capacity that is considerable beyond reported measures. On the inflation side of the mandate, the Fed's preferred indicator remains well above its 2% target holding at a 3.6% annual pace in July. Chair Powell reiterated on Friday that this continues to reflect the reopening boost and is not something monetary policy should be reacting to. The huge disparity between durable goods inflation and services inflation — something highlighted on these pages over recent months — is the predominant factor behind the Fed's think that high inflation will be transitory. Historically, services have been the driver of inflation, with durable goods inflation negative over the past 25 years, on average. That flipped dramatically due to the pandemic — goods consumption surged as services spending plunged — but is now gradually unwinding as the economy opens up. The rotation in spending from goods to services made further progress in July; the former falling 1.1%m/m compared to a 1.0% rise for the latter, but as the chart below highlights, both remain a long way from returning to their pre-pandemic shares of total consumption.
Chart of the week
In Europe, momentum generated by the reopening in Q2 looks to be extending into the current quarter. August's preliminary PMI softened slightly from 60.2 to 59.5 but remained at a highly expansionary level, placing GDP on track for growth of around 2% in Q3. A key development was that the pace of activity in the services sector (59.7) surpassed that for manufacturing (59.2) for the first time over the course of the pandemic. Eased restrictions are driving the former, while for the latter the pace is moderating amid supply chain constraints as new order inflows remain at very high levels, leading to continued pressure on input prices. The account of the ECB's policy meeting late last month noted that, aside from uncertainty around the impact of the Delta, the recovery was seen to be back on track and the pick-up in inflation reflected transitory factors. Unlike at the Fed, the account contained no clear signs of the Governing Council discussing tapering purchases in its PEPP program from their current accelerated pace. An interview with the ECB's Chief Economist Philip Lane suggested that if there were "spillovers" to financing conditions in Europe from Fed tapering, it would be prepared to respond. Contrary to the interpretation of markets, the account noted that the reformulated forward guidance implemented by the ECB following the tweak to its inflation mandate "did not necessarily imply lower for longer interest rates" as, if seen as credible, would result in inflation expectations being anchored at its 2% target.
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In Australia this week, virus cases increased to their highest daily levels of the pandemic, but importantly vaccinations are accelerating sharply, with the double-dose rate sitting at around 33% of the population aged 16 and above, while first doses are at 56%. The tight and extended lockdowns occurring in New South Wales, Victoria and in the ACT are taking a heavy toll on the economy. Labour market conditions have rolled over on these disruptions, with payroll jobs tracked in the ABS's high-frequency series falling by 2% nationally over the second half of July to be down 3.7% since the start of the month. Retail spending fell at its sharpest rate this year with a 2.7% decline in July (-3.1%yr), weighed heavily by the shuttering of non-essential retail in NSW (-8.9%m/m). Meanwhile, the Australian preliminary PMI for August deteriorated to its weakest reading (43.5) since the early stages of the pandemic, indicating that the hit coming to GDP in Q3 is shaping up to be in the order of -3%. But in the meantime, the June quarter national accounts are on the tape for release next week, with the median estimate sitting at 0.5% for Q2 GDP (preview here). Feeding into that report are the inputs that came to hand during the week for construction activity and business investment.
In a weaker-than-expected outcome, construction activity lifted by 0.8% in Q2 against the median forecast for a 2.8% rise (reviewed here). The surprise was the deceleration in private sector residential construction (-0.2%q/q) from the surge in growth in the past couple of quarters, as activity was brought forward by stimulus measures including the HomeBuilder grants scheme and first home buyer incentives. Perhaps capacity constraints were becoming a factor, that is if the rise in materials and labour costs seen in other recent data points are reliable signs of this. More material declines in residential activity are in prospect in Q3 due to the restrictions on the construction sector in the Sydney and Melbourne lockdowns, though there remains a large volume of work in the pipeline beyond these disruptions. Meanwhile, weakness persists in private non-residential construction following the hit to investment plans at the onset of the pandemic; activity in the segment falling a further 0.4%q/q to be down 12% through the year. Offsetting support came from the public sector (3.2%q/q) with state and territory governments bringing forward projects to provide stimulus to their local recovery efforts.
Private sector business capex saw its strong momentum maintained in June quarter rising by 4.4%; annual growth accelerated — partly reflecting base effects — to 11.5% (reviewed here). The tax incentives from last year's federal budget (then expanded in Budget 2021/22) and the strength in domestic demand conditions have driven equipment spending to an 8-year high to be 10% above pre-pandemic levels. Capex in buildings and structures lifted by 4.6% for the quarter, though the more relevant guide for the contribution to GDP from non-residential work comes from the construction activity data. Firms' forward-looking investment plans for 2021/22 were upgraded strongly by 12.5% from 3 months to $127.7bn, raising questions around the durability of that optimism given the sharp deterioration in the economy associated with Delta.
