As with the rest of the world, the new year in Australia has started under the cloud of Omicron. A rapid recovery from the Delta wave was well underway before the turn of the year and while a strong 2022 outlook should still be intact, the spread of the virus and associated disruptions to supply chains and the labour force have cast significant uncertainty over conditions. There has been a sharp drop-off in high-frequency indicators of mobility and card spending, but amid the usual slow down in activity over the summer holiday period it is difficult to establish a clean read on the Omicron effect. However, as this week's data points can attest, the domestic economy was firing on all cylinders ahead of this latest wave.
The reopening from the Delta lockdown in Victoria and the lure of Black Friday discounting drove retail sales to a 7.3% rise in November, more than twice the expected pace and the fastest increase in 18 months (see here). There was a heavy tilt towards discretionary spending ahead of Christmas as non-food sales lifted by 14.4%m/m led by clothing and footwear (38.2%) and department stores (26%). This left November sales incredibly elevated at a record high and more than 20% above pre-pandemic levels, which should put any slow down associated with Omicron in context. Furthermore, household spending should continue to be bolstered by a tightening labour market—job vacancies were at a record level pressing 400k following an 18.5% acceleration over the most recent quarter—and from high accumulated savings.
In the housing market, activity in New South Wales and Victoria looks to have rebounded from the Delta lockdowns, driving national housing finance commitments to their sharpest rise since the start of 2021 with a 6.3% increase in November (see here). With the HomeBuilder grants rolling off, owner-occupier commitments had fallen by 15.4% between May-October but this decline was partially reversed by a 7.6%m/m rise while investor commitments lifted 3.8% to a record high. November building approvals advanced 3.6% in November driven by a 7.5% boost in the high-density segment (see here). Australia's trade surplus narrowed further but was still elevated at $9.4bn in November (see here). The post-lockdown rebound in demand saw imports rise 6.3%m/m to return to pre-pandemic levels. After a recent slide in earnings as the iron ore price retraced, exports steadied with a 1.6%m/m rise.
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Turning to the US, the recent minutes from the Federal Reserve's December meeting left markets with the impression of a Committee looking to reduce ultra-accommodative monetary policy with an increased sense of urgency as both sides of its dual mandate come within reach. This is being driven by high inflation with this week's CPI readings for December showing further increases. Headline CPI turned out at a 7% year-over-year pace for the first time since the early 1980s while the core rate was up at 5.5% making a new high since 1991. Compositionally, the inflation impulse continues to be driven by highly elevated durable goods (16.8%yr) and energy prices (29.3%yr), albeit with the latter easing back slightly this month. While these pressures should eventually fade due to a combination of base effects and a resolution of supply constraints, core services inflation has firmed to 3.7%yr—its fastest since 2007—driven by rising prices in the housing components, and this could limit the expected slowing in inflation through 2022. Meanwhile, the labour market continues to tighten and is placing upward pressure on wages. Both unemployment (3.9%) and underemployment (7.3%) had fallen to pre-pandemic levels in December.
The Fed is now having to speed up its timeline for removing accommodative policy: QE will wind up in March and markets widely expect this is also when the first rate hike will be announced. But the bigger picture is how high rates will need to rise and, perhaps more importantly, how the Fed will go about reducing the size of its $8.8tn balance sheet as part of this tightening cycle. Complicating matters is the recent flattening in the yield curve, which runs the risk of inverting once rates start rising. This is generally seen as a reliable indicator of weaker growth and inflation prospects but would also exert compression on interest margins earned by banks. Hence why the December minutes noted some officials had brought up the option of "relying more on balance sheet reduction and less on increases in the policy rate" to achieve a tighter policy stance, with the thesis being that reducing the Fed's sizeable bond holdings would help up pressure on longer-term yields.
Over in Europe, inflation is also coming under intense scrutiny with December's preliminary CPI reading hitting 5%yr and the core measure rising to 2.6%yr. Generally speaking, ECB officials are more relaxed about the situation than in the US. ECB Chief Economist Philip Lane noted in an interview during the week that because of the lag associated with monetary policy, hiking rates in 2022 would only start taking effect in 18-24 months' time, and by that stage, the ECB forecasts inflation will have already fallen back below its 2% target. However, ECB Executive Board member Isabel Schnabel in a speech this week identified that upside risks to inflation could accompany Europe's green transition and that monetary policy may eventually have to respond.
