The spillover effects from the Ukraine war have kept commodity prices elevated through the week, adding upside risks to inflation. Central banks are keen to normalise policy, but hiking into a highly uncertain outlook is not without its complications.
RBA reaffirmed its patience
As expected, the RBA left monetary policy settings on hold at this week's meeting (reviewed here). Describing the war in Ukraine as a "major new source of uncertainty" for the global economy, and with wages growth around the slow rates seen prior to the pandemic despite a tightening labour market on the domestic front, the decision statement from Bank Governor Philip Lowe reiterated the patient approach the Board is taking in assessing developments. Expectations for underlying inflation to move above the target band through the year will not spark a pre-emptive hike in rates given that the pace is forecast to ease back in 2023. Market pricing for the first hike (from 0.1% to 0.25%) has been pushed back to July, but the extent of tightening seen through 2022 of at least 100bps continues to look overdone.
Australia's economy surged on reopening from the Delta lockdowns...
After contracting by 1.9% in the lockdown-affected Q3, the Australian economy rebounded by 3.4% in the December quarter. This advanced GDP to 3.4% above its pre-pandemic level, re-establishing the momentum in the expansion from the Covid recession. On the back of eased restrictions and pent-up demand, household consumption was resurgent (6.3%q/q) with discretionary spending (14.2%q/q) seeing the largest rebound. The vaccine rollout contributed to robust sentiment, and with the labour market tightening and monetary policy very accommodative, households were confident to spend out of accumulated savings. The household saving ratio fell from 19.3% to 13.6% over Q4 but remains well above pre-pandemic levels and will likely continue to support consumption. The strength of consumer demand did lead to rising price pressures, though supply constraints remain the more prevalent driver than high wages growth.
Residential construction (-2.2%q/q) and business investment (-0.3%q/q) were weak in the quarter and both lost momentum over the back half of 2021 amid supply constraints and lockdown disruptions. The vast residential construction pipeline that has built up on the back of the stimulus response should drive a resumption of the first half upswing as the headwinds dissipate. Meanwhile, recent data have reported an increase in firms' forward-looking investment plans and tax incentives and accommodative financing conditions should see business investment regaining momentum. Net exports weighed on GDP in Q4 (-0.2ppt) and over the year (-0.7ppt), but the reopening of the international border will allow for a recovery in services exports, providing a source of growth in 2022. With the pandemic a fading headwind and the RBA to keep monetary policy accommodative to support the return to full employment, the outlook for the Australian economy in 2022 is positive. My feature-length review of the Q4 national accounts with analysis and charts can be accessed here.
... and looks to be coming through Omicron with resilience
Retail sales defied January's Omicron surge rising by 1.8% in the month, confirming a reduction in the volatility of spending levels and patterns as the pandemic has progressed (reviewed here). Housing market activity in New South Wales and Victoria has rebounded strongly from lockdown restrictions to drive a resurgence in national housing finance, with commitments rising by 2.6% in January to a new record high level (reviewed here). Housing prices continue to rise, though February's 0.6% rise was the slowest month-to-month rise reported nationally by CoreLogic since late 2020. Dwelling approvals continued to unwind in January, though the outsized fall (-27.6%) looks to be related to holiday and Covid disruptions (reviewed here). A rebound in key commodity prices drove a widening in the trade surplus to $12.9bn in January, ending a narrowing trend over recent months (reviewed here).
In the US, the Fed remains on track to hike in March...
During testimony to Congress this week, despite the high uncertainty around the Ukraine war, Fed Chair Jerome Powell said that the time to start normalising monetary policy was at hand. Chair Powell said he was in favour of commencing the hiking cycle with a 25bps rate increase at the March meeting, with the option of announcing a larger 50bps increase to be kept on the table if needed to bring inflation under control. Meanwhile, plans around the reduction of the balance sheet would be further developed at the upcoming meeting.
The US labour market remained in robust shape as February nonfarm payrolls increased by 678k, well clear of the 423k rise expected and with revisions to the prior 2 months contributing a further 92k to employment. The participation rate ticked up in the month to 62.3% but still leaves a significant shortfall of around 1ppt compared to its pre-pandemic level. Strong labour demand and a shortfall in participation continues to see the labour market tighten as the unemployment rate fell from 4% to 3.8% reaching a 2-year low. Despite this, wage pressures moderated in the month with annual growth in average hourly earnings slowing from 5.7% to 5.1%yr.
... while the ECB is reassessing the situation
More insight into the hawkish tilt taken by the ECB's Governing Council came to light in the account from the February meeting. The assessment that inflation risks were "tilted to the upside" was in reference to concern over the recent trend where the data was coming in stronger than expected, with price pressures also seen as likely to persist for longer than anticipated. This was validated by the initial estimate of inflation in February coming in above consensus: the headline rate lifted from 5.1% to 5.8%yr (vs 5.6% expected) and the core rate pushed up to 2.7%yr from 2.3% (vs 2.6% expected).
But the willingness to move towards pulling back policy accommodation came before the Russia/Ukraine escalation and its associated implications. Surging energy prices will add to inflation pressures but with the situation highly uncertain it is clearly a very difficult time for the ECB to start normalising policy. At next Thursday's meeting, the ECB may respond by reaffirming its previously announced QE tapering schedule, ending the speculation from recent weeks that a more accelerated timeline was in prospect. There is also likely to be an emphasis on flexibility; ECB Chief Economist Philip Lane said in a speech this week that new policy programs could be implemented if required to calm stressed markets.
