A rally across global equity markets in Friday's session took the edge off what was a rough week, characterised by weakening sentiment with inflation high and global growth prospects under pressure. A slight moderation in US CPI may have been taken as a sign that inflation has peaked, while easing inflation expectations have taken bond yields lower.
Australian consumer sentiment fell sharply...
Rising inflation and the RBA starting to hike rates in response to it drove a 5.6% fall in Australian consumer sentiment in May. This was the 6th consecutive month-on-month fall in sentiment that leaves the Westpac-Melbourne Institute Index at its lowest level since August 2020. Weaker confidence is playing out through a re-rating of family finances. With households projecting forward a higher pace of inflation, the squeeze on real incomes together with the anticipation of upcoming rate hikes led to a sizeable deterioration (-11.2%) in assessments of family finances on a 12-month outlook. The key for household spending going forward is how that negative signal interacts with balance sheets that have been bolstered by rising income from a tightening labour market, accumulated savings and higher asset prices over the course of the pandemic, all factors that should give households some resilience to inflation and rate hikes.
Views on the housing market were also of interest given the sensitivity to rising rates. Sentiment towards purchasing a dwelling is weak, currently at its lowest level in 14 years. Still, consumers expect house prices to rise over the coming year, albeit at an increasingly slower pace. On the economy, domestic factors and global headwinds from the Ukraine war and China's lockdowns saw consumers downgrade their expectations for conditions over the coming 12 months to a below average level. However, despite a fall in May, the 5-year economic outlook remains at an outright strong level, suggesting that households view the near-term headwinds as temporary.
... but household spending was still robust
As highlighted above, consumer sentiment has been falling throughout 2022 but Australian retail sales have been resilient. March's 1.6% rise followed similar increases over January and February, all solid outcomes amid the disruptions from the Omicron wave and major flooding on the east coast (reviewed here). Over the first quarter, retail sales lifted by a solid 2.9%. Detailed data this week showed that the contribution of inflation to that increase was 1.7ppt, its strongest quarterly rise since 2000, but underlying demand was still robust with volumes adding the remaining 1.2ppt.
In particular, it was discretionary-related demand that drove the increase in retail volumes. Basic food volumes contracted by 1.5%q/q as supply chain pressures led to less discounting at supermarkets that weighed on demand. Non-food volumes, however, lifted by 2.9% to far outpace the headline increase, rising to 16% above their pre-Covid level. Ongoing reopening effects and the recovery of domestic travel were boosting demand across a range of categories including cafes and restaurants (8.3%q/q), department stores (4.3%q/q) and clothing and footwear (3.6%q/q).
US inflation to keep the Fed on the path to neutral
In the key release of the week, US CPI data remained consistent with the Fed removing accommodation at an accelerated pace over coming meetings. With the pace of annual CPI to April moderating on both a headline (8.5% to 8.3%) and core basis (6.5% to 6.2%), the peaks for inflation may be in given upcoming base effects, though supply constraints from the Ukraine war and China's lockdowns could yet put renewed pressure on prices. If inflation is now at or around its peak, it's the pace of the descent that markets are keying off and that put the month-on-month CPI rates in focus. A 6.1% fall in fuel prices pulled down headline CPI to a 0.3%m/m rise (from 1.2%), but a range of price rises lifted core CPI by more than expected to 0.6%m/m (from 0.3%).
Durable goods, a major driver of inflation over the past year or so, has seen its peak with annual inflation falling by almost 5ppts over the past two months to 14%yr and will act as a disinflationary pulse on the core CPI. However, services inflation is escalating and reached 5.4%yr (ex-energy) in April, with rising housing and rent costs the major contributor. There are also pandemic-related increases still coming through, for example airline fares surged in April (18.6%m/m). Signs that core CPI will see a protracted slowdown leaves the Fed committed to hiking rates (50bps increases are expected at the next two meetings), but it is also raising risks around the growth outlook, hence the weakness in market sentiment.
Hawkish shift from the ECB
Expectations have firmed around a July rate hike from the ECB after speeches from key officials tilted hawkish. ECB President Christine Lagarde said this week her expectation was that purchases under the APP program are on track to be wound up "early in the third quarter" and clarified that the guidance for rate hikes to take place "...some time after the end of net asset purchases" could be as short as a few weeks. That timeline would open the door to the first hike coming at the meeting on 21 July. Executive Board member Isabel Schnabel gave an in-depth analysis of global inflation dynamics, arguing that monetary policy could not sit idle despite euro area inflation being largely being driven by offshore influences. A strong demand environment had given domestic firms pricing power, leading to the pass-through of high input prices to consumers. This had bolstered corporate profits, despite the euro area experiencing a terms of trade shock, and led to the possibility of rising wages in a tightening labour market, which could ultimately see high inflation persisting.
UK growth slows
First quarter GDP growth in the UK came in at 0.8%q/q, a solid outcome given the headwinds from Omicron and the squeeze on real incomes from high inflation, but slightly weaker than expected (1%) and also down from 1.3% in Q4. Weak growth forecasts published by the Bank of England have put the attention firmly on a challenging outlook for the UK, and that was consistent with the trends in the monthly GDP estimates; growth was frontloaded into January and February before declining in March (-0.1%). In some better news, Q1's growth outcome saw UK GDP rising above its pre-Covid level, a recovery that took 2 years from the onset of the pandemic.
