This week saw the Fed, BoE and RBA hiking rates due to rising wage-price pressures in their respective economies. Markets have been volatile due to uncertainty over the various reaction function of central banks. In the US and Australia, the focus is on bringing down inflation but in the UK weak growth prospects are set to play an increasing role.
RBA turns hawkish
The RBA hiked rates by 25bps this week and shifted to an explicit tightening bias that has a larger hike on the cards next month. The cash rate target was lifted from 0.1% to 0.35% and the rate on Exchange Settlement balances increased from 0% to 0.25%. The RBA's balance sheet is also set to start winding down, with the Board electing not to reinvest its maturing bond holdings. For more on the May meeting, a full review is available here.
The recalibration of the RBA's policy settings came as a revised set of economic forecasts in the Bank's quarterly Statement on Monetary Policy showed projections for a tighter labour market, faster wages growth and inflation above the 2-3% target. With the national unemployment rate now expected to fall to a lower level at 3.5% than anticipated in February (3.75%), rising pressure on labour costs picked up in the RBA's business liaison is forecast to translate to faster growth in the Wage Price Index this year (to 3% from 2.75%) and next (3.5% from 3%). Near-term inflation pressures from supply constraints saw the 2022 forecast for underlying CPI lifted materially from 2.75% to 4.6%. As those bottlenecks ease, inflation pressures are expected to moderate to the top end of the target band in 2023 (3.1%), underpinned mainly by faster wages growth. That outlook for wage-price pressures has put the prospect of a frontloaded hike in June on the radar; a 40bps hike would return the cash rate to its pre-pandemic level of 0.75%.
Beyond June, rates are set to keep rising, with the above forecasts based on an assumption of the cash rate lifting to 1.75% by the end of the year and then to 2.5% in 2023. This is a more modest path than priced by markets but looks more likely to eventuate. While the RBA's growth outlook for 2022 is robust at around 4.25%, it is projected to slow to 2% in 2023. That slowdown suggests that as 2023 progresses, the growth-inflation trade-off for the Board is set to become more complex.
Australian data remains solid
Staying on the domestic scene, data points through the week were generally solid. Retail sales lifted by 1.6% in March to be up by almost 3% for the first quarter. With prices on the rise, growth in underlying volumes will be of interest in next week's detailed release. In the housing market, housing finance commitments increased by 1.6% in March, but with the RBA's hiking cycle underway and house prices in Sydney and Melbourne declining demand is set to cool (see here). Building approvals remained on the unwind over the first quarter, with the surge seen from mid-2020 to mid-2021 now supporting a large pipeline of residential construction work (see here). Meanwhile, the boost to Australia's terms of trade from rising commodity prices was reflected in another elevated trade surplus in March (see here).
Fed accelerates policy normalisation...
The Fed delivered what was priced by markets at its meeting this week, announcing a larger rate hike of 50bps to bring its policy rate to 0.75% to 1% and committing to start reducing its balance sheet in June. With inflation running well above the 2% target and a tight labour market generating wage pressures, Fed Chair Jerome Powell said at the post-meeting press conference that the committee's intent over the remainder of the year would be to "... expeditiously move our policy rate up to ranges of more normal neutral levels", revealing that there is broad support to hike by 50bps at each of the next two meetings.
The FOMC's estimate of the range neutral rate is somewhere between 2-3%, though Chair Powell said it was prepared to tighten rates to a more restrictive range in order to bring down inflation. Strength in underlying demand conditions is giving the Fed confidence that the US economy can withstand what shapes as an aggressive tightening cycle to come. Meanwhile, quantitative tightening will start in June, with $47.5bn of maturing bond holdings to roll off the balance sheet per month, rising to a peak pace of $95bn/mth after 3 months.
...as the US labour market remains strong
April's payrolls report was mixed on the headline details but conditions in the US labour market continue to remain strong. Employment advanced by a stronger-than-expected 428k in the month (vs 380k expected), though net revisions saw -39k taken off non-farm payrolls over February and March. Although the unemployment rate was steady at 3.6%, the elevation in job vacancies to 11.5m in March suggests further declines are likely. A tight labour market is seeing average hourly earnings growth rise at a 5.5% annual pace, little changed from the prior month. The most disappointing aspect of the report was the easing in the participation rate from 62.4% to 62.2%, its first decline since May last year.
BoE hiked rates again but the MPC is divided on the outlook
The Bank of England increased its policy rate by another 25bps to 1% this week, though a complicated economic outlook sees an MPC increasingly divided in their views on the path forward. With the key rate rising to the 1% threshold, BoE staff have been tasked with formulating a framework for sales of the Bank's bond holdings acquired under its QE program, with the details to be reported in August.
Highlighting the range of views, the MPC voted 6-3 to hike rates by 25bps, with the 3 in the minority voting for a 50bps hike. In looking ahead, 2 members no longer agreed with the Bank's forward guidance that further hikes "...may still be appropriate". This comes after the BoE's latest Monetary Policy Report revised the inflation outlook up and cut forecast economic growth. UK inflation is now expected to peak at 10.2% towards the end of the year. As the squeeze on real incomes intensifies, UK GDP is expected to contract in Q4. With inflation remaining elevated relative to the BoE's target in 2023, GDP growth is forecast to fall by 0.25% next year.
In the post-meeting press conference, Governor Andrew Bailey said policy was treading a "narrow path" given the outlook. On the one hand, surging inflation had required rates to increase, but on the other the nature of the economic shock to real incomes meant that demand would slow and put downward pressure on inflation.
Varying messages from ECB officials
Several officials from the ECB provided markets with insights on their thinking this week. Of note, Executive Board member Isabel Schnabel said that once net asset purchases have concluded, a rate hike in July was possible. If there were signs high inflation was becoming embedded through wage negotiations, Schnabel said talking would not be enough and the ECB would "need to act". In a speech, ECB Chief Economist Philip Lane said forward-looking measures of wage growth had found some evidence of faster rises being built into negotiations in 2022 given the high inflationary environment, though increases then slowed in 2023. Meanwhile, Executive Board member Fabio Panetta said a cautious view on policy was required given the risks to the growth outlook building in the continent.