Macro (Re)view (24/6) | Growth prospects in focus

A challenging outlook for growth prospects is leading to increasingly complex reactions in markets. We see bond yields having pulled back over the week on the risks of recession, an outlook that has weighed on the commodities complex and contributed to falling inflation expectations. Equities have rallied, potentially driven by the idea that weaker growth and inflation declining will allow central banks to pivot from their messaging around the need to keep hiking rates quickly. 

Global growth is slowing going into Q3    

The round-up of global PMIs reflected the slowing growth thematic that was prevalent in markets this week. Although still remaining above the 50 level and consistent with economic activity expanding, June's advanced PMI readings suggested that the pace of growth had slowed across the US, Europe and the UK after opening up the second quarter with strong momentum. Some of the common themes were that demand had softened in response to high inflation and weak confidence, while manufacturing output had continued to slide due to the renewed supply disruptions caused by the Ukraine war and China's lockdowns.  

S&P Global chart

The slowdown had been most pronounced in Europe, with the composite PMI easing to a 16-month low at 51.9 from May's 54.8 reading. The close proximity to the Ukraine war was adversely affecting business and consumer confidence, and the services sector that had seen a boost following the easing of Covid restrictions for the summer was losing momentum. The UK's PMI reading had held up at 53.1 in June, unchanged from May, though weakness in new order growth and declining confidence pointed to slowing activity ahead. In the US, June's PMI reading at 51.2 was its weakest since the start of the year as spending in the services sector, particularly in discretionary-related areas, had weakened with household incomes squeezed by high inflation. Price pressures were still elevated, though they appeared to be easing as demand was cooling.   

RBA monitoring inflation expectations

With Australian inflation unlikely to peak until later in the year, RBA Governor Philip Lowe in a speech this week reaffirmed the guidance that further rate hikes remain on the table. Ongoing pressure on fuel and energy prices has prompted the RBA to lift its forecast for peak inflation from around 6% to 7% in the fourth quarter. While monetary policy cannot address these impulses pushing up inflation, Governor Lowe has also been highlighting the influence on inflation from strong demand in the Australian economy running up against capacity constraints. The most important insight from the speech was that higher rates were needed not only to bring demand into closer alignment with supply but also to keep inflation expectations anchored in the 2-3% target range. 

The June meeting minutes revealed that the Board's decision to speed up to a 50bps hike from a 25bps hike at the previous meeting was taken due to a shifting "inflation mindset" in which firms are increasingly willing to pass through higher input costs into prices, while workers, in the knowledge the labour market is strong, could be on the press for higher wages to compensate for the rising cost of living. While a 50bps hike is already expected in July, I think this week's communications indicate a 50bps hike in August could be a real possibility as well. Given the August meeting will come on the back of the Q2 inflation data, the risk is a strong print could prompt another upward revision to the RBA's inflation forecasts that will accompany that meeting, thereby making it difficult for the Board to scale back to a 25bps hike at that juncture. If the Board was to end up hiking by 50bps in August (for a total of 175bps since May), I'd expect a pause would then be likely, with rate hikes not coming back onto the radar until November following the Q3 CPI data and revised RBA forecasts. 

Fed committed to the inflation fight 

Over two days of testimony to the Congress, Fed Chair Jerome Powell told lawmakers the FOMC's commitment to lowering inflation was "unconditional". Chair Powell reiterated that this commitment would see the FOMC continuing to hike rates "expeditiously", removing stimulatory policy that was adding to inflation pressures. Pressed on whether an aggressive tightening cycle could cause the US economy to slow sharply and potentially tip into a recession, Chair Powell conceded that while it was a possibility, a downturn was not a necessary antidote to high inflation. But, overall, the tone was consistent with the messaging coming out of last week's policy meeting that the FOMC has shifted to prioritising inflation over risks to growth.  

UK inflation continues to rise

Headline inflation is yet to peak in the UK, with 12-month CPI ticking up to 9.1% in May from 9% in April. The BoE expects the peak will come later this year in Q4, with the pace running in double digits by that stage factoring in the next increase in the household energy price cap. After accelerating to 6.2% in April, the core rate eased by more than expected to print at 5.9% in May. The inflation situation keeps the option of a 50bps rate hike from the BoE in play, and the MPC's Catherine Mann, one of the three members who voted for that course of action at last week's meeting, said in a speech her view was partly shaped due to the depreciation in the Sterling that was boosting imported inflation. However, a weak result for retail sales in May (-0.5%m/m) and a fall in consumer sentiment to a record low are indicative of the strains households are feeling and could point to the BoE remaining with 25bps rate hikes.  

Macro (Re)view (17/6) | Off to the races

In the week of Royal Ascot, a race of a different kind went up a notch as central banks sped up the normalisation of policy settings. This was headlined by the Fed's 75bps hike but extended as far as the SNB, surprising markets with a 50bps hike. The BoJ remains the outlier keeping policy unchanged. An aggressive hiking cycle poses major risks to global growth prospects, leading equity markets to reprice accordingly and yield curves to flatten.   

Labour market data supports a 50bps RBA rate hike in July 

The Australian labour market continued to tighten in May, with this week's data set to keep the RBA normalising rates at an accelerated pace. Employment more than doubled the expected figure to advance by 60.6k in May, a result strong enough to hold the national unemployment rate at its 48-year low of 3.9% amid a surge in participation to a new record high at 66.7%. Full time employment continued to rise at pace lifting by a further 69.4k in the month, supporting the ongoing expansion in hours worked to 4.9% above pre-Covid levels. The rate of underemployment now has a 5 in front of it for the first time since 2008 (5.7%) and total underutilisation in the labour market is at a 40-year low (9.6%). My full review of the May Labour Force Survey can be accessed here. 

Although the pace of wages growth remains modest (2.4%Y/Y in Q1), the NAB Business Survey continues to indicate that labour costs are on the rise, while this week's decision by the Fair Work Commission to raise the national minimum wage by 5.2%, a tick above the rate of inflation (5.1%), will provide a boost. Appearing in a TV interview, RBA Governor Philip Lowe reiterated that the strength of demand was putting pressure on the capacity of the economy and, together with global factors, was contributing to high inflation. This has led the RBA to forecast a higher peak for inflation at 7% (from around 6%) by the end of the year, further supporting the case for a follow-up 50bps rate hike in July. While consumer sentiment has weakened sharply, Governor Lowe continued to remain upbeat on the economic outlook pointing to the strength of household balance sheets and the labour market. 

Fed accelerates tightening with a 75bps rate hike 

With May's CPI report showing US inflation lifting to 8.6% and concerns this was feeding into higher inflation expectations, the Fed responded by dialling up the pace of its tightening cycle with a 75bps rate hike at this week's meeting that takes the policy rate to 1.5% to 1.75%. Furthermore, members on the FOMC have significantly lifted their expectations for the scale of tightening required, signalling its policy rate will rise into a restrictive range for economic activity by the end of the year. In the post-meeting press conference, FOMC Chair Jerome Powell said a 50 or 75bps rate "seems most likely" at the July meeting.  

Upward revisions to the inflation outlook in 2022, with the headline PCE gauge rising to 5.2% and the core PCE rate at 4.3%, have prompted a more forceful reaction from the FOMC. The Summary of Economic Projections pushed the median estimate for the fed funds rate this year to 3.4% from 1.9%, with further hikes in 2023 taking the terminal rate to 3.8% (from 2.8%). The by-product of a more aggressive and frontloaded hiking cycle is lower output, with GDP growth revised down from 2.8% to 1.7% in 2022 and from 2.2% to 1.7% in 2023 before levelling out to a pace around trend in 2024 (1.9%). Despite these growth downgrades, unemployment is projected to rise only modestly across the projection period from 3.7% to 4.1%. This is a vastly more sanguine view on the economic outlook compared to the repricing that occured in markets this week that reflected expectations for a sharp slowdown and runs the risk of deteriorating into a downturn on the back of aggressive monetary policy tightening.     

BoE resists pressure hiking rates by another 25bps 

As other central banks are in the process of speeding up the return to more normal settings, it remained business as usual for the Bank of England this week as it hiked rates by another 25bps to 1.25%. The MPC's decision was sealed by a 6-3 vote (as it was in May), with the minority (comprising Haskel, Mann and Saunders) again calling for a larger 50bps hike. While sticking with 25bps hikes for now, the MPC appeared to position for greater optionality by replacing its previous policy guidance with a commitment to "act forcefully" in response to inflationary pressures.  

The situation for the BoE is finely balanced. On the one hand, it lifted its forecast for peak inflation to above 11% in October (currently running at 9%), which allows for another large increase in the energy price cap, but on the other, the growth outlook is deteriorating and it now expects GDP to contract by 0.3% in Q2. For the time being, households appear to be holding up still increasing spending despite a large squeeze on real incomes and very weak sentiment. A tight labour market has been a key support, with the unemployment rate at 3.8% and below its pre-pandemic level. The BoE also noted that cost of living support measures by the UK government would bolster households.      

ECB makes plans to deal with fragmentation  

After limited details emerged from the ECB's meeting last week on how it planned to contain peripheral yield spreads as it begins hiking rates from next month, the Governing Council went to the unusual step of calling an "ad hoc" meeting to discuss the matter. The meeting statement reported that reinvestments from its maturing PEPP holdings will be applied with "flexibility", allowing the ECB to purchase more Italian and other nations' bonds. 

Although it is unclear how much PEPP redemptions would amount to, analyst estimates suggest this could be in the order of €200bn through the remainder of the year. The statement then went on to confirm that the Governing Council had tasked its committees with accelerating the preparatory work for a new "anti-fragmentation" tool. Earlier in the week, the ECB's Isabel Schnabel in a speech said there were "no limits" to the central bank's commitment to ensuring the smooth transmission of its monetary policy stance across the euro area.      

Australian employment 60.6k in May; unemployment rate 3.9%

The Australian labour market tightened further in May as employment came in well above expectations. Strong demand for labour was accompanied by a rise in the partcipation rate to a new record high. Today's report points to a 50bps RBA rate hike in July.  

Labour Force Survey — May | By the numbers

• Employment surged higher by a net 60.6k in May, well above the consensus forecast for a 25k rise. April's increase was revised slightly higher to 4.4k from 4k. 

• National unemployment rate remained at 3.9%, missing expectations for a fall to 3.8%. However, the underemployment rate printed with a 5-handle (5.7%) for the first time since 2008 and total underutilsation has fallen to a 40-year low (9.6%). 
• Participation rate lifted from 66.4% to 66.7% in May, a new record high.

• Hours worked advanced by 0.9%m/m to be up by 2.1% over the year.

Labour Force Survey — May | The details

The Australian labour market continues to go from strength to strength. Today's report for May showed the national unemployment rate remained at 3.9%, it lowest since 1974. In a tightening labour market more and more Australians are finding work and working the hours they are looking for. As a result, the rate of underemployment has fallen below 6% for the first time since 2008 and total underutilisation in the labour market has declined to its lowest level since 1982. 

After declining slightly over the past couple of months due to the disruptions from Omicron and the east coast floods and through the Easter holiday period, participation picked back up in May to rise to a new record high at 66.7%. Meanwhile, the share of Australians in work continues to rise, resetting to a new record high in May at 64.1%, 1.6ppts above its pre-Covid level. 

May saw a resurgence in employment, posted at a net increase of 60.6k in the month. Employment had slowed in March and April, reflecting the impact of the floods in New South Wales and Queensland and reduced hiring during the Easter holiday period. In May, full time employment lifted by 69.4k while part time employment declined by 8.7k. So far in 2022, growth in full time employment has been incredibly strong (307k) as part time employment has declined (-99k). This likely reflects a couple of factors. Firstly, many part time workers have likely taken on additional hours amid very high levels of job vacancies, thus crossing the threshold defined by the ABS for being employed full time (35 or more hours in the survey week). Secondly, given those high vacancies, many Australians previously working part time have been able to find full time positions.    

Total hours worked in the economy lifted by a strong 0.9% in May following on from April's 1.3% rebound from the east coast floods. This takes monthly hours to 4.9% above their pre-Covid level from March 2020. Reflecting the strength in the employment outcome, full time hours advanced by 1.4% in May to be 6.4% higher across the Covid period. Part time hours were down in the month (-1.5%) and are below their pre-Covid level (-2.6%).  

Total hours worked would have recorded an even stronger rise in May but for the significant disruptions that continue to be posed by Omicron and, more recently, seasonal flu. The number of Australians working fewer hours than usual due to illness surpassed the peak seen during the Omicron wave rising to 780.5k in May (around 5.6% of the labour force). Increased illness at schools likely drove the large rise in the number of people taking time away from work for caregiving reasons in May to 352.4k (around 2.5% of the labour force).  

Labour Force Survey — May | Insights

A strong report today confirmed that the Australian labour market continues to tighten. With the RBA noting in its decision to hike rates by 50bps at the June meeting that the labour market conditions were "contributing to the upward pressure on prices", another 50bps hike in July is surely on the cards. There are a couple of key points to note, however. Firstly, the rise in the partcipation rate to record highs creates a much better supply-demand balance than seen in many other labour markets around the world, which is likely to mean wages growth will not accelerate at an uncomfortable pace for policymakers. Secondly, hiring is settling towards a pace that the Australian economy can comfortably sustain as labour demand remains strong. 

Preview: Labour Force Survey — May

The ABS is due to publish Australia's Labour Force Survey for May at 11:30am (AEST) today. With the RBA stepping up the pace of withdrawing policy support, further signs of tightening in the labour market strengthen the likelihood of a second consecutive 50bps rate hike at the July meeting.    

As it stands | Labour Force Survey

Australia's unemployment rate stands at a 48-year low of 3.9%.  This has been a remarkable recovery from the height of the pandemic crisis when the unemployment rate climbed to 7.5% during the national lockdown, a level not seen since the late 1990s. Underemployment (6.1%) and underutilisation (10%) are at their lowest levels since 2008. The recovery in the labour market has been accompanied by increases in employment and participation to record highs.

April employment slowed to a 4k rise around broadly offsetting contributions from the full time (92.4k) and part time segments (-88.4k). The fall in part time employment may have been partly related to Easter and school holiday periods, though it is also likely to be reflecting a 'switching' to full time employment from people working increased hours (to 35 hours or more in the reference week) as many businesses continue to face staff shortages in a tightening labor market and with Covid-related absences still at high levels. The flood recovery effort in New South Wales and Queensland could also be adding to these frictions. 

Hours worked lifted by 1.3% in April, more than rebounding from their fall in March (-0.3%) when staff absences from Omicron and severe wet weather on the east coast caused major disruptions. In April, full time hours advanced by 2.2% as part time hours declined by 2.2%. Participation in the labour force eased from 66.4% to 66.3% but remained around record highs. 

Market expectations | Labour Force Survey

For today's report, the median estimate for employment is an increase of 25k (range: 0-40k). The latest payrolls data indicated employment slowed over the second half of April through the Easter and school holiday period before starting to rise in May. Overall, the risks look to be to the downside for the employment number. The market expects the unemployment rate to decline further, to 3.8% in May from 3.9% in April (range: 3.8% to 4%). 

What to watch | Labour Force Survey

The focus remains on the unemployment rate and the broader measures of underutilisation. Last week's decision by the RBA to hike rates by 50bps referenced domestic capacity constraints and the tightening labour market as factors "contributing to the upward pressure on prices". Should the unemployment rate fall to 3.8% as expected, it would strengthen the case for the RBA to hike rates again by 50bps in July. 

Macro (Re)view (10/6) | On a journey

High inflation and ever more hawkish central banks put markets under pressure this week. Friday's upside surprise on US inflation portends a Fed staying aggressive on rates, likely taking its peers in the same direction. Even the ECB will not be able to sit this hiking cycle out, signaling a rate increase in July and a departure from an era of ultra-accommodative policy. At home, the RBA stepped up its hawkishness surprising the market with a 50bps hike. 

RBA steps up normalisation with 50bps rate hike  

The RBA stepped up the pace in withdrawing "extraordinary monetary support" delivering a 50bps rate hike at this week's meeting to take its policy rate to 0.85% (reviewed here). The hiking cycle started in May with a smaller hike of 25bps, though significant increases to the RBA's inflation forecasts (with the peak since revised higher) due not only to global supply factors but also domestic capacity constraints had put the writing on the wall for this week's decision. 

Governor Philip Lowe's decision statement highlighted the strength of the economy and robust outlook as no longer justifing the settings required during the pandemic. With this being the case, I expect another 50bps hike in July. A speech by Governor Lowe on 21 June (Economic Outlook and Monetary Policy) looks crucial in terms of signaling the pace and extent of hikes seen over the back half of the year, on which there was little provided this week. The market is priced for another 8 hikes in 2022, though I struggle to see the RBA being able to deliver on this and anticipate the cash rate at around 2% by the end of the year. 

US inflation surprised to the upside in May

May's inflation report produced the wrong kind of surprise as price pressures reaccelerated in the month. After easing back to a 0.3% rise in April, headline CPI lifted by 1% month-on-month in May to comfortably clear the expected increase of 0.7%. This drove annual headline inflation to a new peak for the cycle at 8.6% (vs 8.3% exp), resetting from the previous high of 8.5% in March. Inflation on the core rate (ex-food and energy) printed at 0.6% in May (vs 0.5% exp) and although the annual pace eased from 6.2% to 6%, this disappointed expectations for a slowing back to 5.9%.   

After declining in April, fuel prices picked back up to rise by 4.1%m/m on the ongoing effects of the Ukraine war and drove the acceleration in May's inflation. The other major contributors were food (1.2%m/m) and shelter costs (0.6%m/m). Price rises in these essential items are amplifying cost of living pressures and with real incomes continuing to be squeezed, consumer sentiment is weakening. 

Core services inflation remains on the rise (0.6%m/m) to be 5.2% higher over the year. Rising shelter costs (5.4%Y/Y) have been a big factor in this, as have Covid-exposed components such as airfares (37.8%Y/Y). The surge in US inflation was to a large extent driven initially by durable goods on surging demand at a time of supply chain constraints. However, durable goods are now pulling down on inflation due to a combination of base effects and consumer demand rotating back to services. Annual inflation for durable goods is now 11.4%, down from its peak pace of 18.7% in February, and replenished retailer inventories are likely to keep this trend going. 

All in all, May's report raises the possibility that the Fed may need to keep hiking by 50bps beyond the June and July meetings, increasing risks to the growth outlook. The immediate focus is on next week's meeting where the updated set of economic projections will be a chance for the FOMC to reset expectations around where the peak for rates may be.  

 

ECB succumbs to global rate hiking cycle

The set of announcements at this week's ECB meeting confirmed QE purchases will be wound down on 1 July and that the Governing Council intends to start hiking rates with a 25bps increase later that month. Described in the post-meeting press conference by ECB President Christine Lagarde as being "on a journey" of shifting away from ultra-accommodative policy, the Governing Council has plans to press on with more tightening as the summer progresses. 

The decision statement noted that at the September meeting, a larger hike (presumably 50bps) was on the table if "...the medium-term inflation outlook persists or deteriorates". The guidance in the lead-up to this week's meeting was for a 25bps increase in September, though this new line implies that the inflation outlook now needs to fall in order to prevent a 50bps hike.   

The updated forecasts published this week contained significant upward revisions to the inflation outlook in 2022 and 2023 such that even with a subsequent easing of price pressures, both the headline (2.1%) core rates (2.3%) are still expected to be above the 2% target in 2024. To emphasise the challenge confronting the ECB with an inflation rate currently above 8%, the Governing Council went on to signal that beyond the September meeting it anticipates a "gradual but sustained path of further increases in interest rates" will be needed.

ECB chart

Despite downgrading its outlook for growth across 2022 (3.7% to 2.8%) and 2023 (2.8% to 2.1%), the ECB remains more sanguine than markets on growth prospects. For that reason, markets are left questioning the viability of an ECB hiking cycle when it sees the risk of a much more severe slowdown building the longer the Ukraine war and its associated terms of trade shock persists.

Markets were also left to ponder the impact on the bond market from an impending hiking cycle. Although it had been speculated prior to the meeting that the ECB was considering a new purchase facility to help contain sovereign spreads from widening too severely, no such plans were forthcoming. President Lagarde did not discard the possibility of a new facility being developed, though for the time being the ECB would be relying on the flexibility built into reinvestments in its PEPP program. 

Global risks piling up 

Both the World Bank and OECD marked to market their respective outlooks for global growth prospects, with downward re-ratings for 2022 coming in response to the shock of the war in Ukraine and its associated amplification of inflation pressures. As the year has progressed the outlook has deteriorated and become more uncertain; the World Bank cut its latest forecast for global growth in 2022 to 2.9% from the 4.1% pace anticipated back in January, while the OECD's projection has fallen to 3% from 4.5% in December. 

This represents a sharp slowdown from 2021 when lockdown reopenings generated a 5.7% expansion in global GDP. Although it is not the base case for either group, the World Bank and the OECD warned of the risk of global stagflationary conditions if the war in Ukraine has a more adverse impact on growth and causes inflation to remain elevated for longer than anticipated. Also cited was the risk that interest rate hikes by central banks across the globe could tighten the screws on economies through 2023 to a larger extent than envisaged.   

Current conditions according to the latest global PMIs indicated economic growth was holding up in expansionary territory in May, albeit at a soft pace. While there were signs that some input cost pressures were easing in the manufacturing sector, input price pressures in the services sector were increasing due to rising energy, materials and wage costs.  

S&P Global chart 

RBA hikes rates by 50bps in June

The RBA Board today stepped up the pace in normalising policy from the emergency settings required during the pandemic, hiking its key rates by a larger-than-expected 50bps. This takes the cash rate target to 0.85% and the rate on Exchange Settlement balances to 0.75%. 

Today's decision to hike by 50bps was very much at the hawkish end of outcomes expected by markets and analysts ahead of the meeting (see here). However, the move was consistent with the main theme from the May meeting where the Board stated its intent to withdraw "extraordinary monetary support". A 25bps increase initiated the hiking cycle last month, and with the pace ramping up to a 50bps hike today, consistent with recent moves from the likes of the Fed, RBNZ and BoC, the policy rate in Australia is now just above its level from before the pandemic (0.75%).

RBA Governor Philip Lowe's decision statement indicated that inflation was likely to reach a higher peak in 2022 than it anticipated last month (5.9%). In May, the inflation outlook was lifted sharply, mainly stemming from the disruptions to global supply chains from Covid lockdowns and the war in Ukraine but also reflecting building capacity constraints in the domestic economy, including from the tightening labour market. With the hiking cycle now well underway, the RBA forecasts inflation will moderate next year but remain above the 2-3% target until 2024, leaving it with more work to do. 

The RBA clearly has a great deal of confidence in the ability of the Australian economy to withstand this hiking cycle. Governor Lowe emphasised today that the Board is hiking into what are strong economic conditions, bolstered by the income boost from a record high terms of trade. The growth outlook in 2022 is underpinned by consumer demand, rising business investment and the residential construction pipeline. The RBA also expects labour demand will drive down unemployment even further from its near 50-year low of 3.9%. 

Going forward, Governor Lowe noted the Board will be attentive to data on the consumer and how demand evolves given the present crosscurrents from strong balance sheets and high savings on the one hand but squeezed real incomes and rising rates on the other. The economic outlook offshore was also identified as crucial, with growth prospects increasingly under pressure. 

In closing, Governor Lowe signalled further hikes are to follow, with the trajectory for rates over the back half of the year to be guided by the data and its assessment of the outlook for inflation and in the labor market. Markets are pricing the cash rate to rise to around 2.75% by the end of this year. I see the RBA taking a more cautious path, with rates ending the year closer to 2%. The next event of note from the RBA is a speech from Governor Lowe on 21 June (10am AEST), with the minutes from today's meeting released later that morning.  

Preview: RBA June meeting

After commencing its rate hiking cycle at the May meeting, the RBA Board is set to hike rates again today (decision due at 2:30PM AEST). My expectation is that the Board will hike its key rates by 40bps, increasing the cash rate target to 0.75% and the rate on Exchange Settlement balances to 0.65%.

The process of withdrawing the emergency support the RBA delivered to the Australian economy during the pandemic has been a long and gradual one that started around 12 months ago. This has seen the Term Funding Facility wound down, the 3-year yield target being discontinued and QE purchases ending. The next step was taken in May with the decision to hike the cash rate target off its pandemic low of 0.1%, a move characterised by the RBA as the start of "normalising monetary conditions". 

With updated forecasts revising the core inflation outlook materially higher to remain above the 2-3% target band until mid-2024, the most significant observation from the RBA coming out of the May meeting was the role domestic capacity constraints were playing in adding to price pressures coming from global factors. The domestic aspect is what monetary policy is being used to address. Although settling for a 25bps hike in May, the meeting minutes later revealed that a larger hike of 40bps hike had come under consideration.  

Since the May meeting, last week's national accounts underscored the resilience of the economy, with output rising by 0.8% in a heavily disrupted March quarter, driving the post-Covid expansion in GDP to 4.5%. Reflecting the tightness in the labour market with the unemployment rate at its lowest level since 1974 at 3.9%, the national accounts also reported labour costs were picking up, indicating aggregate wages growth is likely to rise further in the quarters ahead. 

In what shapes as a finely balanced decision, markets and analysts are split on whether the Board will hike by 25bps or 40bps today. My expectation is the Board will side with 40bps, with the move to frontload the hiking cycle being consistent with its messaging around "normalising monetary conditions" by returning the policy rate to its pre-pandemic level of 0.75%. However, more important than today's decision is how the RBA sees the trajectory for rates evolving over the back half of the year, with markets to key off any comments in this respect in today's statement from Governor Lowe. The technical assumption used by the RBA in its forecasts has the cash rate rising to 1.75% by the end of the year, leaving daylight to a more aggressive profile being priced by markets.  

Macro (Re)view (3/6) | Australian households drive Q1 GDP

A return to familiar themes this week with strong data and high inflation pointing to central banks with work in front of them, the Bank of Canada responding with another 50bps hike. A steeper yield curve supported the US dollar, though the Australian dollar lifted with the Q1 GDP report seen as keeping a 40bps RBA hike next week on the table. Equities in the US and Europe declined, though Asia advanced as lockdown measures eased in China. 

Australian economy was resilient in Q1...

March quarter real GDP increased by 0.8%, a resilient showing from the Australian economy amid the disruptions from Omicron and floods that came on top of supply constraints and global headwinds. Output advanced despite these disruptions causing hours worked to fall by 0.9% in the quarter. Activity was 3.3% higher through the year, lifting the post-Covid expansion in GDP to 4.5% above pre-pandemic levels. Some of the main themes in the quarter were: robust consumer demand led by discretionary spending around a rotation from goods to services as remaining Covid restrictions eased; surging corporate profits, driven by the mining sector as rising commodity prices reset the terms of trade to a new record high; and increasing price pressures with broad labour costs picking up. My 'In review' feature article on the Q1 national accounts with in-depth analysis and charts is available here. 

... driven by household spending

Household consumption maintained its strong momentum that was generated by Q4's reopening from the Delta-wave lockdowns, realised in a 1.5% increase in Q1. Although rising inflation has seen growth in real disposable income contract over the past two quarters, households have been buffered by high levels of accumulated savings, which they are comfortable to draw on given the strong labour market. With the household saving ratio still very elevated at 11.4%, this can continue for a while yet.     

Notably, the consumption basket of households saw a pronounced rotation away from goods (0.3%q/q) into services (2.3%q/q), as the wider easing of restrictions boosted demand for travel (59.9%q/q) and at hotels and restaurants (5.3%q/q). This factors into the strength being seen in discretionary demand (4.3%q/q), which is driving overall consumption and has now more than fully recovered its Covid-driven fall. April retail sales data showed this strength in discretionary spending had continued early in the current quarter (see here).  

RBA to hike rates by 40bps next week 

With the policy rate sitting at 0.35%, the strength of the economic expansion, the tightening labour market and high inflation are sure to see the RBA hiking rates next Tuesday. Markets and analysts are divided on whether the Board will back up May's hike with another 25bps increase or opt for the larger 40bps hike it considered at the previous meeting. I am on the side of 40bps on the basis that such a move would return the cash rate to its pre-pandemic level of 0.75%, consistent with the RBA's messaging around now being the appropriate juncture to remove "extraordinary monetary support". However, there probably isn't much in it either way (the RBA's arrangement of monthly meetings might argue against the need for larger hikes), and ultimately Governor Lowe's statement could be more important than the decision itself in terms of shaping expectations around the trajectory for rates over the back half of the year. 

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Lastly on Australia, there were a number of domestic data points released through the week. High commodity prices led to another elevated current account surplus in Q1 (see here), while the trade surplus pushed back above $10bn in April (see here). Cooling conditions in the housing market partly contributed to a 6.4% fall in housing finance commitments in April (see here), while monthly dwelling approvals were down by a further 2.4% to be 32.4% lower over the year (see here).    

US labour market remains strong 

Employment in the US economy continued to rise at pace in May, with nonfarm payrolls printing at 390k, well above the consensus estimate of 318k. Net revisions trimmed 22k off payrolls over March and April, though with job openings in the labor market standing at an elevated 11.4m, demand from firms to hire more workers is clearly very strong. Reflecting the tightness in the labour market, the unemployment rate held at 3.6% for the third month running, a tick higher than the 3.5% level it stood at just before the pandemic struck. The key gauges for Fed policy both showed slight improvement, with the participation rate up from 62.2% to 62.3% and average hourly earnings growth easing from 5.5% to 5.2%yr, but these outcomes do not shift the outlook for 50bps hikes at the next couple of meetings.  

With markets sensing the peak for inflation may already be in, the idea from the Atlanta Fed's Raphael Bostic that the Fed could pause on tightening once these hikes have been delivered has gained traction. However, there has been pushback to this from the likes of Fed Vice Chair Brainard and Fed Governor Waller. This all comes ahead of next Friday's CPI data for May. 

Euro area inflation rises through 8%

Upside surprises on the preliminary readings of May euro area inflation came ahead of next week's ECB meeting, with the Governing Council to remain unmoved on rates while scheduled purchases in its APP program are continuing through June. Annual headline inflation is now running above 8%, with a 0.8%m/m rise lifting the pace from 7.4% to 8.1% (vs 7.8% exp). As a net importer of commodities, the euro area has been left heavily exposed by the surge in energy prices (39.2%yr), accentuated by the war in Ukraine. However, even if energy and other volatile items are excluded, inflation pressures have broadened out, reflected in the core rate rising from 3.5% to 3.8%yr (vs 3.6% exp). 

Back on the energy situation, EU leaders agreed this week to new sanctions on Russian oil imports, likely to place more upward pressure on prices. However, the sanctions were less stringent than initially planned, covering seaborne imports but exempting pipeline flows from Russia. The guidance from ECB officials, reiterated this week by Chief Economist Philip Lane, has been that it will conclude APP purchases early in Q3, clearing the way for the first rate hike at the July meeting. While this is more or less locked in, markets are likely to keep pushing pricing for liftoff to commence with a larger 50bps hike than the 25bps increase being guided.