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.