With the Federal Reserve indicating it will take a more data-dependent approach in hiking rates, weakness in US GDP saw markets taking greater confidence that rates won't reach the levels FOMC members expect, in turn supporting risk sentiment. This was despite US wage-price pressures showing no sign of easing in this week's data. Domestically, a softer-than-expected Q2 inflation report has seen markets settling on the RBA hiking by 50bps next week.
Australian inflation was strong in the June quarter...
Headline inflation was 1.8% in the June quarter, lifting the annual rate from 5.1% to 6.1%. Those outcomes were below market expectations, going against the run of play for upside surprises in global inflation prints, and markets responded by pricing out the chances of a 75bps RBA rate hike next week. Underlying inflation on the trimmed mean was 1.5% in the quarter, in line with consensus and Q1's outcome, as the annual pace elevated from 3.7% to 4.9%.
Overall, inflation in Q2 at 1.8% was a touch softer than in Q1 (2.1%) as petrol prices recorded a much more moderate increase this quarter due to the impact of the federal fuel excise tax cut. Another contributor was grocery prices rising at a slower pace after lifting very sharply in Q1; however, supply constraints associated with the recent foods and Covid disruptions mean price levels continued to increase. Meanwhile, new dwelling costs lifted further to be by around 20% over the year, with a large part of the increase reflecting the pass-through of higher materials and labour costs to consumers. Despite these cost escalations, consumer demand for new homes has been strong due to the support of construction subsidies and interest rate cuts following the onset of the pandemic. Reopening factors associated with international (19.9%q/q) and domestic travel (1.7%q/q) and rising prices for consumer durables due to strong demand, higher freight costs and supply chains pressures were also major contributors to quarterly inflation. For more on the Q2 CPI data see here
... and consumer demand may be cooling
Cost of living pressures and rising interest rates may be turning the screws on consumer demand as retail sales slowed to a 0.2% rise in June, its weakest outturn in 6 months with turnover growth softening sequentially in month-on-month terms over Q2. However, it is also clear that a rotation back to services is underway after the easing of Covid restrictions, so this could be contributing to weaker spending in durable goods that dominate retail sales (note the retail data do not include fuel). For Q2, nominal retail sales lifted sharply by 3.2% but next week's full release will be key as it will detail the price/volume split.
Fed hiked rates by a further 75bps...
In the US, for the second meeting in succession, the Fed's FOMC met expectations delivering a 75bps rate hike, bringing the Fed Funds target range up to 2.25 - 2.5%. At the post-meeting press conference Chair Jerome Powell said that with the FOMC having made good on its pledge of "expeditiously" returning rates to a setting it considers to be in the neutral range, neither expansionary nor contractionary for economic activity, it would now move to a "meeting by meeting" approach to policy. Interpreted by markets as opening the door to a potential dialing down in the pace of rate hikes going forward, risk assets performed.
That is somewhat surprising given Chair Powell made clear the focus was still very much on bringing down inflation and that the June summary of economic projections in which the median estimate for the terminal Fed Funds rate of 3.75 to 4% next year was still a good guide to where the FOMC believes policy needs to head. That comes as the Fed's preferred inflation gauge was above expectations for June, rising by 0.6% month-on-month and firming the annual pace from 4.7% to 4.8%. Meanwhile, the tight labour market pushed the employment cost index up by 1.3% in Q2 (vs 1.2% exp), indicating second-round effects from high inflation will continue to be closely monitored by the Fed.
... as the US economy slows
June quarter GDP was weaker than expected at -0.2%q/q following a 0.4%q/q contraction in Q1. Although net exports and inventories account for the largest part of those contractions, it is clear that domestic demand weakened sharply in Q2 (-0.1%) from Q1 (0.5%). Driving that slowdown was weakness in private investment (-3.6%q/q) and household consumption almost stalled over the quarter. Growth in real personal spending was 0.3% in Q2, down from 0.5% in Q1, with an increase in services consumption (1.0%) broadly offset by declining demand for goods (-1.1%).
Euro area growth and inflation surprised to the upside
Despite euro area inflation coming close to hitting a 9% pace in July printing at 8.9%Y/Y and coming in stronger than expected (8.7%), second quarter GDP growth in the bloc at 0.7%q/q surprised well to the upside of consensus (0.2%). After growth of 0.5% in Q1, that left GDP up by 1.2% over the first half of the year, a surprisingly resilient outcome given the outlook has deteriorated significantly following the war in Ukraine, uncertainty over energy supply, household spending power squeezed by inflation and with the ECB now hiking rates.
Alongside the rise in headline inflation, the core rate lifted from 3.7% to 4%Y/Y indicative of broadening price pressures beyond energy (39.7%Y/Y) and food (9.8%Y/Y). Goods inflation (ex-energy) (4.5%) continues to outpace services inflation (3.7%), though the latter is on the rise following the wider reopening of the sector.
