For markets well accustomed to upside surprise after upside surprise on US inflation, July's below consensus outcomes on the headline and core measures was reason enough to drive a rally in risk sentiment, denting the US dollar a bit. There was no real reaction in the bond market as the US curve between the 2 and 10-year segments remained inverted by around 40bps, likely with last week's very strong labour market report still clear in the mind in terms of assessing the outlook for Fed policy.
US inflation slows in July
In welcome news, US inflation pressures showed significant signs of easing as both consumer prices and producer prices posted their weakest month-on-month outcomes in July since the early stages of the Covid pandemic. Headline consumer prices flatlined in the month (vs 0.2% expected) resulting in the year-over-year pace slowing from 9.1% to 8.5%, while a 0.3%m/m rise left the core rate (ex-food and energy) steady at 5.9%Y/Y. Pipeline inflation pressures also cooled as producer prices declined in July (-0.5m/m), though the annual pace is still elevated (9.8%Y/Y) and it will take a much more sustained easing in the indicators of supply chain constraints to come down.
Compared to June's 1.3% rise in headline CPI, the 0% outcome in July represented a significant slowing in inflation. This was predominantly driven by a large fall in gasoline prices (-7.7%m/m), though inflation in durable goods (0.3%m/m) and services (ex-energy) (0.4%m/m) also slowed noticeably in the month. On the other hand, food (1.1%m/m) and shelter (0.5%m/m) costs are continuing to rise at a strong pace and both components have made substantial contributions to the annual inflation rate.
Australian consumer and business sentiment diverges further
Consumer sentiment on the Westpac-Melbourne Institute index fell a further 3% in August to remain around the lows from the previous two downturns (GFC and Covid) in Australia. Contrast that with business sentiment in the NAB Survey rising to an above-average level of +7 in July. Consumers are feeling downbeat due to the rise in inflation while the RBA's rate hiking cycle has come as a further hit to household budgets. However, household spending has remained much more resilient than the sentiment readings would imply. Firms, in seeing robust demand, have been confident in passing on cost increases to customers. Still, firms are taking on some margin compression with purchase costs rising at a faster pace than product prices in the NAB survey. The strength of the labour market is also leading to fast rises in labour costs (running at a quarterly pace of 4.6% in July) and next week's Wage Price Index data for Q2 will provide an update of increases to base wages in Australia (0.8%q/q expected). July's Labour Force Survey is also due next week with the median estimate for employment sitting at +25k and 3.5% on the unemployment rate.
UK economy contracts as households' resilience starts to fade
Real GDP in the UK contracted by 0.1% in the June quarter. Factors unrelated to underlying economic conditions largely drove the decline, including from the winding up of government pandemic-related spending measures and the effect of an additional public holiday during the Queen's Jubilee. However, there are now clear signs that household consumption is losing momentum as high inflation is driving falling real incomes and as the BoE continues to raise rates. In the June quarter, household consumption slowed sharply to fall by 0.2%q/q from a 0.6%q/q increase in Q1. The pressure on household spending is set to intensify given household energy prices will reset higher in October, though some of the impact should be attenuated by fiscal support measures expected to be announced once the leadership of the government has been settled.
More broadly, the bleak outlook for the UK economy outlined by the BoE (discussed in last week's review) reflects the adjustment from a negative shock to the terms of trade. Surging global prices for energy and goods, of which the UK is a net importer, have seen import spending accelerate sharply over the year (31%) whereas earnings from exports are up relatively modestly (13.1%). That outflow of capital has seen the trade deficit widen significantly to around 5% of nominal GDP from around 0.2% a year ago.
The resulting impact has unleashed widespread inflation pressures in the UK as firms have passed-through input cost rises to customers. The next phase, as described by the BoE, is the pullback in demand as declining real incomes forces households and businesses to cut spending, with the Bank forecasting the UK economy to fall into a recession by the end of the year.