RBA continues to hike at pace
The RBA Board delivered its third consecutive 50bps rate hike this week, its 4th hike overall in the current tightening cycle, taking the cash rate target to 1.85% (reviewed here). The main message in Governor Philip Lowe's statement was that further hikes are needed to lower inflation and to achieve a "more sustainable" supply/demand balance in the Australian economy. This was, however, a nuanced statement, seemingly giving encouragement to markets that sense a downshift in the pace of RBA hikes is nearing. The statement referred to its commitment to the inflation target while also keeping the economy on an "even keel". It may also be notable that whereas previously the Board characterised its rate hikes as the "withdrawal of extraordinary monetary support", it now refers to the "normalisation of monetary conditions", adding also the cash rate was "not on a pre-set path" in that process.
The RBA's August Statement on Monetary Policy spoke of the "narrow" path ahead of the Board as it looks to press on with hiking rates, responding to forecasts for higher inflation at the same time as the growth outlook has softened. Growth this year is now expected to come in at 3.25%, 1ppt lower than in the May update, before slowing to a 1.75% pace in both 2023 (down from 2% previously) and 2024. The inflation outlook was revised to show an expectation that price pressures will remain elevated for longer. The peak for headline CPI is now forecast to be 7.75% (up from around 7% previously) in the December quarter, moderating next year to 4.25% (from 3.25%) before returning to the top of the target band at 3% in 2024. Although a stronger labour market has seen the Bank lift its forecast trajectory for wages growth, higher inflation means the squeeze on real house incomes is now expected to be larger. The associated implications are a key factor the Board is monitoring.
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For those interested, I have reviews on the main Australian data points from the past week in retail sales (here), housing finance (here), dwelling approvals (here) and international trade (here).
BoE speeds up tightening as the outlook deteriorates
Invoking its guidance to "act forcefully" to the rising risk of persistent inflationary pressures, the Bank of England's MPC upped the pace of its tightening cycle, increasing Bank rate by 50bps to 1.75%. Five committee members changed their vote at this week's meeting, swinging the outcome to an 8-1 decision from 6-3 in favour of June's smaller 25bps hike. The move to turn more aggressive on tightening came as the Bank had to once again raise its inflation forecasts, now expected to reach a peak of around 13% in Q4 with the next reset in household energy prices to hit in October, but risks an increasingly severe growth tradeoff with the economy expected to fall into recession by the end of the year.
The latest Monetary Policy Report presented a grim outlook for the UK economy. The overall synopsis is that the intensification of inflation pressures will further squeeze real household incomes and cause a recession. In the post-meeting press conference, Governor Andrew Bailey said the BoE was uncertain of the magnitude of that recession, with estimates for the peak-to-trough decline in output in a range between 1.5% to 2.25%, heavily dependent on the evolution of energy prices. The top of that range would be a recession broadly similar to the early 1990s but less severe than during the GFC. It then forecasts a weak recovery of flat growth in 2024 and just 0.4% in 2025. Concerningly, inflation is now projected to remain elevated for longer. After peaking at 13.3% in Q4, inflation falls to 9.5% by Q3 next year, the figure revised up sharply from 5.9% in the May forecasts. It then takes another year for inflation to return to the Bank's 2% target, in Q3 2024.
In addition to hiking rates, the MPC also outlined its plans for reducing the size of its balance sheet. Back in February, the MPC began the process of quantitative tightening, deciding against reinvesting maturing bonds held in its Asset Purchase Facility (APF). In a market release, the MPC advised that it intends to commence active gilt sales "shortly after" its September meeting if market conditions are deemed "appropriate". The MPC's plan targets an overall reduction of £80bn in the APF's gilt holdings over the coming 12-month period, constituting £10bn of sales each quarter with the remainder coming from maturing bonds rolling off the balance sheet.
Hot US labour market defies recession fears
A stunning labour market report in July saw non-farm payrolls surging by 528k, coming in more than double the consensus estimate of 250k. July's outcome (and net revisions of +28k over May-June) have driven US employment back above its pre-pandemic level, to now stand 32k higher than in February 2020. The unemployment rate is at its lowest level since the pandemic struck, falling from 3.6% to 3.5%, and broader underemployment remained at the historical low of 6.7%. The ongoing imbalance in the US labour market is on the supply side, with the participation rate a touch lower at 62.1% than in June (62.2%) and remaining more than 1ppt lower than pre-pandemic. Wage pressures remain elevated as a result, with growth in average hourly earnings ticking up to a 5.2%Y/Y, whereas markets forecast the pace to ease from 5.1% to 4.9%.