An above consensus outcome on core inflation in the US drove an aggressive reaction in markets as expectations for more Fed tightening saw equities decline and the dollar rising. Yields at the front end in the US lifted sharply, leaving the 2-year yield at its highest since 2007. Next week, both the Fed and BoE have policy meetings.
More work in front of the RBA
At this week's appearance before the parliamentary Standing Committee on Economics, RBA Governor Philip Lowe reaffirmed the commitment to bring inflation back to the 2-3% target band while aiming to keep the economy "on an even keel". Governor Lowe said that with the cash rate now close to estimates of the neutral range, the Board has more optionality and will discuss whether to hike rates by 25 or 50bps at the October meeting. Further rate hikes are on the table with the RBA intent on ensuring high inflation does not become entrenched through the wage-setting process. Although there is little sign of that at the moment, Governor Lowe said the RBA would need to remain alert given the strength of the labour market.
After a temporary slowdown around the middle of the year, activity in the labour market rebounded in August leading to rises in employment (33.5k), participation (66.6%) and hours worked (0.8%). Increased participation saw the unemployment rate ticking up slightly, though at 3.5% it remains at lows going back to 1974. Underemployment (5.9%) and overall underutilisation (9.4%) also stand at historical lows. For my full review of the August Labour Force Survey see here.
Consumer and business survey data was also in focus domestically this week. According to the Westpac-Melbourne Institute index, consumer sentiment saw its first rise in 10 months after lifting 3.9% in September but remains deeply pessimistic at an 84.4 reading. Despite this, household spending has been robust, highlighted in last week's national accounts. The backdrop of strong demand fed into an upbeat NAB Business Survey with confidence and conditions rising further above their long-run average levels in August.
Core inflation rises in the US
Although headline inflation in the US has come off its highs, a pick-up in the underlying pace saw expectations for the Fed's tightening cycle repriced higher, including speculation of a 100bps hike at next week's FOMC meeting (75bps expected). Inflation pressures had eased in July and although headline inflation was again subdued at 0.1% month-on-month and the annual pace slowed from 8.5% to 8.3%, the core rate went the other way rising by 0.6%m/m to 6.3%yr (from 5.9%).
Headline inflation has been held down over the past couple of months mainly by falling gasoline prices, which were off 10.6% in August following a 7.7% decline in July. Beneath the surface, a key dynamic continues to play out with the contribution to inflation from services components remaining on the rise. As inflation started to accelerate in 2021, goods were the main driver due to strong demand associated with the pandemic colliding with constrained supply chains. With those effects now unwinding, stickier services categories are taking over in driving inflation. Shelter and rent costs are up sharply over the year (6.3%) and that has played a major part in elevated core inflation.
Close call next week for the Bank of England
Next week's BoE meeting shapes as a closely run thing with the MPC set to weigh up hiking Bank rate by 50 or 75bps. Inflation and labour market data released this week were stronger than expected on the key details and suggests the MPC could opt for 75bps, though a very weak retail sales report (-1.6%m/m in August) is a sign of the pressure households are under and could therefore argue for 50bps. Adding to the complexity is that the government has said there will be a 'fiscal event' the day after the meeting where it will unveil more of the details on the 2-year energy bill price freeze and other support measures.
Headline CPI inflation on a 12-month basis softened a touch from 10.1% to 9.9% in August (vs 10.0% expected). However, the core rate showed its fastest month-on-month rise (0.8%) since March, firming the 12-month pace from 6.2% to 6.3% (vs 6.2%). Signs of broadening price pressures across the CPI basket come as an unwelcome development, particularly as average weekly earnings growth exceeded expectations at 5.5%yr in July.
Rising wages reflect a tightening labour market in the UK where the unemployment rate fell to 3.6%, its lowest in 48 years. That has been driven by strong demand for labour - the most timely gauge of employment reported a 71k increase in August (vs 60k) - but also by a constrained supply of workers due to the pandemic. The inactivity rate lifted to its highest since 2016 (21.7%), driven largely by a significant rise in the number of people away from work due to long-term illness over the Covid period, now standing at 352k.
