Markets continued to adjust to the key message from last week's Jackson Hole symposium: that higher rates for longer are likely to be needed to return inflation to target. Accordingly, next week is likely to see the ECB and BoC each hiking rates by 75bps and the RBA by another 50bps on Tuesday. A well-rounded non-farm payrolls report out of the US has given markets optimism that some of the supply constraints in the labour market are easing, which is key to reducing wage-price pressures.
US labour market remains strong and participation lifted
August's non-farm payrolls report was well received by markets with the key takeaway being that labour market imbalances showed signs of easing. Employment on non-farm payrolls lifted by 315k in the month, slightly stronger than expected (298k) while net revisions lowered payrolls over June and July by 107k. The US economy continues to generate a strong pace of employment growth, and a rise of around 200k in job openings in July to 11.2 million indicates labour demand is likely to remain robust for some time.
While the unemployment rate unexpectedly ticked up from 3.5% to 3.7% (vs 3.5% expected), this was mainly driven by a rise in labour force participation, lifting from 62.1% to 62.4%. The pandemic led to a lot of early retirements in the US and so it is more instructive to look at prime age participation (25-54yrs): this jumped from 82.4% to 82.8%, its highest level since February 2020. Increased labour supply helped to keep wage pressures from pushing higher as growth in average hourly earnings held steady at 5.2%yr.
On the back of CPI inflation flatlining on a month-on-month basis in July, the detail in August's labour market report potentially makes the Fed's decision to hike rates later this month a close call between 50bps and 75bps. However, the resolve of the Fed to lower inflation was made clear last week at Jackson Hole and the ultimate destination for rates likely remains unchanged. Cleveland Fed President Mester this week said a raise and hold strategy in the fed funds rate to "somewhat above" 4% by early next year was needed to return inflation to target.
Supply constraints weighed on the Australian economy in Q2...
Updates were received on construction activity and business investment for Q2 ahead of next week's June quarter national accounts. Notwithstanding, real GDP is expected to have increased strongly by 1.2% in the quarter supported by household demand that has remained resilient to high inflation, falling real incomes and rate hikes (preview available here). Further signs of that resilience came through in July retail sales, up by a stronger-than-expected 1.3% in the month.
Construction work done contracted by a sharp 3.8% in the June quarter as capacity constraints associated with materials and labour shortages held back activity (reviewed here). These pressures have been acute in the residential sector, causing the volume of work done in the quarter to decline significantly by almost 7%. A very substantial residential pipeline, including more than 100k homes under construction, is contributing to supply constraints and timeframes are being pushed out as a result. Approvals for detached homes continue to hold up, however, and are at levels similar to pre-pandemic peaks, rising by 1%m/m in July. The preference shift away from higher-density living and a desire for more space — themes that emerged during the pandemic — continues to play out. Unit approvals fell to their lowest monthly level in more than a decade, driving a 17.2% fall in headline dwelling approvals in July (reviewed here).
Private sector capital expenditure declined by 0.3%q/q, defying expectations for a 1% rise (reviewed here). Although business investment on equipment and machinery saw a solid rise (2.1%q/q) this was offset by weakness in buildings and structures (-2.5%q/q), the latter reflecting construction capacity pressures. Capex stalled over the first half of the year and will need to regain momentum if supply constraints are to be resolved. Forward-looking investment plans for 2022/23 were upbeat in that respect as estimate 3 came in at $146.4bn, an 11.7% upgrade on estimate 2 put forward by firms 3 months ago.
... and housing market conditions continue to cool
Activity in the housing market is slowing as the effects of affordability concerns and the RBA's rate hiking cycle are starting to take hold. An 8.5% fall in housing finance commitments in July (reviewed here), its sharpest decline since the start of the pandemic, and the acceleration in housing price declines to 1.6%m/m nationally in August according to CoreLogic are clear indicators of softening demand. As is a slowing pace of credit growth, with July's aggregate for housing credit seeing its slowest month-on-month rise (0.5%) since early 2021.
Euro area inflation rises through 9%; ECB set to hike rates by 75bps
August's preliminary estimates reported headline inflation in the euro area lifted from 8.9% to 9.1%yr, and the core rate pushed up to 4.3%yr from 4%; both outturns were stronger than expected and at record highs since the inception of the single currency. These outcomes added weight to the calls from hawkish end of the ECB's Governing Council for a 75bps rate hike to be on the table at next week's meeting, which is now the consensus view in markets.
ECB Executive Board member Isabel Schnabel delivered a key speech at the Jackson Hole symposium arguing the case for the Governing Council to act forcefully in response to high inflation, despite risking weaker growth and higher unemployment. Schnabel outlined a more frontloaded approach to tightening was appropriate to avoid the risk of high inflation becoming more persistent, as well as to shore up the ECB's credibility with respect to its inflation mandate and in recognition that a slower approach now risked requiring tighter monetary policy for longer down the track.
Although not precluding a 75bps rate hike next week, a speech from ECB Chief Economist Philip Lane had a more cautious tone. Lane said the ECB was taking a "meeting-by-meeting" approach, continually reassessing the gap between the current policy rate and the expected terminal rate needed to be reached to lower inflation to target. Lane argued that gap should be closed at a "steady pace" through a "mutli-step calibrated series" of hikes rather than "a smaller number of larger rate increses". Uncertainty around the transmission of policy tightening on financing conditions and the flexibility to make "mid-course corrections" were key factors for Lane's thesis.