Preview: RBA November meeting

The RBA slowed the pace of its tightening cycle to a 25bps hike in October following four consecutive increases of 50bps between June and September, coming after the initial hike in May (25bps). Although last week's CPI report is likely to prompt the RBA to raise its inflation forecasts in its quarterly Statement on Monetary Policy (due Friday), markets do not expect a reversal of the October pivot and are priced for a 25bps hike to bring the cash rate target to 2.85% and the Exchange Settlement rate to 2.75% (decision due at 2:30PM AEDT). Later on in the evening, Governor Philip Lowe is scheduled to speak (7:20PM AEDT). 

Monetary policy decision

At the September and October meetings, the Board debated hiking by 25 or 50bps with the arguments coming out in favour of the former at the most recent meeting. The same discussion will likely take place today. Markets are priced for 25bps, but after headline and underlying inflation surprised to the topside in Q3, the risk is that the outcome could be 50bps. The RBA continues to state it will calibrate the "size and timing" of rate hikes to the inflation and labour market data. 

Given the expectation is for 25bps, a 50bps hike if it were to eventuate would be seen as a major U-turn from the Board so soon after its October pivot. The RBA would object to that characterisation, but unless there has been a material reassessment of the inflation outlook that requires more frontloaded hikes, then hiking by 50bps today seems problematic to communicate and is ultimately unlikely to make much difference to bringing down inflation if it then slows back to a 25bps hike in December.

The main arguments behind the October downshift: waiting on the lagged transmission from the earlier hikes into the economy and an overarching judgement to move more slowly on hikes given the uncertainty of the global and domestic outlook, all still hold. The other point the RBA has emphasised is that its higher frequency of meetings affords it more flexibility to adjust the pace of hiking relative to other central banks still delivering outsized hikes.

Economic forecasts 

The RBA's updated economic and inflation forecasts won't be published until the monetary policy statement is released on Friday, but they will be tabled to the Board for today's meeting. Governor Lowe will likely provide an overview of the main changes in today's decision statement and in tonight's speech. Upside risks to inflation and downside risks to growth are likely to be the main themes.

Factors that will put pressure on the Australian growth outlook are the deteriorating global backdrop and rising cost-of-living pressures at home. Modest downgrades to the growth outlook in 2022 (3.2%) and 2023 (1.8%) shape as likely outcomes.  For inflation, Q3's outturns for headline CPI at 7.3%Y/Y and 6.1%Y/Y for the trimmed mean (or underlying rate) are likely to see the forecasts for their respective peaks later in the year pushing higher. Accordingly, the peak for headline CPI may be raised to above 8% (from 7¾%) and to around 6.5% trimmed mean (from 6%).   

Summary 

My view is in alignment with market pricing for the cash rate target to be hiked by 25bps to 2.85%, though 50bps is a risk. The key is the degree to which the RBA's inflation outlook has changed since the October meeting following the Q3 CPI data. Although some upward revision here is likely, I see the case for the RBA to continue to hike in 25bps increments. 

Macro (Re)view (28/10) | Upbeat tone continues

An increasing sense of optimism is playing through markets on the idea central banks may be close to paring back their aggressive hiking cycles. The reaction to this week's ECB meeting was upbeat, while the Bank of Canada hiked by 50bps instead of the 75 expected. The Fed is still expected to deliver another 75bps hike next week, but pricing for the terminal rate has been scaled back, with lower bond yields boosting equities (China and HK notable exceptions on country-specific risk factors). Also next week, meetings from the Bank of England and RBA are on the calendar. 

RBA to reassess the inflation outlook; markets still expect a 25bps hike 

Australian inflation printed stronger than expected in the September quarter at 30-year highs ahead of next week's RBA meeting. Although this is likely to cause the RBA to raise its inflation forecasts, markets are confident the Board will not walk back its decision from the October meeting to slow the pace of tightening, with another 25bps rate hike expected. On the inflation numbers, headline CPI was 1.8% in the September quarter elevating the annual pace from 6.1% to 7.3%. while the trimmed mean or core rate also printed at 1.8%q/q to be up at 6.1%Y/Y from 4.9% (reviewed here). 

The key themes that have characterised the rise in Australian inflation remained intact, with disruptions to global supply chains in goods and energy markets stemming from the shocks of the pandemic and Ukraine war the main cause. The floods on the east coast of the nation have contributed to strong rises in grocery prices, particularly for fruit and vegetables. Domestically-generated inflation accelerated in the quarter (up 2%q/q) with reopening factors playing a role as demand rotates back to services such as travel and dining out following the removal of Covid restrictions. Inflation is yet to peak and will rise in Q4 as government rebates on power bills and the federal fuel excise tax cut unwind. This is likely to lift the peak in inflation to above 8% in headline terms and 6.5% on the core rate. 

Given this backdrop, the focus of the federal government was to avoid adding to inflationary pressures in its 2022/23 budget (reviewed here). In effect, this was more of a budget update to reflect the incoming government's policy platform following their win at the May election. After incorporating significant reductions to the budget deficit, now expected at 1.4% of GDP this fiscal year, due to higher revenue from strong economic conditions and elevated commodity prices and new savings measures, the cost of new policy was broadly neutral at 0.1% of GDP out to 2025/26. The government sought to highlight more medium-term issues around spending sustainability given forecasts for an expanding structural deficit, though for the time being the key point for markets is that the fiscal authority is at the least not making the RBA's job to lower inflation harder.   

ECB goes 75bps again and tweaks its guidance  

A second consecutive 75bps hike to the ECB's key interest rates opened the door to a slower pace of tightening from here on as policy moved closer to estimates of neutral. The decision statement noted that the Governing Council "expects to raise interest rates further" but it removed the reference to tightening "over the next several meetings". Post meeting in the press conference, President Christine Lagarde said while there was more work to do to normalise monetary policy, it would now be appropriate to scale the pace of future hikes to: i) the inflation outlook, ii) the amount of tightening already delivered, and iii) having regard to the lags of transmission to the real economy from the earlier hikes. There is of course the overlay of deteriorating economic conditions, as indicated by the deepening contraction in the euro area PMI to a near 2-year low in October, which could end up having the largest say on the level rates are ultimately raised to.         

Aside from hiking rates, the ECB made significant tweaks to their TLTRO III tranche of loans to the banking sector. The intent behind the changes is to get the balance sheet working in closer alignment with the monetary policy tightening cycle by reducing its size through the early repayment of outstanding loans. This has been incentivised by making retroactive changes to the interest rate payable by banks. Special conditions were applied to TLTROs during the pandemic that meant in many cases the interest rate payable was negative, but from 23 November the interest rate will now be calculated at the average of the depo rate over the period until maturity. The depo rate currently stands at 1.5% and is rising sharply amid the ECB's aggressive hiking cycle. Meanwhile, the ECB also announced that minimum reserves banks are required to hold for regulatory purposes will now be remunerated at the depo rate instead of the higher MRO rate (currently 2.0%), effective 21 December.    

US economy remains resilient

Third quarter US GDP growth came in stronger than expected at 0.6%q/q, reversing the decline in output seen through the first half of the year. Swings in net exports and inventories due to disruptions in global supply chains are causing volatility in the headline growth numbers. Beneath the surface, domestic demand is still expanding, though only at a modest pace. Growth in personal consumption lifted by 0.4%q/q driven by the post-pandemic rotation back to services (0.7%q/q) from goods (-0.3%q/q). A strong labour market is continuing to support income and spending, though the saving rate of US households has declined to 3.1%, close to its low for the cycle. High inflation means US household are saving less, though accumulated savings built up over the pandemic are still elevated. Ahead of next week's Fed meeting, inflation on its preferred gauge pushed up from 4.9% to 5.1%yr in September on the core PCE deflator. Wage pressures according to the employment cost index were a touch softer at 1.2%q/q and held the pace at 5% through the year to Q3. Markets sense the Fed is close to pivoting to a slower pace of rate hikes, but a 75bps hike is seen as a near certainty next week.  

Australian Q3 CPI 1.8%, 7.3%Y/Y

Upside surprises in today's Australian Q3 CPI report lifted inflation further above the RBA's target band to 7.3%Y/Y on a headline basis and 6.1%Y/Y on the core rate, both running at 30-year highs. Pressure on household energy bills is now adding to the inflationary impulse that remains driven by new dwelling and grocery prices as well as reopening factors from the lifting of pandemic restrictions. Following its downshift at the October Board meeting, I expect the RBA to continue with rate hikes in 25bps increments. 

Consumer Price Index — Q3 | By the numbers 

• Headline CPI was 1.8% in the September quarter — stronger than the 1.6% rise expected but in line with Q2's outcome — as the annual pace elevated from 6.1% to 7.3% (vs 7.0% expected). Seasonally adjusted CPI also came in at 1.8%q/q and 7.3%Y/Y.  

• The average of the three underlying CPI measures firmed from 1.5% to 1.8% in the quarter to be running at 5.9%Y/Y.  

• Trimmed mean was 1.8% — higher than the 1.5% rise expected and up from 1.6% in Q2  — as the annual rate lifted sharply from 4.9% to 6.1% (vs 5.5% expected).

• Weighted median was 1.4%q/q, in line with the pace in Q2, though the annual rate advanced from 4.3% to 5.0%. 
• CPI excluding 'volatile items' firmed to 2.1% in Q3 (from 1.6% in Q2), lifting the the annual rate to 6.7% from 5.3%). 

Consumer Price Index — Q3 | The details 

Australian inflation outcomes were more elevated than expected in the September quarter, driving the headline CPI (seasonally adjusted) to print with a 7 handle for the first time since the late 1980s and the core rate (trimmed mean) to a new high since 1990. 

In the September quarter, headline CPI increased by 1.8% to match the rise seen in Q2. As in recent quarters, new dwelling costs and grocery prices continued to contribute significantly to inflation. There was some relief to cost of living pressures as fuel prices fell in the quarter (their first decline since the pandemic lockdowns of 2020), reflecting the decline in global oil prices and the federal excise tax cut; however, that was more than offset by rising household energy prices, even with varying various state government rebate schemes coming into effect.  

Inflation remains overwhelmingly driven by goods, accounting for around three-quarters of the annual increase in the CPI. This is lagging trends offshore where goods-driven inflation is rolling over as supply pressure ease. Services inflation in Australia can be expected to rise from here, in part driven by rising rents. 

Upward pressure on new dwelling costs persists with a record number of homes under construction, though Q3's increase (3.7%) was the slowest in a year. Strong demand and supply disruptions are driving up materials and labour costs. Meanwhile, the HomeBuilder grants scheme is still yet to fully unwind, so that process continues to push up new home prices. Given the impact of RBA rate hikes, the unwinding of construction subsidies and the weakening coming through in commencements (down almost 9% over the first half of the year), this should be around the peak for new dwelling costs. 

Prices across the grocery basket have risen at elevated rates over the past year reflecting higher costs for producers for inputs and freight and supply disruptions. Recent floods have accentuated pressure on fruit and vegetable prices (16.2%Y/Y). Bread and cereal prices (10%) are up on the back of the shock from the Ukraine war and its disruption to global wheat supply. Dairy prices have risen at their fastest pace since 2008. 

Reopening factors continue to remain an important driver of the inflationary pulse. The return to unrestricted travel is driving up both international (25.3%Y/Y) and domestic (10.8%Y/Y) travel costs. Strong demand and the end of state government voucher schemes have seen dining-out costs push through 6% on an annual basis. People getting out and about more often has generated pressure on clothing and footwear prices (5.3%Y/Y), albeit discounting led to a slight fall in Q3 (-0.2%). 

Household utilities posted their strongest quarterly rise in 5 years (4.8%) on the back of rises in gas (10.9%) and electricity prices (3.2%). Disruptions in global energy supply stemming from the war in Ukraine have pushed up production costs for domestic wholesalers; however, the flow-through to power bills is yet to fully impact because state government rebates were initiated. The ABS estimates that utilities costs would have risen by almost 12% in the quarter in the absence of the rebates.  

Consumer Price Index — Q3 | Insights 

Today's inflation outcomes present the likely scenario of the RBA revising up its inflation forecasts in the November quarterly monetary policy statement, due next week following the Board meeting. Having made the decision to downshift to a 25bps hike in October following a string of 50bps hikes, my sense is that the Board is unlikely to turn back to frontloading. Increasingly, the Board and RBA officials have been referencing the lags associated with monetary policy transmission — its tightening cycle has lifted the cash rate by 250bps since April — and the risks building to the economic outlook from offshore. They have also been emphasising the higher frequency of RBA meetings relative to its central bank peers hiking more aggressively. Key also is that wage pressures are assessed as "not inconsistent" with the inflation target in a very strong Australian labour market. While today's report could have implications for the terminal rate and the duration of the hiking cycle, I think the RBA will continue with rate hikes of 25bps.   

Preview: Australian Q3 CPI

Australian inflation is expected to print with a 7 handle in today's Q3 CPI data, due at 11:30am AEDT, marking a new high since 1990. The RBA's rate hiking cycle commenced in May with the cash rate rising by 250bps so far. At the October meeting, the RBA downshifted to a 25bps hike after four consecutive 50bps increases, coming ahead of the expected peak in inflation in the December quarter.   

As it stands | CPI 

Inflation rose further above the RBA's 2-3% target band in the June quarter. The headline CPI was 1.8% in the quarter, lifting the annual pace from 5.1% to 6.1%; the trimmed mean or core rate advanced by 1.5%q/q to 4.9%Y/Y (from 3.7%). 

The rise in Australian inflation has been predominantly driven by global factors stemming from the disruptions to global supply chains caused by the pandemic and the war in Ukraine. The nation's strong economic recovery from the pandemic has also contributed to rising inflation. Reflecting this, rising goods prices have contributed strongly to Australian inflation with only a modest contribution coming from services.

The main contributors to the rise in inflation have been new dwelling costs, fuel and more recently from higher grocery prices. Beyond these effects, price pressures have gradually broadened out across the CPI basket driving the uplift in core inflation.  

Market expectations | CPI

Headline CPI is expected to print at 1.6% in the quarter between a wide range of forecasts from 1.1% at the low end to 2.0% on the top side. Annual inflation is forecast to come in at 7%, its highest since 1990. With price pressures broadening, core inflation is set to rise further. The median forecast for the trimmed mean rate is 1.5%q/q and 5.5%Y/Y.         

What to watch | CPI 

There is expected to be a slight easing in headline inflation in Q3 to 1.6% from 1.8% in Q2. Beneath the surface, the major drivers of inflation are likely to be food and new dwelling costs. Food prices remain on the rise due to a combination of supply pressures and higher input and freight costs. New dwelling costs are set to add further to inflation on the back of sharply rising materials and labour costs and as government subsidies continue to unwind. The easing will be driven by electricity and fuel prices. Although wholesale energy prices surged in the quarter, electricity prices are expected to fall because state governments responded with varying rebate schemes to support households. Meanwhile, fuel prices fell sharply in the quarter reflecting declining crude oil prices and the effects of the federal government's excise tax cut. Looking ahead, Australian inflation is set to rise further next quarter (the RBA forecasts the peak at 7¾ per cent) as the electricity rebates and fuel excise tax cut come off. 

Australian Federal Budget 2022/23: Steady as it goes

The Australian Federal Budget 2022/23 reports an improved fiscal position on the back of the nation's strong economic recovery from the pandemic and surge in the terms of trade. New spending measures are modest with the government focusing its fiscal strategy on avoiding adding to inflationary pressures in the near term. 

Federal Budget 2022/23 | Budget Position

The budget deficit for 2022/23 is forecast to come in at $36.9bn (1.5% of GDP), a sharp improvement on the deficit of $78bn anticipated in the Pre Election statement (PEFO) published back in April. This improvement largely flows from a much smaller deficit in 2021/22 ($32bn) than was earlier expected ($79.8bn) because the Australian economy outperformed key forecasts and elevated commodity prices drove the terms of trade to a record high level.  

A smaller deficit is also forecast for 2023/24 at $44bn (from $56.5bn in April); however, the budget position is then anticipated to deteriorate with larger deficits seen in 2024/25 ($51.3bn) and 2025/26 ($49.6bn). The government anticipates the deficit to widen due to rising cost pressures in some of its major programs, including aged care and the National Disability Insurance Scheme.  

Overall, the budget deficit for the 4 years to 2025/26 is projected to be $181.8bn, almost $43bn narrower than was forecast in the PEFO statement.    

Federal Budget 2022/23 | Policy Measures

The government notes its fiscal strategy is to avoid adding to inflation pressures while at the same time starting the process of lowering the deficit. Over the 4 years to 2025/26, forecast net revenue has received a boost of $52.5bn; this budget injects only a net $9.8bn of new spending into the economy over the period. There has been a focus by the government to redirect spending commitments made by the previous government as well as bolstering tax avoidance measures, together finding some $28.5bn over the forward estimates.   

New policy measures in this budget are largely those the government took to the May election. The signature policy is "Cheaper Child Care" at a 4-year cost of $4.7bn. Cost of living support is narrow coming via expansions to the Pharmaceutical Benefits Scheme, lowering the cost of medicines (4-year cost $1.4bn). The paid parental leave scheme will be gradually scaled up to cost the budget an additional $0.5bn by 2025/26. The government is committing $0.35bn towards a new Housing Accord that targets 1 million affordable homes to be built over a 5-year period from 2024.  

Federal Budget 2022/23 | Payments and Receipts

As a share of GDP, government payments are forecast to lower to 25.9% from 26.8% in 2021/22 reflecting the strength of the domestic economy, reducing welfare payments. However, payments are then expected to rise to 27% of GDP in 2023/24 as the economy slows and hold close to that level in the following two years.    

Government receipts hit their high point in 2021/22 at 25.4% of GDP as the economy recovered and commodity prices surged. They are expected to ease back to 24.5% of GDP in 2022/23 before rebounding to 25.3% of GDP in 2023/24. In the 2024/25 and 2025/26 years, receipts are around 2ppts lower than payments in each financial year, highlighting the structural pressures on the horizon.

Alongside the strong economic recovery from the pandemic, government net debt fell from 28.6% of GDP in 2020/21 to 22.5% in 2021/22, before lifting modestly to 23% in 2022/23. Reflecting the spending pressures on the budget, the trajectory for government net debt rises to 28.5% of GDP in 2025/26. 

Federal Budget 2022/23 | Economic Outlook

The domestic economic outlook forecast by Treasury is set against a deteriorating global backdrop due to intensifying headwinds from high inflation and supply disruptions impacting energy markets. The outlook for global GDP growth has been downgraded materially, slowing to 2.75% next year from 3.75% expected back in March, with notably weaker outlooks in the US, UK and euro area. 

In Australia, GDP growth was downgraded modestly in 2022/23 to 3.25% ahead of a slowdown to 1.5% in 2023/24, a pace well below trend. The main factor is a weakening in household consumption growth (from 6.5% to 1.25%) reflecting a sustained period of falling real incomes and monetary policy tightening with the RBA's hiking cycle expected to top out at 3.35% on the cash rate. Growth below trend sees the forecast for the unemployment rate rise to 4.5% in 2023/24 (up from 3.75%), leading to inflation pressures coming off as the CPI eases to 3.5% and wages growth stabilises at 3.75%. Inflation is then forecast to return to the middle of the RBA's target band the following year.   

Macro (Re)view (21/10) | UK reset supports sentiment

A reset in UK politics following the resignation of PM Truss and the rescinding of "The Growth Plan" mini-budget led to a retracement in gilt yields, giving broad support to sentiment. European equities advanced while the US was boosted by solid earnings results, though Asian markets underperformed. The upbeat dynamics saw the US dollar weaken as the news came through of more intention by Japan to defend the yen. 

RBA elaborates on its downshift 

A nuanced assessment of conditions and uncertainty over the economic outlook prompted the RBA to downshift the pace of its hiking cycle to a 25bps increase earlier this month following four consecutive 50bps moves. The October meeting minutes outlined the debate the Board had around hiking by 25 or 50bps, with the analysis ultimately supporting the former. Key factors were downside risks posed to domestic economic growth with the earlier rate hikes yet to have their full impact on conditions; wages growth running at a pace not "inconsistent" with the inflation target; a deteriorating global economic outlook; and an overarching judgement that a slower pace of tightening was appropriate given the uncertainty of the outlook. 

The Board was cognizant that its decision to downshift would make it an outlier amongst its central bank peers still in the process of frontloading rate hikes, coming at risk of making it harder to return inflation to target if there was a dovish reaction in markets and inflation expectations moved higher. The RBA countered those risks by noting it met more frequently than other central banks, allowing for more flexibility in its tightening cycle. That was a point emphasised by the RBA's Michelle Bullock in a speech this week, where the deputy governor noted the pace of the bank's tightening cycle had matched or exceeded that seen in other comparable economies.

The key inputs for the RBA remain the labour market and inflation. September's labour force survey reported a broadly unchanged analysis on conditions from the prior month, with the unemployment rate holding at 3.5% on a minimal rise in employment (0.9k) and steady participation (66.6%) (reviewed in full here). The report was consistent with the RBA's downshift with the labour market remaining robust but looking to be tracking toward a consolidatory phase post pandemic. Next week will see the treasurer presenting the federal budget (25/10) followed by the inflation data for Q3 (26/10). 

Bank of England puts QT back on the radar

As the Bank of England's interventions into the gilt market came to an end, the central bank put quantitative tightening (QT) back on its radar. The BoE now says it plans to commence active sales of its gilt holdings on 1 November after the planned September start date was derailed by market dysfunction that ensued after the announcement of the Truss government's mini-budget. 

With fiscal support now greatly rolled back, the BoE will have to assess the implications for monetary policy from an inflation outlook now likely to be higher in the medium term and with weaker growth dynamics. A speech by the BoE's Ben Broadbent cast doubt over the scale of tightening priced into rates markets where the terminal rate sits above 5%. Meanwhile, inflation has continued to rise, with headline CPI moving back up to 10.1%yr in September (from 9.9%) and the core rate resetting to a new 30-year high at 6.5%yr (from 6.3%). 

ECB set to hike rates by 75bps again 

Indications in the lead-up to next week's ECB meeting point to another 75bps rate hike being announced by the Governing Council after the increases in July (50bps) and September (75bps). The hawkish stance remains firmly intact as euro area inflation in September was confirmed to be running at 9.9%yr on a headline basis with the core rate at 4.8%yr. In addition to rates, recent media reports mean the ECB's thinking on QT and its TLTRO programs is set to come under the spotlight in the post-meeting press conference. 

The reporting has suggested that the plans being drawn up for QT centre on the phasing out of APP program reinvestments from Q2 next year. Meanwhile, the ECB appears keen to reduce excess liquidity in markets by prompting banks into the earlier repayment of their TLTRO loans. According to the reports, options for achieving this include retroactive changes to the program terms or by adjusting the tiering multiplier, in effect lowering the remuneration paid by the ECB on banks' TLTRO balances. 

Fed's Beige Book reported signs of weakening demand and easing prices  

US economic conditions were broadly described to have "expanded modestly" in the latest Fed Beige Book amid signs that rising interest rates were starting to take effect. High inflation remains a headwind, though there had been some easing in price pressures on the back of falling fuel and freight costs, while pricing power among firms was starting to become more bifurcated as customers in some industries were now pushing back on price rises. The impact of rate hikes were assessed to be weighing on the housing market and discretionary spending more broadly, though supply chain disruptions were also a factor, notably affecting new vehicle sales. Some cooling in labour demand was reported by firms due to concerns over a weakening economic outlook, though the labour market was still tight and was pushing up wage costs.

Australian employment 0.9k in September; unemployment rate 3.5%

Conditions in the Australian labour market remain largely unchanged with the key indicators steady in September. Employment and hours worked consolidated over Q3, partly impacted by Covid-related and seasonal factors. The labour market looks to be settling following the pandemic, though labour demand is still robust and should support employment growth. Given its focus on the labour market data, today's report looks broadly consistent with the RBA's decision to downshift the pace of its rate hiking cycle. 

Labour Force Survey — September | By the numbers

• Employment posted a minor increase of 0.9k in September, well below the consensus forecast (25k). Upward revisions lifted employment in August to 36.3k from 33.5k. 

• The unemployment rate remained unchanged at 3.5%, in line with expectations. Underemployment was steady at 6%, though total underutilisation increased to 9.6%. 
• The participation rate held at 66.6%, remaining around record highs.    

• Hours worked were flat in September and only 0.2% higher over Q3. Covid-related absences and seasonal volatility have disrupted activity in the labour market in recent months.  

Labour Force Survey — September | The details

There was little change to the labour market in September as many of the headline indicators were unchanged from August. Employment increased by only a net 0.9k, with a 13.3k gain in full-time employment largely offset by a 12.4k fall in part-time employment. 

Hours worked were unchanged over the month as Covid-related absences fell from their highs but annual leave saw an increase. For Q3 overall, hours worked lifted only by 0.2% to be 4.5% higher than their pre-pandemic level from March 2020. 

After causing significant disruption through autumn and winter, the effect of Covid-related absences eased in September. Around 570k Australians reported working fewer hours than usual in the month due to illness, still an elevated number but well down from an average of around 760k over the previous 5 months. This supported a decline in absences for caregiving reasons, to 316k from more than 350k in August. Although Covid-related disruptions eased, there was a noticeable rise in annual leave of nearly 320k people compared to August. This was a return to more normal levels of annual leave in September compared to 2020 and 2021 which were impacted by lockdowns.

 

The size of the labour force increased by a modest 9.8k in September, leaving the participation rate steady around record highs (66.6%). With employment rising by only 0.9k that meant unemployment rose by 8.8k. When rounded to one decimal place, the unemployment rate held at 3.5%, in line with the lows last seen in 1974. Given hours worked were flat, there was no change in the broader underemployment rate (6%). Underutilsiation was a touch higher in the month at 9.6% but remains at 40-year lows. 

Labour Force Survey — September | Insights

The labour market looks to be moving toward a phase of consolidation following the recovery from the pandemic and as its associated disruptions dissipate. Employment on a 3-month rolling average in Q3 was just 0.2k, down from 39.3k in Q2; however, my interpretation is that the extent of the slowdown has been accentuated by seasonal and Covid-related volatility. The elevated stock of vacancies indicates labour demand remains strong, though the pace of hiring has clearly slowed as the labour market has tightened. Those vacancies will help keep a hold on the unemployment rate as growth in the working-age population (currently 1.2%Y/Y) returns to a more normal pre-pandemic pace in response to the reopening of the borders. Given wage pressures in Australia have remained relatively contained compared to many other advanced economies, today's report on the labour market supports the downshift made by the RBA to a 25bps rate hike earlier in the month after four consecutive 50bps increases to the cash rate. 

Preview: Labour Force Survey — September

The ABS is scheduled to publish Australia's Labour Force Survey for September at 11:30am (AEDT) today. Employment is expected to advance by 25k in the month and hold the unemployment rate at 3.5%, in line with the lows last seen in the 1970s. Hours worked are rising broadly in line with the increase in employment, though with significant disruptions from Covid-related absences.     

As it stands | Labour Force Survey

Employment increased by 33.5k in August (vs 35k expected), broadly reversing a 40.9k decline in July. The result was driven by full-time employment (58.8k) as employment in the part-time segment fell (-25.3k). At just under 13.6 million, total employment stands at 4.5% above its pre-Covid level. 

The strong post-Covid recovery in employment has driven Australia's unemployment rate down to 50-year lows and the participation rate to record highs. In the month of August, there was a slight uptick in the unemployment rate from 3.4% to 3.5% as an increase in labour force participation exceeded the rise in employment. The participation rate now stands at 66.6%, up 0.2ppt over the month. Underemployment is down at 5.9%, its lowest since 2008, while total underutilisation is at a 40-year low of 9.4%.  

Hours worked across the Covid period are up 4.8% since March 2020, close to the expansion in employment (4.5%). A combination of Covid-related absences and school holiday periods weighed on hours worked over June-July but August saw a rebound of 0.8%m/m. 

Market expectations | Labour Force Survey

The median estimate for employment is for a rise of 25k between a range of forecasts from 13.5k to 45k. The ABS's payrolls series suggests employment conditions have remained solid with the index fairly flat over the month to mid-September. The unemployment rate is expected to hold at 3.5% (range: 3.4% to 3.6%).  

What to watch | Labour Force Survey

Headline employment is the figure to watch in today's report. The 3-month average is currently running at 22.5k, though that includes July's fall which was associated with seasonal volatility. With the post-Covid recovery broadening out, the pace of hiring has moderated over the course of the year; employment averaged 61.2k per month in Q1 and then eased to 37.7k in Q2. The levels of job advertisements and vacancies have come off their highs but remain very elevated. Overall, employment looks to be settling to a more sustainable pace but still above the flow of entrants into the labour force and therefore consistent with maintaining downward pressure on the unemployment rate.  

Macro (Re)view (14/10) | Tide yet to turn on US inflation

Another volatile week for markets with bonds again at the epicentre of the moves. A stronger-than-expected print on US inflation has prompted yet another reassessment of the path for Fed rate hikes. In the UK, the end of the Bank of England's temporary interventions in the gilt market came to a head with PM Truss securing the resignation of Chancellor of the Exchequer Kwarteng as the government looks for a reset following its mini-Budget.   

Global growth outlook downgraded 

In its October World Economic Outlook, the IMF left its forecast for global growth in 2022 unchanged at 3.2% but cut its 2023 forecast to 2.7%; the downward revisions to the latter now exceed 1ppt since the April report reflecting the headwinds from the squeeze on real incomes from high inflation, the war in Ukraine and slowing growth in China due to lockdowns. The group now expects global inflation to reach a new peak of 9.5% before declining in 2023 to 4.7%. While prescribing central banks to stay the course in tackling inflation, the IMF in its Global Financial Stability Report warned of the fragility of the situation, highlighting that financial conditions could tighten in a disorderly manner posing further risks to the economic outlook.  

US inflation again surprises to the upside...

September's US CPI data came in stronger than expected and was driven by the core components of the index, highlighting the broad-based nature of price pressures. Headline CPI lifted 0.4%m/m (vs 0.2% expected) easing the annual pace from 8.3% to 8.2% (vs 8.1%), while the core rate was up 0.6%m/m (vs 0.2%) elevating the year-on-year pace from 6.3% to 6.6% (vs 6.5%), a new cycle high. This was the 8th occasion in the past 12 months that annual core CPI has surprised on the upside of expectations. 

Over Q3, the headline inflation rate fell by almost 1ppt from its peak of 9.1% in June, mainly reflecting declines in gasoline prices and an easing in goods inflation. However, the core rate has picked up over the period, from 5.9% to 6.6%, on the back of rising services inflation. This has come about as spending patterns have adjusted to the wider reopening of the economy after the pandemic, and from the lagged effect on rents from a very strong housing market. Going forward, goods inflation is likely to slow further because upstream price pressures faced by producers have eased, delays hampering supply chains are shortening and wholesalers are continuing to build up inventories. On the services side, leading indicators show rents are now retracing their upsurge, but this will take some time to flow into the CPI data. On the other hand, wage pressures in a tight labour market present a risk that services prices could prove to be difficult to slow. 

... leaving the Fed to keep hiking rates 

With high inflation persisting, this only adds weight to the central message in the FOMC's September meeting minutes: the policy pivot will not be forthcoming until rates have been hiked to a level seen by the Committee as sufficiently restrictive. The dot plot implies this is around 4.5%, still well above the current setting (3-3.25%) with a 75bps hike expected at the next meeting, though there could be some upside risk to this given that market pricing for the terminal rate is now pressing 5% off the back of the CPI report. The mindset of the Committee was made clear by the view that "a period of below-trend real GDP growth" and a softer labour market are required to turn the tide on inflation and that "...the cost of taking too little action to bring down inflation likely outweighed the cost of taking too much action". 

Pessimistic Australian consumer sentiment continues

Australian consumer sentiment fell deeper into pessimistic territory, slipping a further 0.9% to an 83.7 reading on the Westpac-Melbourne Institute Index in October, well below the neutral line of 100. High inflation and the RBA's rate hiking cycle continue to weigh on sentiment. However, the RBA's downshift to a 25bps rate hike earlier this month generated an immediate lift in sentiment of almost 15% compared with responses taken prior to the October Board meeting. 

In contrast, business confidence continues to hold up around its long-run average, printing at +5 in the NAB Business Survey for September. Business confidence is being underpinned by robust trading conditions (+25), which are at their strongest since early 2021. Confidence may have been buoyed by an easing in price pressures with labour and purchase costs moderating in the month. 

Over at the RBA, Assistant Governor Luci Ellis gave a detailed overview of how the Bank has approached the task of estimating the neutral rate and how it arrived at the conclusion that the neutral setting (in nominal terms) for the cash rate is "at least 2½ per cent". However, the main point Ellis made was that the neutral rate should serve as a guide to informing how monetary policy may be contributing to the prevailing economic conditions rather than dictating the appropriate level of interest rates.

ECB considering a 2023 start to QT

According to ECB sources quoted by Reuters, policymakers are doing more of the groundwork in preparation for running down its bond holdings. The article reported the plans being discussed relate to holdings in the APP program, with the reinvestment of maturing bonds speculated to start being phased out in Q2 2023. Another Reuters article reported the ECB was considering making retroactive changes to its TLTROs, under which the ECB provided cheap loans to banks. Pressure is mounting because with the ECB hiking rates, the remuneration the ECB is paying on banks' excess liquidity (partly acquired through TLTROs) is increasingly widening over the interest cost of the TLTROs, which some officials see as working against the objective of tightening monetary policy.