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.
