Price action following the latest US CPI report indicated markets have come to the view that the turning point is in with inflation now past its peak. Risk assets surged as terminal rate pricing in the Fed's policy rate pulled back below 5% and expectations firmed up for a slower pace of hikes starting in December. Substantive progress toward the reopening in China was another factor that boosted sentiment. Amid these developments, the US dollar fell very sharply by around 4% over the week.
US CPI still high but takes a turn for the better
The first downside surprise in US inflation since April has put a downshift in the pace of Fed rate hikes firmly on the table. Indications from the Fed's policy meeting last week were that the FOMC was leaning towards a 50bps hike in December following four consecutive 75bps increases, and October's CPI data has only firmed up that view. Although there is another CPI report due before the December meeting, it's probably not pivotal to the decision as the FOMC should be able to detect enough signals that the inflationary pulse is slowing.
Headline CPI was 0.4%m/m in October, lowering the annual pace from 8.2% to 7.7% - its slowest since January. The core rate printed at 0.3%m/m and eased to 6.3%yr from 6.6% in September. Taking a 3-month average, headline CPI has slowed to 0.3% - down sharply since the middle of the year as gasoline prices have fallen - while the core rate is running around 0.5%, which is still elevated but the trajectory has softened.
From a compositional standpoint, services prices remain the main driver of inflation, mostly due to rising rents. Goods prices are now weighing on the inflation rate. During the pandemic, rising goods prices were the main reason inflation surged as consumption rotated away from services, leading to strong demand at a time when supply chains were severely hampered. Lower input prices, eased supply chain disruptions and weaker demand are now working to see goods-related inflation unwinding, which has further to play out. Services inflation is still rising driven by factors such as the earlier strength in the housing market, reopening effects pushing up prices for airfares, hotels and dining out, and businesses passing through higher prices they have faced, including for labour costs.
Australian consumer sentiment falls further...
A 6.8% plunge in November saw Australian consumer sentiment tracked by the Westpac-Melbourne Institute index fall to a new low for the cycle, broadly in line with its level at the outset of the pandemic. The renewed weakness appeared to be driven by a negative reaction to the recent federal budget, which kept new spending to a minimum to avoid adding to inflation pressures but left households without the sort of cost-of-living assistance they may have been expecting. The underlying details in the report showed consumers see the economic outlook developing in a similar fashion to the RBA and other forecasters, with a growth slowdown anticipated due to an expectation for further rate hikes and high inflation likely to pressure their finances. That has seen some of the optimism towards the labour market fade, though they remain broadly upbeat about that situation. Sentiment on the housing market became more negative in terms of the outlook for buying intentions and housing prices.
... and businesses are less confident in the outlook
For businesses, the latest NAB survey reported ongoing strength in conditions (+22) but seemingly with concern over the outlook as the confidence indicator weakened to a zero reading. There is broad-based strength in conditions with the trading, employment and profitability components all remaining elevated while forward orders are robust despite softening in the month. Inflation pressures held fairly steady at historically high rates. Confidence has slipped below average in response to a weakening global economic outlook and in the knowledge that RBA rate hikes will slow domestic demand. On the RBA, a speech from Deputy Governor Bullock reiterated that its more cautious path of tightening has come in response to the high level of uncertainty around the economic outlook and with rates having already risen significantly since May.
UK economy contracts in Q3...
The UK economy posted a 0.2% contraction in real GDP in the third quarter, which while affected by the additional bank holiday for Her Majesty's state funeral likely portends the start of the recession the Bank of England has been warning about. GDP fell just short of returning to its pre-pandemic level following the recovery and is now rolling over again. In Q3, the driving factor behind the contraction in growth was a 0.5% decline in household consumption, a clear sign that cost-of-living pressures are hitting demand. The ONS reported that consumer prices based on the household consumption deflator increased by 2.3% in Q3 and by 9.1% over the past year. A large contributor to high inflation in the UK has been the surge in the price of imports (21.2%Y/Y), most notably for goods and energy.
... as the outlook in Europe deteriorates
The European Commission published its Autumn economic forecasts in which it cut the growth outlook and revised its inflation projections higher. Faced with an energy crisis and a real income shock, the Commission expects the euro area economy to fall into recession by the end of the year, with growth of just 0.3% now expected in 2023, down from 1.5% previously. A rebound is anticipated to generate a 1.5% rise in GDP in 2024. The timing for the peak in inflation has been pushed out to the end of 2022, lifting to 8.5% at that stage. Inflation is expected to remain elevated at 6.1% next year and is only anticipated to be within sight of the ECB's target by the end of 2024 after slowing to 2.6%. On the ECB, the central bank this week took steps to support market functioning around the year-end period by raising its limit for securities lending against cash put up as collateral from €150bn to €250bn.