A week of recalibration in markets as central banks in the US, UK, Australia and others further afield gave their latest insights on the path ahead for their respective tightening cycles. The overall message has been to deemphasize the pace of hikes as the focus turns to the end destination for the level of interest rates. That destination is likely to be higher than previously expected in the US but lower in the UK. In response, US equities were under pressure as yields at the front end of the curve marched higher.
Fed looks to change gears...
The Federal Reserve's FOMC hiked by another 75bps this week elevating the policy rate target in the US to 3.75-4%. The Committee's decision statement opened the door to a slower pace of hikes, citing the accumulation of tightening and the lags in monetary policy transmission, but in the post-meeting press conference Chair Jerome Powell said it was now likely rates would need to be raised to a higher level to lower inflation to the 2% target. Whereas the hiking cycle has so far largely been focused on finding the appropriate speed to raise rates, Chair Powell said the FOMC's focus was now turning to the ultimate level rates need to get to and for how long rates will need to remain in a "sufficiently restrictive" zone. The FOMC's economic projections from September pointed to a terminal rate in the 4.5-4.75% range; market pricing post this week's meeting indicates the peak is expected to be around 5%. All in all, a step down to a 50bps hike looks likely at the December meeting. Although the October CPI data is a key event next week, Chair Powell said a step down wasn't contingent on a softer inflation outcome in that report.
... as the US labour market remains solid
Employment on nonfarm payrolls came in at 261k in October, beating expectations for 193k and revisions boosted the prior two months by a net 29k. The labour market only recently recovered to pre-pandemic levels of employment in August. There was a rise in the unemployment rate from 3.5% to 3.7% and in the broader underemployment measure from 6.7% to 6.8%, but both indicators are at historically low levels. The aspect of the labour market that continues to lag is the participation rate, which at 62.2% is still more than 1ppt lower than prior to the pandemic. Even in the prime age category (25-54yrs), and thus less impacted by retirements caused by the pandemic, participation is also lower at 82.7% from around 83% pre-Covid. A constrained supply side is contributing to average hourly earnings running at an elevated pace, though, at least from an inflation standpoint, the trajectory is slowing coming in at 4.7%yr.
RBA turning more cautious
The RBA hiked rates by 25bps for the second meeting in succession, lifting its main policy rate to 2.85% (reviewed here). The step down from a sequence of frontloaded hikes came last month and at a post-meeting speech, Governor Philip Lowe said a more conventional pace of tightening was appropriate given that rates had already risen "substantially" (now up 275bps since May); the effects of those hikes were yet to be felt, and to balance risks to the growth and inflation outlook in Australia. Those risks were highlighted in the Bank's quarterly Statement on Monetary Policy to be on the upside for inflation and to the downside for growth.
Inflation is now forecast to reach a higher peak of 8% in Q4 and to come down more slowly thereafter, remaining above the top of the target band at 3.25% at the end of the forecast period in 2024. Meanwhile, forecast growth has been trimmed to 3% this year (from 3.25%) and to slow more sharply in 2023 and 2024 with output now expected to expand at 1.5% in both years, down from 1.75% previously. That set of outcomes defines the "even keel" the RBA is trying to keep the economy on while it sets about lowering inflation from its 30-year high. The other implication, though, is that given the outlook is highly uncertain, the RBA is turning increasingly cautious and mindful of the risk of overtightening monetary policy. The Board's guidance remains that it expects to raise rates further "over the period ahead" and while it is keeping its options open to scale the pace of hikes depending on the incoming data, it appears 25bps will be the standard incremental increase from here.
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Highlights in the data flow domestically this week were the continued weakness in the housing sector in response to the RBA's rate hiking cycle. Housing prices according to CoreLogic were down 1.2% nationally in October, their 6th consecutive monthly decline, while housing finance commitments fell sharply by 8.2% in September (see here). New dwelling approvals declined by 5.8% in September (see here). Consumer demand remains broadly resilient to headwinds from cost-of-living pressures and weak sentiment, though retail sales volumes slowed to a 0.2% rise in Q3 (see here). Lastly, the trade surplus rewidened to $12.4bn in September on the back of elevated export income from iron ore and LNG (see here).
Mixed signals from the Bank of England
The Bank of England invoked its pledge to "act forcefully" against inflation pressures by stepping up the pace of its latest rate hike to 75bps while at the same time pushing back on market pricing for the peak level of rates. Seven of the 9 MPC members voted to hike by 75bps, that number rising from 3 members at the previous meeting in September where rates went up by 50bps. The meeting minutes detailed that the government's price cap on energy bills was the swing factor that tipped the majority to side with 75bps on this occassion, as it would boost demand and likely add to inflation pressures.
This week's hike lifted Bank rate to 3.0%, which has risen by 290bps since December but is still some way short of the terminal rate priced into markets at around 5%. At the post-meeting press conference, Governor Andrew Bailey went to the unusual step of stating clearly that the MPC believed this pricing to be overdone, which followed similar comments from Deputy Governor Broadbent during a recent speech. The reason for that is because of the dire economic outlook the Bank published in its latest Monetary Policy Report, with the UK economy expected to enter a prolonged recession by the end of the year. To generate its forecasts, a standard assumption the Bank uses is that its policy rate will move in line with the market curve, in this case reaching a peak of 5.25%. Under that assumption, the forecast recession stretches into 2024, with inflation well below target by then and the economy operating with a large degree of excess supply.
One of the other major uncertainties for the BoE is the path fiscal policy will now take under the new leadership of the government. The mini-budget announced under former PM Truss has been condemned, but the shape fiscal policy will now take won't be fully known until later in the month, and that could have significant implications for the growth and inflation outlook of the BoE. For now, the BoE's guidance is that further rate hikes "may be required", though Governor Bailey said that the 75bps hike delivered this week shouldn't be seen as the new normal.