Despite improving signs on the inflation front and weaker growth outlooks going into 2023, central banks continue to assert that they have more work in front of them. That was the key message from the Federal Reserve, European Central Bank, and the Bank of England this week even as all 3 slowed the pace of their respective tightening cycles.
Australian labour market strengthens further...
Conditions in the Australian labour market have continued to strengthen, leaving the RBA's guidance for rates to continue to rise in 2023 on track. Employment came in at 64k in November, strongly above consensus for the second month in succession (October was revised up to 43.1k), confirming a reacceleration in employment after a slowdown in Q3 (full review here). Rising employment has been met with a lift in the participation rate back to record highs (66.8%). The unemployment rate held at 3.4%, its lowest rate since 1974, though broader measures of spare capacity declined further such that total underutilisation in the labour force established a new 41-year low (9.3%).
... but sentiment is weak going into 2023
Consumer sentiment on the Westpac-Melbourne Institute Index bounced by 2.9% in December but is still at deeply pessimistic levels (80.3), reflecting cost-of-living pressures on households. There were indications in the report that households sense the end of the RBA's hiking cycle is nearing, but the effects of the earlier hikes have yet to fully flow through. In anticipation of a material slowdown in household spending, business confidence in the NAB Survey turned outright negative in November (at -4 index points), belying the robust conditions (+20 points) currently reported.
Fed remains on the press despite easing US inflation
After 4 successive 75bps rate hikes, the Federal Reserve's FOMC made its well-telegraphed downshift to a 50bps hike this week. The policy rate now stands in the 4.25 to 4.5% range, up by a rapid 425bps since the start of the year. And all indications are that the FOMC is not done yet. The decision statement noted that "ongoing increases" in rates were anticipated and in the post-meeting press conference Chair Jerome Powell said policy had not yet reached the "sufficiently restrictive" levels needed for inflation to return to target. On top of this, the updated set of economic projections raised the median forecast for the peak in the fed funds to 5.1% from 4.6% previously, against market pricing for rate cuts in the back half of 2023.
Indeed, Chair Powell confirmed it was still the FOMC's view that rates will need to remain at restrictive levels for a "sustained period" and that backing away prematurely posed more risk to the economy than overtightening in the first place. Clearly, FOMC members are yet to be convinced that the inflation impulse is waning despite markets taking encouragement from the past two CPI reports (more below). That was underscored by FOMC members' median projections for both headline and core PCE inflation being adjusted higher through to the end of 2024. The upward revisions to inflation in 2023 (3.1% from 2.8% on headline and 3.5% from 3.1% on the core rate) are notable as they come alongside the growth outlook for next year being cut sharply to 0.5% from 1.2%.
This week's CPI data for November was softer than expected on the back of a downside surprise in October. Headline CPI was 0.1% month-on-month (vs 0.3% expected), slowing annual growth to 7.1% from 7.7%, while the core rate was in at 0.2%m/m (vs 0.3%) and 6.0%yr (down from 6.3%). The two main drivers of the softening in inflation over the past couple of months have been a disinflationary pulse coming through from goods, consistent with improved supply chain pressures and reduced demand (due to spending rotating back to services), and falls in energy prices from their peaks earlier in the year. However, services inflation is still elevated on the back of surges in rents and housing costs.
Hawkish turn from the ECB
Although the European Central Bank hiked rates by 50bps (to 2.0% on the depo rate), dialling down the pace from 75bps at the past two meetings, this was far from a step closer to the end of the tightening cycle. In fact, according to a Bloomberg article, there was a "sizeable push" within the Governing Council for the pace to remain at 75bps at this week's meeting. However, the main message was in the decision statement and then in President Christine Lagarde's post-meeting press conference that rates needed to "rise significantly at a steady pace" to reach levels that are "sufficiently restrictive" to bring inflation back down to target. The Governing Council also gave the green light to start quantitative tightening in March, with the plan to initially reduce the reinvestment of maturing bonds in the Asset Purchase Programme by an average of €15bn per month (representing around 50% of redemptions) through to the end of June.
This vastly more aggressive tone from the ECB comes in response to a "substantial upward revision to the inflation outlook". December's ECB staff projections have been revised to show inflation falling back at a slower pace in 2023 (6.3% from 5.5%) and 2024 (3.4% from 2.3%) and to still remain above target at the end of the projection horizon in 2025 (2.3%). Notably, falls in food and energy prices drive the forecast decline in the inflation rate, with price pressures in the core components expected to remain sticky. Reflecting the economic headwinds the euro area is confronting from tighter monetary policy, high energy prices and slowing global growth, a "short-lived and shallow recession" is now factored into the ECB's baseline outlook, resulting in weaker but still positive growth in 2023 (0.5% from 0.9%). A rebound is then projected in 2024, with forecast growth left unchanged at 1.9%.
ECB chart
Bank of England downshifts
The Bank of England reverted back to a 50bps rate hike this week lifting the policy rate to 3.5%, downshifting from November's outsized hike (75bps). The less aggressive stance follows the recent Autumn Statement, giving the BoE greater clarity over the direction of fiscal policy under the new leadership of the government, and the BoE's special bond-buying operations that settled the gilt market soon after the mini-Budget was tabled. But even though calmer waters have prevailed, the 9-member MPC split this week's vote 3 ways: 6 opting for 50bps, 2 (Tenreyro, Dhingra) voting for no change, and 1 (Mann) calling for another 75bps hike.
November's inflation data showed a slight cooling in price pressures as headline CPI softened from 11.1% to 10.7%yr and from 6.5% to 6.3%yr on the core rate, but with data on the labour market remaining strong and pay growth pushing up to a 6.1% annual pace, the MPC retained the policy guidance that further rate hikes "...may be required", reaffirming also that it is prepared to "act forcefully" again if needed. However, the MPC removed its explicit pushback to a peak rate above 5%, reflecting the reduction in market pricing over recent weeks to 4.75% currently.
Crucially, the implications for BoE policy from the government's fiscal plans appear limited. According to the MPC's assessment, the measures in the Autumn Statement modestly lower the inflation outlook (-0.75ppt in Q2) and add to growth in 2023 (0.4ppt). The fiscal impulse to growth is then expected to be neutral in 2024 before turning slightly contractionary in 2025 (-0.5ppt).
