Risk assets rallied strongly as markets drew a dovish interpretation from a speech by US Federal Reserve Chair Jerome Powell. That momentum was checked by strong US employment and wages data late in the week that suggested the overall picture for US rates will remain hawkish. In the Asian region, equities were boosted by reopening speculation in China. Next week, the RBA is expected to hike rates by 25bps and Australian Q3 GDP data will contain key insights on households.
Status quo to hold for the RBA...
Going into next week's RBA meeting, expectations are set on another 25bps rate hike ahead of the Board's summer break. Governor Philip Lowe at his Senate appearance and then at a Bank of Thailand event said domestic inflation was forecast to slow next year as the effects of eased supply pressures, falls in commodity prices and higher interest rates work their way through the economy. In encouraging signs, the monthly inflation gauge in October showed headline CPI softened from 7.3% to 6.9%yr and from 5.4% to 5.3%yr on an underlying basis; however, that is short of the evidence the RBA needs to pause its hiking cycle, with only 43% of prices in the basket updated for October, household energy prices being a notable exclusion.
... with Q3 GDP to provide key insights on households
Time will also be needed for the Board to consider the Q3 GDP report, which won't be available until the day after the December meeting. Here, the key details will centre on household spending, incomes and saving. As my GDP preview outlines, the consumer is expected to have remained robust in the quarter but the headwinds from falling real incomes and weak sentiment are consistent with the RBA's weaker growth outlook in 2023. The first signs of that weakness may have emerged as retail sales fell by 0.2% in October (-0.6% ex-food), though that should be read with some caution given that spending is likely to rebound in November due to Black Friday sales (see here).
Lead-in indicators for Q3 GDP for construction activity and business investment this week were mixed. Construction work done advanced by 2.2% in the quarter supported by engineering activity and a rebound in building activity from weather-related and supply disruptions (see here). That was counterbalanced by a disappointing outturn from capital expenditure in Q3 (-0.6%) as equipment spending pulled back (see here). Forward-looking investment plans for 2022/23 remain upbeat despite expectations for a global and domestic economic slowdown. The 4th estimate of investment plans indicates firms intend to lift capex over the back half of the current financial year to just shy of $160bn, which is the strongest outlook since 2014/15.
The housing market continued to show its sensitivity to the RBA's tightening cycle. Rising interest rates are weighing on housing finance commitments, down a further 2.7% in October (see here), while housing prices nationally corrected lower again in November to be 7% below their recent peak according to CoreLogic. The dynamics are also weak for dwelling approvals posting a larger-than-expected decline of 6% in October (see here).
Fed Chair Powell sees risk of overtightening
US Fed Chair Powell's speech to the Brookings Institution effectively confirmed to the markets that the downshift to a 50bps rate hike at the upcoming FOMC meeting is locked in. Whereas at the previous meeting Powell's message was that greater risks were posed to the economy from not tightening monetary policy enough, this week there were signs of a softening in that stance. Following his prepared remarks, Powell said the FOMC wanted to avoid overtightening in the first place, and it would risk manage the situation by slowing the pace of rate hikes. However, Powell was clear that downshifting was of much less significance to the FOMC than the terminal level rates need to hit to lower inflation back to target and the length of time they need to remain in the restrictive zone.
Price and wage dynamics have yet to show convincing signs of turning as the US economy remains underpinned by resilient households. Real growth in personal consumption expanded by 0.5% in October, its strongest increase since January. The labour market remains a key support for household income as a stronger-than-expected 263k jobs were added to nonfarm payrolls in November. That kept the unemployment rate at 3.7%, remaining around its lows from the eve of the pandemic. But with the participation rate now materially lower than in early 2020 (62.1% on the latest read), a constrained supply side sees average hourly earnings growth at the elevated pace of 5.1%yr. That remains around the pace of inflation on the Fed's preferred gauge with the core PCE deflator running at 5%yr in October.
Better signs on euro area inflation
Euro area inflation remains a long way from coming back to the ECB's target, but the worst of it may at least be in the past. Inflation in the euro area has continually surprised to the upside of expectations in 2022, so an easing in the headline rate from 10.6% to 10%yr - coming in below the 10.4% expected - made for a welcome change. But core inflation holding steady at 5%yr is indicative of the broad-based nature of price pressures. Although there is little sign of high inflation becoming embedded in wage-setting processes, the situation remains under close watch by the ECB given the strength in the labour market has pushed the unemployment rate down to a new series low of 6.5% in October.
ECB President Christine Lagarde told the European Parliament this week that the Governing Council expects to keep tightening its monetary policy stance to prevent inflation expectations from breaking higher. November's inflation data may be enough to sway the Governing Council into downshifting to a 50bps hike from 75bps later this month. Lagarde also said that plans for reducing the ECB's balance sheet - part of the tightening in monetary policy - would be announced at the upcoming meeting.
