The rally in US equities from the October low relented as the main indices saw their steepest declines in 5 weeks. In contrast, China moving away from its Covid zero approach boosted some markets in Asia. There are increasing signs that central banks may be past peak hawkishness. In Australia, the RBA hiked by 25bps and will now break for the summer. The Bank of Canada hiked by 50bps but is now "...considering whether the policy interest rate needs to rise further" observing that inflation pressures may be "losing momentum". It is likely that the Federal Reserve, European Central Bank and the Bank of England will all slow the pace of their respective tightening cycles next week.
Resilient households continue to anchor Australian economic growth...
The Australian economy expanded by 0.6% in the September quarter as household spending remained resilient to falling real incomes and interest rate hikes. Real GDP growth increased by 5.9% through the year, driven by a consumption-led recovery on the reopening of the services sector from the pandemic. My In review series has in-depth analysis and key charts from the Q3 national accounts here.
In the quarter, household consumption growth slowed but was still solid at 1.1% (11.8%Y/Y), supported by the ongoing rebound in services spending, notably in travel and hospitality services. Consumption continues to rise against a backdrop of high inflation, weak sentiment, and, more recently, RBA rate hikes. Real incomes have now fallen in 3 of the past 4 quarters (-0.4% in Q3), seeing their largest annual decline (-2.7%) in three decades. But households have been willing to keep spending as the very strong labour market is bolstering income, backed also by a very elevated stock of excess saving accumulated over the pandemic, estimated to be well over $200bn. The early effects of the RBA's tightening cycle have emerged with interest payments on mortgage repayments surging by 36% in the quarter.
... as the RBA indicates rates will rise further
At this week's meeting, the RBA Board hiked its main policy rate by another 25bps to 3.1%, now up 300bps from the first hike in May (see here). Governor Philip Lowe's decision statement left intact the guidance that the Board "...expects to increase interest rates further", though he reinserted the qualifier that rates are "not on a pre-set course"; similar to a phrase used earlier in the tightening cycle preceding the downshift from 50bps to 25bps rate hikes.
The RBA expects a growth slowdown to 1.5% in 2023 and 2024, but given the scale of the hit to real incomes in the national accounts - coming ahead of the full effects of the tightening in monetary policy - the risks look to the downside. That may make the Board's sensitivity to the growth outlook in its policy deliberations more elevated, continuing to note this week that it is aiming to keep the economy "on an even keel" while returning inflation to target. If the RBA's next set of forecasts in February downgrade the growth outlook and show inflation falling back within the target band by the end of the projection period, a pause in the tightening cycle could be a genuine possibility at the March meeting.
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Data on Australian international trade confirmed a deterioration in the underlying dynamics following a retracement in commodity prices from the elevated levels reached in the early phase of the Ukraine war. The terms of trade declined by 6.7% and the current account swung into deficit for the first time since 2019 (see here). The monthly trade surplus was still elevated in October at $12.2bn, broadly unchanged from September (see here).
Fed to hike by 50bps; softer US inflation expected
A heavy-duty week awaits in the US headlined by the Federal Reserve's policy meeting and the November CPI report. Markets have long anticipated the pace of Fed tightening will slow to a 50bps hike. Much of the focus therefore will be on the new set of projections for the economic outlook and the policy rate. October saw a cooling in US inflation and that is expected to have continued into November, with the key core rate forecast to slow to 6.1%yr from 6.3%.
The FOMC's projections for the fed funds rate will be effectively marked to market, raising the estimate for the terminal rate from 4.6% to around 5%. Markets will also be looking out for insights around how long the FOMC anticipates rates will need to remain at their peak level in order to lower inflation back to target. Recession risks rise the longer the period of restrictive monetary policy. Throughout the tightening cycle, Fed officials have said the risks of overtightening were less severe to the economy than not tightening enough. However, last week, Chair Jerome Powell was more nuanced on this point, so how the FOMC sees this balance of risks evolving will also be of interest.
Downshift on the cards for the ECB and BoE next week
Ahead of next week's ECB meeting, Chief Economist Philip Lane said both the inflation outlook and the quantum of tightening already delivered will factor into the Governing Council's deliberations on rates. Markets have been reluctant to price out another 75bps hike following a recent speech by Executive Board member Isabel Schnabel, but a downshift to a 50bps move may come if the more dovish section of the Governing Council get their way. The updated set of economic and inflation forecasts to be published alongside the meeting are likely to hold the key. A more severe growth slowdown in 2023 (currently 0.9%) and inflation coming back below the 2% target over the projection period would tip the scales to a 50bps hike.
The Bank of England will also meet next week. Here, markets are more convinced that rates will be hiked by 50bps, with November's larger 75bps hike seen as a one-off move. Since the November meeting, the UK government's Autumn Statement presented what was seen by markets as a credible path for fiscal policy, albeit with much of the tightening delayed until 2024/25. That should give the BoE more comfort over the inflation outlook, allowing it to revert back to a 50bps hike.
