A predictable response from markets this week to an upside surprise on the inflation gauge watched closely by the Federal Reserve, with equities lower and bond yields rising. Geopolitical factors also played into weak risk sentiment. Other developments of note this week included inflation in Japan rising to a four-decade high and the RBNZ continuing with its hiking cycle.
FOMC minutes underscore the Fed's determination
Although markets latched onto the theme in Fed Chair Powell's post-FOMC meeting press conference that a "disinflationary process" was underway in the US, that message was notably absent in the meeting minutes. Indeed the overall tone was consistent with the FOMC still being wary that policy was not yet "sufficiently restrictive" to lower inflation back to the 2% target. In the final analysis, "almost all" FOMC participants agreed to step the pace of tightening down to a 25bps rate hike, though "a few" members had supported a 50bps hike.
The upside surprise on the closely watched core PCE deflator, which rose unexpectedly to 4.7%yr in January (vs 4.3% expected) from 4.6% previously could liven up the 25 or 50bps debate going forward. There was a resurgence in demand in the month as real personal spending lifted by 1.1% (with services 2.2% & goods 0.6%), its strongest rise in nearly 2 years. This fits with the strength of other data points seen over recent weeks, including the 517k surge in nonfarm payrolls in January.
RBA's hawkish tilt followed higher inflation data in Q4...
More colour around the RBA's recent hawkish tilt was provided in the February meeting minutes. After the Q4 inflation report surprised the RBA on the upside and with several factors still working to support demand, the Board took a pause in the tightening cycle off the table - an option it considered in December - narrowing the decision to one between a rate hike of 25 or 50bps.
In siding with the former, the minutes noted the Board was taking into account the lags of the cumulative tightening in monetary policy, recognising also that moving more slowly was the appropriate course given the uncertainty of the economic outlook. However, the Board strengthed its guidance around the expectation for "further increases in interest rates" and brought this into prominence with the observation the cash rate was "lower than policy rates in many other comparable economies". As recently as late last year, the RBA had been highlighting that the speed of its tightening cycle was at the faster end of the scale amongst its central bank peers.
... but wages growth surprised to the downside
The Board retains its risk management approach to setting policy in an environment where it had seen "the incoming data on prices and labour costs had tended to exceed expectations". In that sense, this week's Q4 Wage Price Index report (see here) went against the grain as wages growth printed at 0.8% in the quarter and 3.3% over the year, coming in on the low side of the RBA's end of 2022 forecast (3.5%).
In the context of the tightening that has occured in the labour market over the past year where the underutilisation rate has declined from an average of 12.5% in Q4 2021 to 9.4% in Q4 2022, the rise in wages growth over that period (2.4% to 3.3%) has been slower than the historical relationship would suggest. Australia's wage-setting processes take time to respond to the underlying labour market conditions, but wages growth is hardly rising at a pace that should be alarming, particularly with a strong response from the supply side that has seen the participation rate elevating to record highs coming out of the pandemic.
Next week's calendar includes the Q4 national accounts where GDP growth is expected to have expanded by around 0.7%, with the details covered in my preview here. That forecast factors in the partial indicators received this week including a 0.4% fall in construction activity (see here) and a 2.2% rise in business capex (see here). The capex survey was notable in that firms'forward-looking investment plans remained upbeat despite the uncertainty of the economic outlook and inflation that has made projects more expensive to undertake.
Re-rating of growth prospects in Europe
After a resilient showing by the European economy over the winter, growth now looks to be picking up. A mild winter helped avoid what risked being an energy crisis, with energy prices falling substantially since mid-December. A rise on the composite PMI to a 52.3 reading in February (from 50.3) indicated activity was expanding at a 9-month high. Services activity accelerated to its fastest since June-22 (53.0); manufacturing output (50.4) returned to expansionary territory for the first time in 9 months on eased supply chain pressures allowing backlogged orders to be filled.
Source: S&P Global
This was also contributing to an easing in input cost pressures in the sector. However, in the services sector, costs were continuing to rise, in part reflecting higher wage costs. Services inflation remains under close monitoring by the ECB, which in January was running at 4.4% and is a key reason why core inflation is up at record highs (5.3%yr). Headline inflation has, however, fallen back to 8.6% from 9.2%.
