Markets closed the opening quarter of the year on an upbeat tone after the immediate concerns emanating from the stresses in the global banking system eased. US and European equities were sharply higher through Q1, with falling bond yields acting as a tailwind on the expectation that both the Fed and ECB are nearing the end of their respective tightening cycles. Domestically, the RBA meets next week where the Board will "reconsider" the case to pause rate hikes.
RBA to pause next week
Declining inflation and soft retail sales data point to the RBA pausing its rate hiking cycle at next week's meeting. Monthly CPI data over January and February should confirm to the RBA that inflation peaked in Q4. The 12-month CPI has slowed in consecutive prints since the December high of 8.4%, easing to 7.4% in January and then to 6.8% in February (see here). This has come on the back of travel costs unwinding after surging ahead of the peak holiday period; though the inflationary pulse in other key categories - notably in home building costs and food - has also weakened. While inflation is still elevated, the momentum is declining, which strongly hints that RBA policy is appropriately calibrated in a restrictive zone.
Equally, a 0.2% rise in February retail sales painted a similar picture (see here). The momentum in retail sales has clearly weakened over the past few months - in particular in discretionary categories - following a strong rise in November driven by Black Friday. Pressures on household budgets and rising interest rates are weighing on spending; meanwhile, the demand for credit has also slowed with annual growth easing to 7.6% in February, down from the high around the back end of Q3 last year at 9.5%.
Conditions in the labour market appear to have eased somewhat as job vacancies declined for the third straight quarter; however, the level remains highly elevated at almost 440k (equivalent to 3.1% of the labour force) and indicates that the demand for labour continues to be strong.
US economy shows signs of cooling
Coming off a strong start to 2023, US personal consumption slowed from 2% in January to 0.2% in February. Adjusting for inflation, volume growth in consumption declined in the month (-0.1%), with weakness evident in both services (-0.1%) and goods (-0.1%). Over the past year, consumption growth slowed to a 2.5% annual pace from 6.7% in February-22. This reflects the fading of the rebound from the pandemic and also a protracted period of weakness in real incomes caused by high inflation. In response, the saving rate - despite rising in recent months - sits well below pre-pandemic levels, printing in at 4.6% in February.
The Fed is making headway in lowering inflation, though progress remains gradual. The headline PCE deflator eased from 5.3% to 5.0%yr in February - its slowest pace since September-21 - while the core rate was 4.6%yr, which was lower than expected but has been little changed over recent months.
Core inflation still rising in Europe
Although headline inflation in the euro area fell sharply from 8.5% to 6.9%yr in March, a firming in the core rate to a new record high at 5.7%yr underscores the ECB's hawkish narrative. Falls energy prices from the highs reached at the outset of the Ukraine war drove the decline in headline inflation. While this has provided some relief to households, other costs have accelerated over the past year, notably food inflation has risen from 5% in March-22 to 15.4% 12 months later. Meanwhile, price pressures in the core of the basket have yet to abate. Services inflation firmed to 5%yr and its elevated pace partly reflects wage pressures being generated by strong labour market conditions. The euro area's unemployment rate was unchanged around historic lows at 6.6% in February.
BoE watching credit conditions
The Bank of England published its latest financial stability review this week while officials from the central bank fronted the Treasury Committee following the collapse of SVB and its UK subsidiary. The overall message conveyed the resilience of the broader UK banking system to the recent stresses, with different rules applying to UK banks for managing interest rate risk. However, the authorities anticipate that spillover effects could lead to headwinds for the UK economy through tighter credit conditions for domestic households and businesses. BoE Governor Andrew Bailey said that if the flow of credit needed to be supported, it could lower the counter-cyclical capital buffer, which would reduce the additional capital it requires banks to set aside as cover for potential losses. Governor Bailey also sought to clarify that the stresses in the global banking system were not a constraint on monetary policy, reaffirming a point he made in a speech earlier in the week.
