The interest rate outlook continued to be the main factor driving markets this week. Equities finished the week upbeat as a gauge of US services sector inflation eased. In Europe, there were signs of stickier inflation, underlining the ECB's hawkish tone. In Australia, a below consensus Q4 GDP print and a softening in inflation make for an interesting RBA meeting next week.
Durability of Australian household spending holds key to outlook
A growth slowdown in the Australian economy to a 0.5% expansion in Q4 real GDP (2.7% year-ended) gives pause for a reappraisal of the strength of the consumer into year-end. Domestic demand stalled in the quarter on slowing household consumption (0.3%) and weakness in private investment (-1.3%).
Meanwhile, a decline in 12-month CPI to 7.4% in January (from 8.4%) will likely give the RBA some confidence going into next week's meeting that its priors for inflation having peaked in Q4 are playing out. A 25bps hike in the cash rate on Tuesday is effectively a done deal, but it will be interesting to observe if this week's data has shifted the dial for the Board. Its clear tilt to a more hawkish narrative in February has been key in driving market pricing for the peak rate above 4%.
My In review series has comprehensive analysis of the Q4 National Accounts with more than 30 key charts here. The key theme was that the post-pandemic rebound in household consumption appeared to wind down in Q4 as the squeeze on household budgets caused by falling real incomes and rising interest rates became more apparent, reflected in a reduction in the saving rate to 4.5%, a low since 2017.
The degree to which a strong labour market and the elevated stock of savings accumulated over the pandemic can support household consumption through these headwinds is key to the economic outlook in Australia. A 1.9% rebound in retail sales in January was stronger than expected but probably inconclusive for making assessments on how households started 2023.
The RBA's tightening cycle continues to have a profound effect on the housing market, with housing prices, housing finance and dwelling approvals all continuing to slide. On the trade front, the current account surplus rewidened substantially in Q4 to 2.3% of GDP as elevated commodity prices are still bolstering export income.
US economy remains robust
The key event for the week in the US showed activity in the services sector confirmed the rebound seen to start 2023. The ISM services index flipped from contractionary territory to end 2022 to indicate a solid pace of expansion in January at a 55.2 reading, which was maintained into February (55.1). Rising activity was underpinned by uplifts in both new orders and employment, signs that demand in the US remains resilient to a rapid Fed tightening cycle and inflationary pressures. Markets keyed off the easing in the gauge of services prices in February (65.6 from 67.8) after commentary from Fed officials had seen pricing for the peak in the fed funds rate lifting to 5.5%, above the 5-5.25% range currently signalled in the FOMC's dot plot.
ECB to keep pressing ahead
An uptick in European core inflation to a new record high validated the ECB's hawkish stance, bringing a peak policy rate of 4% into view. February's headline inflation rate eased from 8.6% to 8.5%, but the core rate moved in the wrong direction rising from 5.3% to 5.6%. The risk of elevated inflation remaining sticky has the ECB on guard, with the account from the February meeting indicating Governing Council is prepared to keep raising rates beyond the 50bps hike it has communicated ahead of the upcoming meeting on 16 March. Comments from ECB President Christine Lagarde were forthright in noting that higher rates for longer will likely be required to ensure inflation falls back to target.
By contrast, BoE Governor Andrew Bailey struck a much more cautious tone saying that further rate hikes in the UK were not inevitable. That came as the BoE's Decision Maker Panel survey reported an easing of inflation pressures and expectations.