A panel of the world's major central bank chiefs at the ECB's Sintra forum made clear that the focus remains on hiking rates to more restrictive levels given the risk of prolonged high inflation. The inflation dynamics in the US, euro area, and UK each have their own characteristics but the commonality is that underlying inflation rates are high and progress in returning it to central banks' targets has been slow. There has been little change in this narrative in 2023. While this has led to more inverted yield curves as recessionary risks have increased there has been a sustained rise in equities, coming through headwinds that include the banking turmoil in the US and Switzerland and a fading reopening in China. At the halfway point of the year (see below) US markets are up around 15-30%, European majors are 15% higher; Asia has been more mixed but the Japanese market has been a standout globally rising 27% through the first half.
Australian inflation slows; RBA still likely to hike
Markets were encouraged by a notable deceleration in Australia's headline inflation rate from 6.8% to 5.6% in May, assessing that this increases the chance of an RBA pause at next week's meeting. Slowing inflation was driven mainly by falling fuel and holiday travel prices, both considered to be volatile items in the CPI basket. Looking ahead to next week, a hawkish RBA that has been highlighting upside risks to the inflation outlook seems likely to give more weight to the elevated underlying inflation measures in the May report. The trimmed mean gauge came in at 6.1%, down from 6.7% in April but still far too high for the Board, while the CPI ex-volatile items and holiday travel measure printed at 6.4% from 6.5% previously.
Household spending and the labour market - two other key areas of focus for the RBA - showed ongoing resilience in the data to hand through the week, pointing to a 25bps rate hike on Tuesday. Retail sales accelerated by 0.7% in May, the strongest outturn since the start of the year. The rise was driven by discretionary-related spending (sales ex-food lifted 0.9%) supported by dining out and end-of-financial-year sales (see here). Despite numerous headwinds including from higher interest rates and cost-of-living pressure, spending is holding up better than may have been expected, with the labour market a key support. Job vacancies declined by 2% for the 3 months to May to be 10% below their peak a year earlier; however, labour demand still remains very strong. Total vacancies in Australia came in a 431.6k, equivalent to a historically elevated share of the labour force at around 3%.
US inflation easing but still elevated
The disinflationary process in the US continued in May with the headline PCE deflator falling from 4.4% to 3.8%, a low going back to April 2021. Underlying inflation, which remains harder for the Fed to shake, ticked down from 4.7% to 4.6%. That said, markets were buoyed by the underlying measure that excludes housing costs (considered a more accurate guide of where inflation is headed) which softened from 4.4% to 3.9%. That particular measure is considered monitored by the Fed and if the trend lower remains in place, the need to hike rates further becomes a more nuanced discussion.
That comes as household demand - while still resilient - appears to have lost much of its momentum. Real consumption lifted solidly by 1% in the first quarter, but this has been followed since by a 0.2% rise in April and a flat outcome in May. A softer impulse from consumption supports an outlook for easing inflation.
ECB Sintra wrap-up
Inflation and the response to it was (unsurprisingly) the theme of the ECB's Sinta Forum. In her opening remarks, ECB President Christine Lagarde said that the series of shocks that caused inflation to surge quickly risked taking longer to unwind. While headline inflation is coming down declining from 6.1% to 5.5% in June, the core rate has yet to decelerate and ticked up slightly from 5.3% to 5.4%, the latter the main focus of the ECB.
The main risk the ECB sees to persistent inflation is from rising unit labour costs. While the ECB expected stronger wages growth in response to a tight labour market and as catch-up to past high inflation, it is concerned that this is occurring against the backdrop of weak productivity growth. To avert a more sustained period of wages following prices, President Lagarde maintained the message that rates would rise further. The key questions the Governing Council were now pondering are the appropriate level rates needed to reach and the length of time they would need to remain there.