A tough Q3 came to a close this week, a quarter in which a significant shift higher in long-end US yields weighed heavily on equity valuations and was a tailwind to the US dollar. The outlook for a more extended period of an elevated Fed policy rate is a theme that is resonating with central banks in other countries with inflation still well above their respective targets.
Despite an uptick in Australian headline inflation, the RBA is likely to leave the cash rate (4.1%) unchanged for the fourth meeting in succession next week. A 9.1% surge in petrol prices saw the 12-month CPI rate rise to 5.2% in August from 4.9% in July (reviewed here). Excluding petrol and other volatile items, underlying inflation softened slightly from 5.6% to 5.3%. Compared to their late 2022 peaks above 8%, inflation has declined materially year to date - a key factor that has kept the Board from hiking further at recent meetings. With retail sales posting an underwhelming 0.2% rise amid the FIFA Women's World Cup (reviewed here) and job vacancies (-9.1%q/q) continuing to moderate from their post-pandemic highs, there were more signs this week that higher interest rates are contributing to cooling demand.
Encouraging US inflation data has weakened the case for the Fed to hike rates further at its November meeting. The core PCE deflator - a key inflation gauge for the Fed - slowed from 4.3% to 3.9%yr in August, a low back to June 2021. More importantly, the recent momentum in both 3-month (2.2%) and 6-month (3%) annualised terms suggests a more rapid pace of decline is in prospect, leaving the Fed's forecast for a 3.7% core PCE inflation rate at year-end looking overdone. Meanwhile, historical revisions to GDP data have upgraded the strength of the recovery in the US from the pandemic. Momentum in the US has been solid through the first half of the year - 0.6% in Q1 and 0.5% in Q2 - with GDP expanding by 1.1% over the period.
After only inching lower in recent months, euro area inflation fell materially in September. Headline inflation declined from 5.2% to 4.3%yr - a near 2-year low - and the core rate came down from 5.3% to 4.5%yr, with both outcomes exceeding the declines expected (4.5% and 4.8% respectively). Although higher oil prices pose a risk of disrupting this downward momentum, a strong disinflationary impulse is coming from the weakness in the euro area economy. This only validates the sentiment coming out of the ECB's meeting two weeks ago that rates have reached their peak.
