Australian trade surplus hits record high in May

Australia's trade surplus reset to a new record high in May as export earnings continued to surge on the back of strength in key commodities. Rising national income is helping to offset the economic impact of the escalation in global oil prices.

International Trade — May | By the numbers

• Australia's trade surplus came in well above expectations in May ($10.8bn), widening out to $16bn from $13.2bn in April (revised from $10.5bn). 

• Exports accelerated by 9.5% in the month to $58.4bn to be up by 38.1% over the year. This followed a sharply upgraded gain in April, revised to 5% from 1%.  
• Imports posted a 5.8% rise to $42.4bn taking out the previous record high in April. Annual growth firmed from 27.4% to 31.4%.

International Trade — May | The details

Australia's position as a major commodity exporter has seen its monthly trade surplus elevating to $16bn in May, almost double its level from February prior to the Russian invasion of Ukraine. With the war driving a surge in commodity prices, the trade surplus has stepped sequentially higher over the period, lifting from $8.1bn to $10.4bn in March, then to $13.2bn in April and now $16bn in May. 

Monthly export earnings are close to pressing $60bn after surging by 9.5% in May alone, taking the overall increase since February to nearly 16%. Exports were driven by a 9% lift in non-rural goods in May, centred rises in the major commodities: coal 20.4%, LNG 11.8% and iron ore 2.8%. With May's surge coming on the back of large increases in the prior two months, coal overtook iron ore as the nation's highest value export, the last time this happened was back in 2009. ABS data suggested the strength was driven by a rebound in shipment volumes after falling in April. Non-monetary gold (71%m/m) also boosted monthly exports.

Rural goods lifted by another 3.6% in May to $5.6bn, a record high. Strong offshore demand, rising prices and favourable weather conditions have seen earnings from rural goods surge since mid-2020.    

The reopening of the international border earlier in the year is starting to see services exports (4.8%m/m) rise sustainably from their lows of the pandemic. 

Imports rebounded from soft outcomes in the prior two months lifting by 5.8% in May to $42.4bn. Increases were broad based but were led by intermediate goods (9%) as fuel imports continued to surge reflecting high oil prices, rising by 22.9% in the month to be up by 151% over the year. 

Pointing to the easing of some of the constraints holding up global supply chains, new vehicle imports lifted by 18.5%m/m and machinery and industrial equipment advanced by 6.5%m/m; the former driving consumption goods to a 5.4% rise in the month and the latter pushing up capital goods by 3.2%m/m. Services imports (4.1%m/m) remain on the recovery path following the easing of restrictions on offshore travel.  

International Trade — May | Insights

Surging commodity prices continue to drive widening Australian trade surpluses. The war in Ukraine and its spillover impact on commodity prices has been a positive terms of trade shock for Australia and other commodity exporting nations. Australia's terms of trade hit a record high in the March quarter and are very likely to reset that benchmark in the June quarter, providing a buffer against the surge in oil prices. However, despite these factors, the Australian dollar has weakened sharply against the US dollar in 2022 (down by around 6%) reflecting concerns over the global economic growth outlook and the aggressive rate hiking cycle from the Federal Reserve. 

RBA hikes cash rate by 50bps in July

The RBA hiked the cash rate target by 50bps to 1.35% at today's meeting, continuing the accelerated withdrawal of monetary policy support implemented during the pandemic. Today's decision followed the step up to a 50bps hike in June after the tightening cycle commenced in May with a 25bps increase. Meanwhile, the rate on Exchange Settlement balances was increased by 50bps to 1.25%. 

Governor Philip Lowe's decision statement reiterated many of the key themes from his recent speech and public appearances. Rising inflation in Australia is reflecting a combination of global factors and domestic capacity constraints with demand robust and the labour market strong. As described today, rates are rising to establish a "more sustainable balance" between spending and the supply capacity of the economy and to keep inflation expectations anchored in the 2-3% target range. Today's statement emphasised the strength of the labour market, highlighting the near 50-year low in the unemployment rate and underemployment that has fallen "significantly". The RBA forecasts the labour market to tighten further given the elevated level of job vacancies, leading wages growth to lift out of its subdued pace in the years prior to the pandemic as a result.

With the RBA recently upping its forecast for peak inflation to 7% towards the end of the year, it is accelerating the withdrawal of stimulatory monetary policy. The next meeting in August will be accompanied by a new set of economic forecasts and will come in the week after the Q2 CPI data. With that report to capture more of the pass-through to energy and food prices in particular associated with the war in Ukraine and the east coast floods in Australia earlier in the year, a further upward revision to the inflation outlook is likely. For that reason, I expect another 50bps rate hike in August. 

Governor Lowe noted the Board will be closely monitoring the crosscurrents for household spending amid the tightening cycle. High household savings, financial buffers and incomes underpinned by the strong labour market are supporting a resilience in spending as highlighted by today's retail sales data, though the Governor highlighted that budgets were under pressure from high inflation and rising interest rates, while housing prices were also on the decline in some markets. The other key factor is around global developments, with Governor Lowe describing the outlook as "clouded" due to the Ukraine war and China's Covid response. Real incomes are being squeezed due to high inflation and rising interest rates. 

The Board's forward guidance remained intact expecting to "...take further steps in the process of normalising monetary conditions in Australia over the months ahead". As mentioned, I anticipate a 50bps hike in August to take the cash rate to 1.85% but then see the Board pausing until later in the year giving it time to assess the effect of the tightening cycle on the domestic economy and to monitor the global situation. My forecast is for the cash rate to end 2022 at just above 2% compared to market pricing for around 3%.

Australian retail sales rise again in May

Australian retail sales posted another solid rise in May, remaining resilient to concerns relating to weak consumer sentiment. Headline sales were up 0.9% in the month but were outpaced by discretionary spending (1.1%), a key theme that has been evident year to date. 

Retail Sales — May | By the numbers 

• National retail sales lifted by 0.9% in May, matching the initial estimate that was above expectations (0.4%), to come in at $34.2bn. Sales in April also advanced by 0.9%.  

• 12-month retail sales lifted from 9.6% to 10.4%. 

Retail Sales — May | The details  

For the 5th consecutive month, Australian retail sales increased with a 0.9% rise posted in May. That matches the rise seen in April but is a step down from the pace in the first quarter where monthly gains ranged between 1.6% and 1.8%. Sales in May were still well above their pre-Covid trend, more than 23% above their level from February 2020. 

A key feature of retail sales this year has been the strength in the discretionary categories. Sales excluding basic food were up 1.1% in May to be up by 10.2% year to date. This has outpaced the rise in headline sales (7.1%) over the period and can be seen in the chart below. While this incorporates the impact of rising prices, first quarter GDP data showed underlying demand was robust and that looks likely to have extended into Q2, supported by factors such as eased Covid restrictions, the strong labour market and the high level of aggregate household savings. 

In May, basic food sales lifted by 0.6% on the back of increased supermarket spending (0.8%), with rising prices (and reduced discounting) a key factor. Across the discretionary categories, department stores led with a 5.1% rise, cafes and restaurants advanced by 1.8% — with the ABS highlighting the impact of higher prices — other retail was up 1.5% and household goods saw a 0.4% lift supported by furniture (2.9%) and hardware sales (0.6%). The one area of weakness was in clothing and footwear (-1.4%), though that was after a strong rise in April (3.1%). Online sales were down 0.6% in May but are still 30% higher over the year and are 89% above pre-Covid levels. 

Outside of Queensland (-0.4%), all other states saw retail sales rise in May (the ACT also saw a modest fall of 0.3%). New South Wales posted a 1.6% increase led by department stores (7.3%), while sales in Victoria were up by 1.3% with strength in cafes and restaurants notable over recent months. Sales in South Australia advanced by 1.9% and by 1.1% in Tasmania but were broadly flat in Western Australia (0.2%).    

Retail Sales — May | Insights

National retail sales continued to rise in May despite weak consumer sentiment due to cost of living pressures, with the RBA also commencing its rate hiking cycle in the month. Although the backdrop looks unfavourable, the data suggests households were continuing to spend, especially in the discretionary areas. This has likely been supported by pent-up demand as remaining Covid restrictions have eased, while household savings are very high on aggregate and the strong labour market is supporting nominal incomes.  

Australian dwelling approvals rise 9.9% in May

Australian dwelling approvals lifted by 9.9% in May after heavy declines in the previous two months. Detached approvals are close to returning to their pre-HomeBuilder levels while higher-density approvals remain volatile from month to month. 

Building Approvals — May | By the numbers

• National dwelling approvals (seasonally adjusted) lifted by 9.9% in May to 16,390, defying expectations for a 2% decline, but are down 20.9% over the year. The decline in approvals in April was downwardly revised from -2.4% to -3.9%.

• House approvals fell by 2.4% to 9,793 (-29.2%yr), with April's outcome revised from 0.4% to -0.5%. 

• Unit approvals rebounded from recent weakness to rise by 35.1% in May to 6,598 (-4.2%yr). Approvals in April fell by 10.3%, downwardly revised from -7.9%. 

Building Approvals — May | The details 

May's 9.9% rise in national dwelling approvals was driven by a rise in higher-density approvals (35.1%), the segment continuing its run of volatile prints over recent months. Detached approvals declined 2.4% in the month, its third consecutive fall. Aside from an unusually low outturn in January (the timing coinciding with the peak holiday period and the onset of the Omicron wave), detached approvals continue to approach their levels from mid 2020 in the early stages of the HomeBuilder stimulus. 

Taking a closer look at higher-density approvals, the underlying data indicated it was largely the high rise segment that drove the increase. There were some large increases in unit approvals posted in May in Sydney, Brisbane and Perth.  

Alteration approvals increased by 3.8% and remain at a high level above $1bn. Sharp rises in materials and labour costs has kept the value of alteration approvals elevated despite the withdrawal of the HomeBuilder stimulus last year. 

Compared to their respective 2021 peaks, the decline in state approvals ranges from -28% (Qld) to -38% (WA). Approvals in New South Wales have declined by 37% and by 33% in Victoria.  

Building Approvals — May | Insights  

A stronger-than-expected result for building approvals led by the higher density segment. Approvals are likely to remain in their downtrend given the large volume of work in the residential construction pipeline; housing prices that are now declining nationally as the RBA's rate hiking cycle has ramped up; and ongoing capacity pressures in the construction sector. 

Preview: RBA July meeting

The RBA moved in line with many of its global central bank peers by stepping up to a 50bps rate hike in June after starting its tightening cycle with a 25bps hike in May. With central banks continuing to frontload rate hikes and in response to risks around the domestic inflation outlook, I expect the Board to hike the cash rate target by another 50bps to 1.35% at today's meeting (decision due at 2:30PM AEST) and for the rate on Exchange Settlement balances to lift from 0.75% to 1.25%.  

At the June meeting, the Board decided a more rapid withdrawal of the emergency monetary policy settings required during the pandemic was warranted. This came in response to the RBA lifting its forecast for peak inflation in Australia from 5.9% to 7% and with the labour market seeing its strongest conditions in many years, underlined by May's report with unemployment remaining at a near half-century low at 3.9%. Speaking at a recent panel event with other central bankers in Zurich, Governor Philip Lowe indicated the board would again be discussing the merits of hiking by 25bps or 50bps at the July meeting. On that basis, the probability of an even larger hike of 75bps being announced today looks remote. 

The key observations from Governor Lowe in his speech on 21 June and in the June meeting minutes were around inflation expectations. Specifically, the RBA had seens signs of the inflation psychology shifting, with firms increasingly gaining pricing power and workers, in the knowledge the labour market was strong, were pushing for higher wages to compensate for cost of living pressures. In that context, the Board assessed there to be a "heightened risk of persistently high inflation" and decided to speed up to a 50bps hike. Governor Lowe said that in order to keep inflation expectations anchored between the 2-3% target band, higher rates are needed to bring growth in spending into closer alignment with the supply capacity of the economy.  

Looking ahead, as previously discussed here, I see another 50bps hike coming in August, with the Q2 CPI data likely to prompt the RBA to again revise up its inflation forecasts. That would bring the cash rate to 1.85% where I anticipate the Board to pause its hiking cycle, allowing it to monitor the domestic data and events offshore. Over the past couple of weeks, markets have responded to the slowing global growth outlook by scaling back their expected peak in the cash rate from above 4% to around 3.75% in mid-2023. 

Post the August meeting, I expect the RBA will be able to ease back to hiking in 25bps increments. I have a 25bps hike pencilled in for November following the Q3 CPI report and revised RBA forecasts, with the cash rate to end 2022 at just above 2%. That differs from market pricing at around 3%, based on the expectation of the Board hiking at every meeting through to the end of the year. 

Australian housing finance rises 1.7% in May

Australian housing finance commitments lifted against expectations rising by 1.7% in May, rebounding from a holiday-related fall in April. Gains were broad based in the month, though commitments to the owner-occupier segment are down by almost 10% over the year while the investor segment is up by around 24%. 

Housing Finance — May | By the numbers

• Housing finance commitments (ex-refinancing) advanced by 1.7% (vs -2.5% expected) to $32.4bn, though annual growth slipped to -0.4% from 2.6%. Commitments in April were revised from -6.4% to -2.8%.
• Owner-occupier commitments rebounded from April's 1.7% fall to post a 2.1% month-on-month rise to $21.2bn (-9.7%yr). 
• Investor commitments lifted by 0.9% in the month to $11.2bn (23.7%yr), steadying from April's 4.8% fall. 
• Total refinancing increased by 3.1%m/m to $17.1bn (16.6%yr) to sit just below its record high. 

Housing Finance — May | The details 

Housing finance commitments have essentially tracked sideways at elevated levels over recent months, alternating between rises and declines of similar magnitudes. May's commitments came in at $32.4bn, around 2.5% off the record high reached at the turn of the year. Both major segments saw increases in the month, with owner-occupier commitments up by 2.1% and investor commitments lifting by 0.9%.

In the owner-occupier segment, the strongest gains came through in the construction-related (8.7%m/m) and alterations (11.6%m/m) categories; these gains are likely boosted by the rises in materials and labour costs amid the supply shortages in the construction sector. Commitments to upgraders lifted modestly (0.3%), while the rise seen in the first home buyer category (3.4%) reversed the decline in April. 

Investor commitments fell for the first time in 10 months in April before picking up again in May (0.9%m/m). Commitments to the segment have run at a clip north of $11bn/mth for 5 consecutive months. 

The state details are summarised in the table below. The main theme remains the divergence between the owner-occupier and investor segments; the former has declined in each state over the year, with first home buyers a major contributor, as the latter has advanced.  

Housing Finance — May | Insights

May's 1.7% rise in housing finance commitments came after a 2.8% falling April, a decline the ABS noted was accentuated by the high number of public holidays in the month. The fundamentals point to a rolling over in commitments through the remainder of the year with the RBA's rate hiking cycle now well underway and house prices turning lower; data from CoreLogic reported national housing prices declined for the second month running in June (-0.6%) led by the Sydney and Melbourne markets. 

Macro (Re)view (1/7) | Leaving Q2 behind

The week brought to a close a tough quarter and first half of the year as markets worked through the risk of recession coming down the line in response to aggressive hiking cycles to curb high inflation. 

The ECB's Forum in Sintra highlighted events this week, with the standout being the panel featuring ECB President Lagarde, Fed Chair Powell and Governor Bailey of the BoE. A united front was presented, prioritising the need to bring inflation under control over the risks posed to growth outlooks. Although there is confidence their course of action will work, the heads of all three central banks thought that it was unlikely the world would return to the low inflationary environment that characterised the previous cycle post the financial crisis. The push toward deglobalisation and the green transition were contributing factors cited, while Governor Bailey highlighted structural changes to the labour market coming out of the pandemic.   

Australian retail sales continue to defy weak sentiment 

National retail sales lifted for the 5th month running with a stronger-than-expected 0.9% rise posted in May, defying the sharp fall in consumer sentiment over recent months. Through the first quarter of the year, retail sales lifted by 2.9% supported by resilient demand (contributing 1.2ppts) as inflation started to ramp up (1.7ppts). So far in Q2, retail sales have risen by 1.8% with the largest increases coming in food (2.4%) and cafes and restaurants (5.1%), categories which the ABS noted are being boosted by rising prices (note fuel is not included in national retail sales). Spending has advanced in clothing and footwear (1.7%), department stores (2.5%) and other categories (2%) but declined in household goods (-2.3%). Overall, while slower volumes are likely for Q2, the data still suggest demand has been broadly resilient to the effects of inflation and weak sentiment.  

The strength of the labour market looks to be a key factor supporting that resilience. Labour demand continues to surge with a further 58.2k job vacancies posted over the 3-month period to May. That brings total vacancies to 480.1k, equivalent to 3.4% of the labour force. The labour market has been the major beneficiary of the economic recovery from the pandemic. Currently, there are 25% of businesses with at least one vacancy, well up from only 11% prior to the onset of Covid. With the labour market to keep tightening, the RBA will be increasingly confident of wages growth rising into the 3s, the level it views as consistent with sustainable 2-3% inflation, which speaks to the idea discussed at Sintra of a departure from low inflation dynamics.  

US tracking towards a slowdown in Q2 GDP   

Market concerns around slowing US growth were encapsulated by the deterioration in the latest reading of the Atlanta Fed's GDPnow model and by the ISM manufacturing index softening to a 53.0 reading in June, its lowest since June 2020. The GDPnow model has the US economy on track to contract by 1% in the June quarter (downgraded from -0.3%), though this is more pessimistic than most analyst forecasts. 

The outlook for consumption is being revised with households facing cost-of-living pressures and rising interest rates. Data for May showed growth in real personal consumption declined by 0.4% in the month, its weakest outcome since December, while revisions reduced the pace of growth in April. The decline in May was driven entirely by falling goods consumption (-1.6%m/m), which is unwinding from the elevated peaks reached during the pandemic. The rotation back towards services continued with a 0.3% rise, though the rebalancing of consumption patterns is proving to be much more drawn out than many expected.   

Meanwhile, inflation on the key core PCE deflator moderated from 4.9% to 4.7%yr in May, a 6-month low. Although inflation on this measure is on the way down, it's too early to call the peak on the headline rate, which is yet to roll over holding steady at 6.3%yr. 

New high for euro area inflation 

Euro area inflation continues to push new record highs as June's preliminary readings came in above expectations. Headline inflation was posted at 0.8% month-on-month, which left the annual rate up at 8.6% from 8.1% in May. The spillover effects from the war in Ukraine saw energy prices surge 3.3% in the month (41.9%yr) and food prices pushed up by 1.1% (8.9%yr). With these two components the major drivers of inflation, there remains a large wedge to the core rate, with its pace easing from 3.8% to 3.7%yr, defying expectations for a lift to 3.9%, partly reflecting the impact of government support measures in Germany. Core inflation is unlikely to have peaked yet, and with the euro area unemployment rate falling to a new low at 6.6% in May wage pressures are likely to be building.  

Macro (Re)view (24/6) | Growth prospects in focus

A challenging outlook for growth prospects is leading to increasingly complex reactions in markets. We see bond yields having pulled back over the week on the risks of recession, an outlook that has weighed on the commodities complex and contributed to falling inflation expectations. Equities have rallied, potentially driven by the idea that weaker growth and inflation declining will allow central banks to pivot from their messaging around the need to keep hiking rates quickly. 

Global growth is slowing going into Q3    

The round-up of global PMIs reflected the slowing growth thematic that was prevalent in markets this week. Although still remaining above the 50 level and consistent with economic activity expanding, June's advanced PMI readings suggested that the pace of growth had slowed across the US, Europe and the UK after opening up the second quarter with strong momentum. Some of the common themes were that demand had softened in response to high inflation and weak confidence, while manufacturing output had continued to slide due to the renewed supply disruptions caused by the Ukraine war and China's lockdowns.  

S&P Global chart

The slowdown had been most pronounced in Europe, with the composite PMI easing to a 16-month low at 51.9 from May's 54.8 reading. The close proximity to the Ukraine war was adversely affecting business and consumer confidence, and the services sector that had seen a boost following the easing of Covid restrictions for the summer was losing momentum. The UK's PMI reading had held up at 53.1 in June, unchanged from May, though weakness in new order growth and declining confidence pointed to slowing activity ahead. In the US, June's PMI reading at 51.2 was its weakest since the start of the year as spending in the services sector, particularly in discretionary-related areas, had weakened with household incomes squeezed by high inflation. Price pressures were still elevated, though they appeared to be easing as demand was cooling.   

RBA monitoring inflation expectations

With Australian inflation unlikely to peak until later in the year, RBA Governor Philip Lowe in a speech this week reaffirmed the guidance that further rate hikes remain on the table. Ongoing pressure on fuel and energy prices has prompted the RBA to lift its forecast for peak inflation from around 6% to 7% in the fourth quarter. While monetary policy cannot address these impulses pushing up inflation, Governor Lowe has also been highlighting the influence on inflation from strong demand in the Australian economy running up against capacity constraints. The most important insight from the speech was that higher rates were needed not only to bring demand into closer alignment with supply but also to keep inflation expectations anchored in the 2-3% target range. 

The June meeting minutes revealed that the Board's decision to speed up to a 50bps hike from a 25bps hike at the previous meeting was taken due to a shifting "inflation mindset" in which firms are increasingly willing to pass through higher input costs into prices, while workers, in the knowledge the labour market is strong, could be on the press for higher wages to compensate for the rising cost of living. While a 50bps hike is already expected in July, I think this week's communications indicate a 50bps hike in August could be a real possibility as well. Given the August meeting will come on the back of the Q2 inflation data, the risk is a strong print could prompt another upward revision to the RBA's inflation forecasts that will accompany that meeting, thereby making it difficult for the Board to scale back to a 25bps hike at that juncture. If the Board was to end up hiking by 50bps in August (for a total of 175bps since May), I'd expect a pause would then be likely, with rate hikes not coming back onto the radar until November following the Q3 CPI data and revised RBA forecasts. 

Fed committed to the inflation fight 

Over two days of testimony to the Congress, Fed Chair Jerome Powell told lawmakers the FOMC's commitment to lowering inflation was "unconditional". Chair Powell reiterated that this commitment would see the FOMC continuing to hike rates "expeditiously", removing stimulatory policy that was adding to inflation pressures. Pressed on whether an aggressive tightening cycle could cause the US economy to slow sharply and potentially tip into a recession, Chair Powell conceded that while it was a possibility, a downturn was not a necessary antidote to high inflation. But, overall, the tone was consistent with the messaging coming out of last week's policy meeting that the FOMC has shifted to prioritising inflation over risks to growth.  

UK inflation continues to rise

Headline inflation is yet to peak in the UK, with 12-month CPI ticking up to 9.1% in May from 9% in April. The BoE expects the peak will come later this year in Q4, with the pace running in double digits by that stage factoring in the next increase in the household energy price cap. After accelerating to 6.2% in April, the core rate eased by more than expected to print at 5.9% in May. The inflation situation keeps the option of a 50bps rate hike from the BoE in play, and the MPC's Catherine Mann, one of the three members who voted for that course of action at last week's meeting, said in a speech her view was partly shaped due to the depreciation in the Sterling that was boosting imported inflation. However, a weak result for retail sales in May (-0.5%m/m) and a fall in consumer sentiment to a record low are indicative of the strains households are feeling and could point to the BoE remaining with 25bps rate hikes.  

Macro (Re)view (17/6) | Off to the races

In the week of Royal Ascot, a race of a different kind went up a notch as central banks sped up the normalisation of policy settings. This was headlined by the Fed's 75bps hike but extended as far as the SNB, surprising markets with a 50bps hike. The BoJ remains the outlier keeping policy unchanged. An aggressive hiking cycle poses major risks to global growth prospects, leading equity markets to reprice accordingly and yield curves to flatten.   

Labour market data supports a 50bps RBA rate hike in July 

The Australian labour market continued to tighten in May, with this week's data set to keep the RBA normalising rates at an accelerated pace. Employment more than doubled the expected figure to advance by 60.6k in May, a result strong enough to hold the national unemployment rate at its 48-year low of 3.9% amid a surge in participation to a new record high at 66.7%. Full time employment continued to rise at pace lifting by a further 69.4k in the month, supporting the ongoing expansion in hours worked to 4.9% above pre-Covid levels. The rate of underemployment now has a 5 in front of it for the first time since 2008 (5.7%) and total underutilisation in the labour market is at a 40-year low (9.6%). My full review of the May Labour Force Survey can be accessed here. 

Although the pace of wages growth remains modest (2.4%Y/Y in Q1), the NAB Business Survey continues to indicate that labour costs are on the rise, while this week's decision by the Fair Work Commission to raise the national minimum wage by 5.2%, a tick above the rate of inflation (5.1%), will provide a boost. Appearing in a TV interview, RBA Governor Philip Lowe reiterated that the strength of demand was putting pressure on the capacity of the economy and, together with global factors, was contributing to high inflation. This has led the RBA to forecast a higher peak for inflation at 7% (from around 6%) by the end of the year, further supporting the case for a follow-up 50bps rate hike in July. While consumer sentiment has weakened sharply, Governor Lowe continued to remain upbeat on the economic outlook pointing to the strength of household balance sheets and the labour market. 

Fed accelerates tightening with a 75bps rate hike 

With May's CPI report showing US inflation lifting to 8.6% and concerns this was feeding into higher inflation expectations, the Fed responded by dialling up the pace of its tightening cycle with a 75bps rate hike at this week's meeting that takes the policy rate to 1.5% to 1.75%. Furthermore, members on the FOMC have significantly lifted their expectations for the scale of tightening required, signalling its policy rate will rise into a restrictive range for economic activity by the end of the year. In the post-meeting press conference, FOMC Chair Jerome Powell said a 50 or 75bps rate "seems most likely" at the July meeting.  

Upward revisions to the inflation outlook in 2022, with the headline PCE gauge rising to 5.2% and the core PCE rate at 4.3%, have prompted a more forceful reaction from the FOMC. The Summary of Economic Projections pushed the median estimate for the fed funds rate this year to 3.4% from 1.9%, with further hikes in 2023 taking the terminal rate to 3.8% (from 2.8%). The by-product of a more aggressive and frontloaded hiking cycle is lower output, with GDP growth revised down from 2.8% to 1.7% in 2022 and from 2.2% to 1.7% in 2023 before levelling out to a pace around trend in 2024 (1.9%). Despite these growth downgrades, unemployment is projected to rise only modestly across the projection period from 3.7% to 4.1%. This is a vastly more sanguine view on the economic outlook compared to the repricing that occured in markets this week that reflected expectations for a sharp slowdown and runs the risk of deteriorating into a downturn on the back of aggressive monetary policy tightening.     

BoE resists pressure hiking rates by another 25bps 

As other central banks are in the process of speeding up the return to more normal settings, it remained business as usual for the Bank of England this week as it hiked rates by another 25bps to 1.25%. The MPC's decision was sealed by a 6-3 vote (as it was in May), with the minority (comprising Haskel, Mann and Saunders) again calling for a larger 50bps hike. While sticking with 25bps hikes for now, the MPC appeared to position for greater optionality by replacing its previous policy guidance with a commitment to "act forcefully" in response to inflationary pressures.  

The situation for the BoE is finely balanced. On the one hand, it lifted its forecast for peak inflation to above 11% in October (currently running at 9%), which allows for another large increase in the energy price cap, but on the other, the growth outlook is deteriorating and it now expects GDP to contract by 0.3% in Q2. For the time being, households appear to be holding up still increasing spending despite a large squeeze on real incomes and very weak sentiment. A tight labour market has been a key support, with the unemployment rate at 3.8% and below its pre-pandemic level. The BoE also noted that cost of living support measures by the UK government would bolster households.      

ECB makes plans to deal with fragmentation  

After limited details emerged from the ECB's meeting last week on how it planned to contain peripheral yield spreads as it begins hiking rates from next month, the Governing Council went to the unusual step of calling an "ad hoc" meeting to discuss the matter. The meeting statement reported that reinvestments from its maturing PEPP holdings will be applied with "flexibility", allowing the ECB to purchase more Italian and other nations' bonds. 

Although it is unclear how much PEPP redemptions would amount to, analyst estimates suggest this could be in the order of €200bn through the remainder of the year. The statement then went on to confirm that the Governing Council had tasked its committees with accelerating the preparatory work for a new "anti-fragmentation" tool. Earlier in the week, the ECB's Isabel Schnabel in a speech said there were "no limits" to the central bank's commitment to ensuring the smooth transmission of its monetary policy stance across the euro area.      

Australian employment 60.6k in May; unemployment rate 3.9%

The Australian labour market tightened further in May as employment came in well above expectations. Strong demand for labour was accompanied by a rise in the partcipation rate to a new record high. Today's report points to a 50bps RBA rate hike in July.  

Labour Force Survey — May | By the numbers

• Employment surged higher by a net 60.6k in May, well above the consensus forecast for a 25k rise. April's increase was revised slightly higher to 4.4k from 4k. 

• National unemployment rate remained at 3.9%, missing expectations for a fall to 3.8%. However, the underemployment rate printed with a 5-handle (5.7%) for the first time since 2008 and total underutilsation has fallen to a 40-year low (9.6%). 
• Participation rate lifted from 66.4% to 66.7% in May, a new record high.

• Hours worked advanced by 0.9%m/m to be up by 2.1% over the year.

Labour Force Survey — May | The details

The Australian labour market continues to go from strength to strength. Today's report for May showed the national unemployment rate remained at 3.9%, it lowest since 1974. In a tightening labour market more and more Australians are finding work and working the hours they are looking for. As a result, the rate of underemployment has fallen below 6% for the first time since 2008 and total underutilisation in the labour market has declined to its lowest level since 1982. 

After declining slightly over the past couple of months due to the disruptions from Omicron and the east coast floods and through the Easter holiday period, participation picked back up in May to rise to a new record high at 66.7%. Meanwhile, the share of Australians in work continues to rise, resetting to a new record high in May at 64.1%, 1.6ppts above its pre-Covid level. 

May saw a resurgence in employment, posted at a net increase of 60.6k in the month. Employment had slowed in March and April, reflecting the impact of the floods in New South Wales and Queensland and reduced hiring during the Easter holiday period. In May, full time employment lifted by 69.4k while part time employment declined by 8.7k. So far in 2022, growth in full time employment has been incredibly strong (307k) as part time employment has declined (-99k). This likely reflects a couple of factors. Firstly, many part time workers have likely taken on additional hours amid very high levels of job vacancies, thus crossing the threshold defined by the ABS for being employed full time (35 or more hours in the survey week). Secondly, given those high vacancies, many Australians previously working part time have been able to find full time positions.    

Total hours worked in the economy lifted by a strong 0.9% in May following on from April's 1.3% rebound from the east coast floods. This takes monthly hours to 4.9% above their pre-Covid level from March 2020. Reflecting the strength in the employment outcome, full time hours advanced by 1.4% in May to be 6.4% higher across the Covid period. Part time hours were down in the month (-1.5%) and are below their pre-Covid level (-2.6%).  

Total hours worked would have recorded an even stronger rise in May but for the significant disruptions that continue to be posed by Omicron and, more recently, seasonal flu. The number of Australians working fewer hours than usual due to illness surpassed the peak seen during the Omicron wave rising to 780.5k in May (around 5.6% of the labour force). Increased illness at schools likely drove the large rise in the number of people taking time away from work for caregiving reasons in May to 352.4k (around 2.5% of the labour force).  

Labour Force Survey — May | Insights

A strong report today confirmed that the Australian labour market continues to tighten. With the RBA noting in its decision to hike rates by 50bps at the June meeting that the labour market conditions were "contributing to the upward pressure on prices", another 50bps hike in July is surely on the cards. There are a couple of key points to note, however. Firstly, the rise in the partcipation rate to record highs creates a much better supply-demand balance than seen in many other labour markets around the world, which is likely to mean wages growth will not accelerate at an uncomfortable pace for policymakers. Secondly, hiring is settling towards a pace that the Australian economy can comfortably sustain as labour demand remains strong.