Australian trade surplus widens to $9.3bn March

Australia's trade surplus widened in March, driven by a softening in import spending as export earnings held around record highs. Sizeable trade surpluses are being driven by surging commodity prices following the war in Ukraine, boosting Australia's terms of trade.  

International Trade — March | By the numbers

• Australia's trade surplus increased by more than expected, coming in at $9.3bn in March (vs $8.4bn expected). February's trade surplus was revised to $7.4bn from $7.5bn.

• Exports were flat on the month (-0.1%) to remain around record highs at $49.5bn (25.5%yr).
• Imports softened in March (-4.6%) to $40.1bn (23.9%yr) after accelerating in February (13.4%).

International Trade — March | The details

A fall in import spending saw Australia's trade surplus widen by around $1.9bn in March to $9.3bn. Overall, in the first quarter, the trade surplus was around $29bn, up slightly from Q4 ($28bn) but below the highs seen between Q2 and Q3 of 2021 (from $30-35bn).

Australia's export earnings are at record highs after accelerating by 10.2% over the first quarter. This reflects strong global demand for domestic commodities and surging prices due to the war in Ukraine. Non-rural goods lifted by a modest 1.7% in March but surged by 13.3% over Q1 on the back of metal ores (18.3%q/q) and coal (17.4%q/q). 

Earnings from rural goods increased by 5%q/q. Cereal exports were lower in March (-13.1%), but given that both Russia and Ukraine are major wheat exporters, demand for the domestic product is likely to have risen since the war. Services exports (which includes inbound tourism) saw a modest improvement over Q1 (2.2%), with the easing of border restrictions to start supporting the recovery of the sector.   

Import spending declined in March (-4.6%) but lifted sharply over Q1 (11.8%) supported by strong domestic demand conditions, with the pick-up also reflecting the impact of higher prices for imported goods. Consumption goods lifted very strongly in Q1 (16.3%) even after seeing a fall in March (-8.4%). All sub-categories saw large rises over Q1, with vehicles (33.1%) and household electrical items (25.5%) the standouts. 

Intermediate goods (inputs used within production) saw a 12.6% lift over Q1 to continue their acceleration as supply chain constraints push up prices. Imports of capital goods advanced by 4.8% in the quarter, supported by a pick-up in business investment associated with the economic recovery and government tax incentives. Services imports have commenced their recovery rising by 10.3%q/q as overseas travel restrictions were eased.   

International Trade — March | Insights

Data on trade prices published by the ABS last week indicated Australia's terms of trade surged in the order of 12% over the first quarter, with accelerating commodity prices in the wake of the Ukraine war driving up export earnings and boosting national income. Notwithstanding a recent pullback, the Australian dollar has risen sharply since the start of the year, with the higher terms of trade a key driver. Despite higher inflation, a rising Australian dollar and strong domestic demand conditions have supported import spending. 

Australian housing finance rises 1.6% in March

Australian housing finance commitments lifted by 1.6% in March to defy expectations for a decline. Investor activity accelerated over the first quarter while owner-occupier commitments rebounded. With the RBA's rate hiking cycle now underway, housing finance is set to unwind from elevated levels. 

Housing Finance — March | By the numbers

• Housing finance commitments ($ value, ex-refinancing) posted a 1.6% rise in March to come in at $33.3bn. The consensus forecast was for a 1.9% fall following  February's 3.5% decline. Annual growth in commitments eased from 14.3% to 11.1%. 
• Owner-occupier commitments firmed by 0.9%m/m to $21.6bn but are down 2.2% over the year.  
• Investor commitments lifted by 2.9%, more than rebounding from a brief pause to the upswing in February (-1.1%), with the monthly level resetting to a new record high at $11.7bn.  
• Refinancing activity was up 4.6% in the month to $16.4bn (28.2%yr)

Housing Finance — March | The details 

Australian housing finance commitments (excluding refinancing) posted a 1.6% rise in March to $33.3bn, sitting just off their record high. Over the first quarter, lending commitments lifted by 6%. Investment lending (2.9%m/m) drove the overall increase in March and in the the first quarter (11.8%). Owner-occupier commitments lifted by 0.9% for the month and saw a rise over the first quarter (3.1%). The main themes during Q1 were: the acceleration in the strength of investor activity, while owner-occupiers rebounded from a lockdown-impacted second half of 2021.  

In the owner-occupier segment, upgraders drove the Q1 rebound (4.2%q/q), more than offsetting weakness from first home buyers (-6%q/q) and in the construction-related area (-1.2%q/q). 

In terms of approvals volumes, all categories in the owner-occupier segment saw declines. Construction-related approvals were down 3.4%q/q and first home buyer approvals fell by 10%q/q, consistent with the unwind from earlier stimulus measures. Approvals to upgraders declined by 1.4%q/q, so the pick-up in lending (4.2%q/q) was driven by rising house prices. 

Since reaching their lows during the pandemic, investor lending has been on a long upswing rising in 20 of the past 22 months. Commitments to the segment are at record highs with accommodative financing conditions, rising house prices and tight rental markets supportive factors. 

At the state level, investor lending surged in New South Wales (11.5%), Victoria (19.6%) and Western Australia (12%) in Q1. Owner-occupier lending rebounded in Victoria (6.5%q/q) and Western Australia (3.8%q/q) but was soft in the other states. Declining activity from first home buyers was a major factor behind this with large declines on the quarter seen in New South Wales (-8.3%), Queensland (-14.6%), South Australia (-9.4%) and Tasmania (-10%). 

Housing Finance — March | Insights

Housing finance commitments lifted strongly over the first quarter, rising by 6% overall on the back of a surging investor segment, while owner-occupier lending rebounded from recent weakness that can be linked to deferred activity during the Delta lockdowns. The combination of an RBA rate hiking cycle and cooling house prices in the nation's two major capitals mean housing finance is set to unwind from elevated levels. Tight rental markets could keep investor activity strong for a while yet. 

RBA commences rate hiking cycle

The RBA has responded to rising wage and inflation pressures by commencing its hiking cycle at today's meeting and signalling a series of further hikes to come through the remainder of 2022 into 2023. A robust outlook for Australian economic growth and a tightening labour market mean policy will be directed at containing inflation, with a frontloaded hike possible at the next meeting in June. 

May meeting decisions

A determination that the Australian economy no longer needs a policy rate at the emergency lows of the pandemic led to the Board hiking its key interest rates by 25bps today. This has increased the cash rate target from 0.1% to 0.35%, while the rate on Exchange Settlement balances was lifted from 0% to 0.25%. As anticipated, this retains the 10bps spread in the cash rate target over the rate on Exchange Settlement balances that the RBA has had in place since November 2020. The actual cash rate will now trade in the range between 0.25% to 0.35% (up from 0% to 0.1% previously). In effect, the RBA met those calling for a hike today halfway between a 15bps (my call) and 40bps increase.    

The Board also announced the start of quantitative tightening (QT), informing markets that it will not reinvest the proceeds from its maturing bond holdings, though it said it has no plans to actively sell bonds back into the market. This decision was expected and means QT will commence in July, which is when the next maturing Australian government bond line falls. As covered in the preview, QT will do more of the heavy lifting in tightening the monetary policy stance from 2023 onwards, so the focus is very much on the policy rate for now. 

Rising wage-price pressures prompt a recalibration of policy  

While many central banks are likely to face an increasingly difficult trade-off between supporting growth prospects and curbing inflation as 2022 progresses, the RBA's situation is much more favourable. In today's decision statement and in his post-meeting press conference, Governor Philip Lowe reiterated domestic growth prospects are robust in 2022 with GDP growth of 4.25% expected before slowing to 2% in 2023. These forecasts are unchanged from February despite rising caution around the headwinds to global growth from the Ukraine war, China's lockdowns and the squeeze on consumption from high inflation. 

A favourable growth outlook means the Board will concentrate policy on containing inflation. Since the Board last met and on the back of the stronger-than-expected Q1 CPI data, its assessment of wage-price dynamics has shifted markedly. With underlying inflation rising above the top of the 2-3% target band to 3.7% in Q1, price pressures have broadened and are expected to be more persistent, with the RBA's liaison identifying that firms are increasingly confident in passing through higher prices to customers. Accordingly, the Bank's updated forecasts (to be released on Friday) have lifted the outlook for underlying inflation this year substantially, from 2.75% to 4.75%, with an easing back to 3% not expected before mid-2024. 

Underpinning a higher inflation outlook is accumulating wage pressures, which are increasingly being reported to the RBA in its liaison program. In a tightening labour market, many firms are having to lift wages to attract and retain staff, and further falls in unemployment are expected. The RBA now expects the unemployment rate to fall to 3.5% (from 3.75% previously) by the end of the year and to hold at that level through 2023. All told, the RBA is now confident that the aggregate measure of wages growth in the Australian economy, the Wage Price Index (next due on 18 May), is on the rise and could lead to more durable inflation pressures. It is in that context that the RBA's policy outlook has shifted.  

More rate hikes to come in 2022 and 2023 

The Board now has an explicit tightening bias in place, with the final paragraph of the decision statement noting that in order to contain inflation "a further lift in interest rates over the period ahead" will be required. Importantly, Governor Lowe said in the post-meeting press conference that the forecast for underlying inflation to run above the top of the target band through to mid-2024 is despite using an assumption where the cash rate rises to around 1.5% to 1.75% by the end of the year and to around 2.5% by the end of 2023. 

Given this, there is a strong possibility the RBA will look to frontload this tightening cycle, following the likes of the Fed, BoC and RBNZ. This could lead to a larger hike (40-50bps) at the next meeting in June, particularly if the WPI data comes in stronger than expected. A more complete assessment of the evolution of the RBA's hiking cycle will be possible after it publishes its quarterly Statement on Monetary Policy on Friday.   

Preview: RBA May meeting

With underlying inflation rising through the top of the target band for the first time in 12 years and a labour market tightening more rapidly than forecast, the RBA looks likely to start moving its policy rate away from emergency settings with a 15bps hike today (decision due at 2:30pm AEST), as well as signalling the start of balance sheet reduction. Upward revisions to the RBA's inflation and wages growth forecasts are set to prompt a recalibration of the policy outlook with Australian growth prospects remaining robust. 

This preview covers 3 key areas of focus for today's meeting. 

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1. RBA to hike rates by 15bps

My call is for the RBA to start moving the cash rate target off its pandemic low of 0.1%. I think this first move will be a smaller hike of 15bps, bringing the cash rate target to 0.25%. Standard moves for the RBA occur in 25bps increments, while there are some calls for a 40bps hike today. 

After the pandemic struck, the RBA cut rates by a total of 65bps through 2020, so a 15bps hike is a gradual start in reducing that emergency support. However, a gradual start could be a significant consideration given the RBA hasn't raised rates since November 2010. It may want to start hiking rates by a smaller amount than usual than to wait until June when markets could pressure the RBA into a larger 40bps hike. 

Since November 2020, the cash rate target has been set at a 10bps spread over the rate on Exchange Settlement balances. The April meeting minutes indicated this arrangement would be retained for the time being, meaning that in the event the RBA elects to hike today, the rate on Exchange Settlement balances would likely rise from 0% to 0.15%. This would shift the range the actual cash rate trades at up from 0% to 0.1% to 0.15% to 0.25%. 

The rise in inflation in Q1 to 5.1%Y/Y on a headline basis and to 3.7%Y/Y on the underlying rate reported last week prompted markets to bring forward their timing for the first hike from June to May, with a 15bps hike fully discounted today. The risk to a May hike call is that the RBA does not have an explicit tightening bias in place having emphasised the importance of waiting for the upcoming wages growth data (due 18 May); however, there were enough signs from the April meeting to indicate that a hike was close. 

This included the hawkish tilt from the Board by removing its "patient" guidance for policy to respond to the evolving wage-price dynamics. The meeting minutes also identified the actions of other central banks in hiking rates to contain inflation as a key consideration for the RBA's reaction function. Having already started their hiking cycles, it is likely that later on in the week the Fed will accelerate the process by hiking by 50bps and the BoE by another 25bps.

Looking beyond today's decision, pricing in the swaps market sees the cash rate being hiked to at least 0.5% by July and to be at least 1% in 6 months' time. This week's updated economic forecasts (discussed below) will be influential to these expectations. 

2. New economic forecasts to revise higher the inflation and wages growth outlook    

Another important consideration behind a May hike is that the timing corresponds with an updated set of quarterly economic forecasts. Those forecasts will be released in full on Friday in the quarterly Statement on Monetary Policy, but they will be in front of the Board for today's decision and are often the catalyst for policy changes. 

There should be some early insights in Governor Lowe's decision statement today, with the forecasts for inflation and wages growth key. Finalised back in February, the inflation forecasts were already in line to be revised materially on the back of the spillover effects from the Ukraine war on fuel and food prices. Q1's stronger-than-expected increases in Australia's key inflation rates mean those revisions will now be even higher than previously anticipated.  

The current forecasts have headline inflation at 3.25% this year, moderating to 2.75% in 2023, while trimmed mean inflation is at 2.75% this year and next. Revisions that take trimmed mean inflation above the top of the target band north of 3% in 2022 and into 2023 would be an important development and could be used to justify a rate hike today.

A higher outlook for underlying inflation is likely to be supported by stronger wages growth due to the labour market tightening more rapidly than expected. The unemployment rate is at a 14-year low of 4% and the high level of job vacancies indicates further falls are likely. That could see unemployment fall even lower than earlier expected by the end of the year (3.75%) and in 2023 (3.75%).  

While Australia is far from a wage-price spiral, a tighter labour market would put upward pressure on wages growth. That would likely see the forecasts for this year (2.75%) and next (3%) lifted. Wages growth of at least 3% in 2022 and higher in 2023 is broadly consistent with the sort of pace the RBA has said is needed for sustainable 2-3% inflation.    

Whereas many central banks are having to cut their growth forecasts, the RBA is unlikely to alter its projections for 2022 (4.25%) and 2023 (2%) too significantly. A tight labour market, high accumulated savings and eased pandemic restrictions are supporting the consumption outlook, while there is also a very large pipeline of residential construction work. Headwinds are mostly coming from offshore, with global growth set to slow on the combined effects of the Ukraine war, China's lockdowns and monetary and fiscal tightening. 

3. Balance sheet reduction to commence in July  

Back in February, the RBA said it would defer to May a decision on the reinvestment of its maturing bond holdings. With the next maturity of Australian government bonds falling in July, a decision today gives markets advanced notice. Previously, the RBA has said the key factors in this decision will be the state of the economy and the outlook for unemployment and inflation. 

Strong growth prospects and an upgraded outlook for unemployment and inflation mean the Board is likely to announce it will allow maturing bonds to start rolling off its balance sheet in July. However, it won't be until 2023 that the balance sheet really starts coming into focus as more of the bonds acquired in support of the 3-year yield target policy mature and as banks start repaying the 3-year funding drawn under the Term Funding Facility. A decision to start balance sheet reduction would put the RBA in sync with many of its central bank peers.  

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A final point to note is that over the Covid period, the RBA has followed up decisions to change policy with post-meeting press conferences. If the RBA does hike today, expect Governor Lowe to front the press and analysts later on in the afternoon.  

Macro (Re)view (29/4) | Domestic reappraisal

Risk sentiment in markets was under pressure over April as bond yields surged on the back of central banks indicating a willingness to do more in response to high inflation, an effort the RBA looks set to join. Growth concerns associated with the Ukraine war and lockdowns in China were also headwinds.  

RBA to hike rates in May...

Rates markets now expect the RBA to start hiking rates at next Tuesday's May meeting, bringing forward the timing from June following this week's Q1 inflation data. The previous expectation for liftoff in June was largely based around the RBA's guidance on waiting for confirmation that a tightening labour market is generating a pace of wages growth consistent with sustainable 2-3% inflation, with the wages growth data not due until 18 May. However, the repricing has come as headline CPI printed with a 5-handle for the first time since 2008 and as underlying inflation moved above the top of the RBA's target band to a 13-year high. 

My own view is that the RBA will hike by 15bps next week, as the May meeting will allow the Board to recalibrate its monetary policy stance to new economic forecasts (published next Friday), while it is also due to make a decision on the reinvestment of maturing bonds acquired under the QE program. From a communications standpoint, this seems a good time for the RBA to start gradually moving the policy rate away from its pandemic low of 0.1% with the economy still performing strongly.

...after inflation accelerated in Q1  

Headline inflation lifted from 3.5% to 5.1%Y/Y in the March quarter as the spillover effects from the Ukraine war drove up fuel (11%q/q) and food prices (2.8%q/q), while ongoing supply constraints added further to housing construction costs (5.7%q/q). A broadening of price pressures amid strong domestic demand conditions saw the trimmed mean (or underlying) pace up at 3.7%Y/Y from 2.6%. (Full review of the CPI report is available here) 

In a global context, Australian inflation pressures have been more modest than in other comparable economies but there was an acceleration in the March quarter. Disruptions to supply chains and higher commodity prices lifted the inflationary impulse from food significantly and increased the contribution to CPI coming from fuel. Australia's very large residential construction pipeline is leading to materials and labour shortages, and with government stimulus grants fading, housing construction costs are a major driver of inflation. 

Excluding the price changes from these more volatile items, Australia's underlying inflationary pulse is being driven by higher goods prices, reflecting the same supply/demand imbalances that has seen goods inflation surge offshore. Underlying goods inflation has jumped from a modest 2.9% to 5.2%Y/Y, its fastest since 2001. This compares with underlying services inflation of 2.6%Y/Y, which is higher than its range over recent years without accelerating in the manner goods inflation has. 

Terms of trade boost to support the Australian economy

Whereas some of the RBA's global central bank peers are facing the prospect of hiking rates into concerns over economic growth prospects as high inflation squeezes real incomes, Australia is a net beneficiary of surging commodity prices. In Q1, Australian export prices surged by 18% as the Ukraine war led to price rises in some of the nation's major commodities (coal 32%q/q, iron ore 24.8%q/q, natural gas 13%q/q and rural goods 5%q/q). With import prices up by a comparatively modest 5.1% in Q1, the nation's terms of trade surged in the order of 12% in the quarter. This boost to national income will help insulate demand from higher inflation.

US domestic demand is showing resilience  

An unexpected fall in Q1 US GDP growth belied resilience in underlying demand conditions. Real GDP contracted by 0.4%q/q in the March quarter, but the decline was driven by negative contributions from inventories and net exports, with the latter reflecting very large US trade deficits. Excluding these components, final sales to domestic purchasers (incorporating household, business and government demand) lifted by 0.6%q/q, up from 0.4% in Q4.

Household spending lifted by a solid 0.7%q/q, though detailed data showed a slowdown over February and March, with goods consumption contracting in both months. The surge in inflation from higher fuel and food prices looks to have weighed on discretionary consumption. Ahead of next week's Fed meeting, its preferred core PCE inflation rate came in at 5.2%yr in March, still very elevated but down slightly from the prior month. 

Meanwhile, the employment cost index — another closely watched measure by the Fed — lifted above expectations rising by 1.4% in Q1 to be up 4.5% over the year. A tightening labour market continues to generate pressure on wages and with concerns this could keep high inflation entrenched, the Fed is all but certain to hike rates by 50bps next week.  

Euro area inflation rises further as GDP growth slows

Despite a retreat in energy prices following their war-driven surge, preliminary inflation readings in the euro area showed further increases in April as GDP growth in the first quarter was weighed by the Russian invasion of Ukraine and lingering Covid effects. Headline inflation firmed from 7.4% to 7.5%yr, with rising food, goods and services prices more than offseting a fall in energy prices in the month following government tax cuts. A material rise in the core inflation rate to a record high at 3.5%yr from 2.9% pointed to broadening price pressures in the bloc, with the war and supply chain disruptions contributing factors. 

From a growth perspective, momentum in the economy has slowed sharply over the past two quarters after GDP had recovered to its pre-Covid level. First quarter GDP growth was posted at 0.2% following the 0.3% expansion in the final quarter of 2021. The ECB expects slow growth ahead with the war and high inflation weakening confidence and the lockdowns in China posing further risks to supply chains. That is restraining the ECB's guidance on tightening, but markets are priced for the ECB to hike rates at least twice by the end of the year due in response to the inflation pressures.  

BoJ remains dovish 

A downward revision to the 2022 economic growth outlook in Japan from 3.8% to 2.9% in response to the headwinds from Omicron and the Ukraine war left the BoJ showing no sign it was close to reducing stimulus at this week's meeting. The BoJ's key decisions included a commitment to make daily bond purchase in defence of its yield curve control policy. This led to further weakness in the JPY, which is trading at 20-year lows to the USD.

Australian Q1 CPI 2.1%, 5.1%Y/Y

Australian annual headline inflation printed with a 5 handle in the March quarter for the first time since 2008, while underlying inflation on the trimmed mean measure accelerated above the top end of the RBA's target band to a 13-year high at 3.7%. The light has turned green for the RBA Board to start its hiking cycle at next week's meeting, lifting the cash rate target by 15bps to 0.25%. 

Consumer Price Index — Q1 | By the numbers 

• Headline CPI printed 2.1% in Q1, stronger than the 1.7% pace expected and up from 1.3% in Q4. The seasonally adjusted CPI was up 2%q/q, lifting the annual pace from 3.6% to 5.2%. 

• The underlying CPI measures (seasonally adjusted) came in either side of estimates but are now above 3% in annual terms:

• Trimmed mean was 1.4%q/q (vs 1.2%), with the annual rate up at 3.7% (vs 3.4%) from 2.6%.

• Weighted median posted at 1.0%q/q (vs 1.2%), with the year-on-year rate rising from 2.5% to 3.2% (vs 3.3%). 

Consumer Price Index — Q1 | The details 

As seen globally, consumer price inflation in Australia has accelerated over the first quarter of 2022 with the spillover effects from the war in Ukraine accentuating existing supply/demand imbalances. Headline inflation on both the quarterly (2.1%) and annual rates (5.1%) saw their fastest increases since the introduction of the GST in 2000. Reflecting a broad-based rise in price pressures across the economy, trimmed mean underlying CPI lifted sharply in Q1 (1.4%q/q) to 3.7%Y/Y and is above the RBA's 2-3% target band for the first time in 12 years. 

Surging fuel prices (11%q/q) and higher base prices for new dwelling construction (5.7%q/q) with the HomeBuilder grants scheme winding down remained major drivers of headline inflation, while food prices lifted 2.8%q/q to add a new material impulse to inflation on the back of higher fertiliser and transport costs and supply-related disruptions. Were it not for the pandemic recovery dining-out voucher schemes in Sydney and Melbourne, food prices would have risen by more. All up, fuel, new dwellings and food accounted for three-quarters of the rise in quarterly headline inflation. Outside of these drivers, education costs lifted 4.5%q/q to make a sizeable contribution to quarterly CPI due to the recalibration of tertiary fees.    

With the Ukraine war leading to supply disruptions, Australian fuel prices posted an 11% surge in Q1 to be up 35.1% over the year. This alone has contributed 1.3ppts to headline inflation over the past year. There will be a pullback in Q2 due to the excise tax cut announced by the federal government in its recent Budget. 

New dwelling costs continue to rise as the dampening effect on developers' base prices from the HomeBuilder grants scheme winds down and as the very large pipeline of residential construction work drives ongoing materials and labour shortages. In the quarter, new dwelling prices were up 5.7% and surged to 13.7%Y/Y. Rents saw their fastest quarterly rise in more than 7 years (0.6%q/q). Although the annual pace is modest (1.0%), this will rise slowly reflecting the tightening in capital city rental markets and will become a driver of inflation. 

Food prices overall increased by 2.8% in the quarter to be up by 4.3% over the year. This leaves annual food inflation at its fastest since Q3 2011. Strong quarterly increases were seen in meats and seafoods (4.8%), fruit and vegetables (5.8%) and non-alcoholic beverages (5.9%). 

Where there was some relief for consumers was in durable goods, with price pressures easing after supply/demand imbalances had driven strong increases over the pandemic recovery. There were price declines in the quarter in furniture and furnishings (-2.5%), clothing and footwear (-0.6%) and AV equipment (-0.2%). Meanwhile, new vehicle costs continued to rise but at a more moderate pace (1%) than in recent quarters. 

  

Consumer Price Index — Q1 | Insights 

Australian CPI came in well above expectations in the March quarter with the effects of the Ukraine war accentuating existing supply constraints amid strong domestic demand conditions. Underlying inflation has accelerated above the top of the RBA's 2-3% target band for the first time since 2010 ahead of next week's Board meeting, where it will also have a new set of economic forecasts to factor into its decision. Although the Board has stressed the importance of the upcoming wage data (due 18 May), I think today's CPI data will prompt the Board to change course and deliver its first rate hike for the cycle next week, lifting the cash rate target by 15bps to 0.25%.   

Preview: Australian Q1 CPI

Australia's March quarter CPI inflation data are due to be released by the ABS at 11:30am (AEST) today. With the spillover effects from the Ukraine war adding to existing supply constraints, headline inflation is expected to have accelerated in the quarter to 4.6%Y/Y with fuel, new dwelling costs and food the major contributors. Broadening price pressures are forecast to drive underlying inflation above the top of the RBA's target band to 3.4%Y/Y. Upside surprises to these key inflation rates could prompt the RBA Board to commence its rate hike cycle at next week's May meeting.     

As it stands | CPI 

Inflation surprised to the upside of market expectations in the December quarter. Headline CPI printed at 1.3% in the quarter, lifting the annual rate from 3% to 3.5%. Underlying inflation measures saw their fastest quarterly increases since at least 2009 as the annual pace returned to the midpoint of the RBA's 2-3% target band for the first time in 7 years. Trimmed mean CPI was 1% in the quarter and 2.6% over the year while the weighted median CPI came in at 0.9%q/q and 2.7%Y/Y. 

Rising petrol prices and higher base prices for constructing new dwellings due to fewer grants being paid out under the HomeBuilder scheme remained the main drivers of inflation. However, the key development over the December quarter was the broadening of price pressures. This included prices of consumer durables picking up, with clothing and footwear a key contributor following widespread discounting during the Delta lockdowns in Q3. Meanwhile, eased border restrictions led to rising domestic travel costs. For a full review of the Q4 CPI data see here.  

Market expectations | CPI

For headline CPI, the consensus forecast is for the quarterly rate to come in at 1.7% (range: 1.4% to 2.0%) on the back of rising prices for fuel, new dwellings and food. This would lift the annual pace up from 3.5% to 4.6%, its fastest since Q3 2008. 

Underlying inflation pressures are expected to rise further after picking up over recent quarters. The key trimmed mean CPI is forecast to print at 1.2% in the quarter, driving the annual rate up from 2.6% to 3.4%. If realised, this would see the trimmed mean at its fastest annual pace since Q2 2009. The forecasts for the weighted median CPI are at 1.1%q/q and 3.3%Y/Y.  

What to watch | CPI 

An upside surprise on CPI, particularly for the underlying measures, could see markets pulling forward their expected timing for the first RBA rate hike from June into next week's May meeting. Current pricing is firming around a 40bps hike in June as consensus, allowing the Board to take in the Q1 Wage Price Index data (due 18 May). But if today's CPI numbers print above expectations, it will lead to larger upward revisions to the RBA's forecast tables in its May quarterly Statement on Monetary Policy (due 6 May). That could prompt the Board to hike next Tuesday, which if it did would likely be a 15bps increase to 0.25%.  

Macro (Re)view (22/4) | Global growth headwinds intensify

Comments from US Federal Reserve Chair Jerome Powell supported the market narrative that central banks are on the path to quickly returning policy toward neutral settings, even as headwinds to global growth are intensifying. Volatility in the fixed income markets remains high with implications for equities while strength in the US dollar index has extended to be trading around 2-year highs.  

IMF downgrades global growth, upgrades inflation outlook 

The IMF this week outlined the increasingly complex economic outlook that has unfolded following the Ukraine war, with rising inflation pressures intensifying the headwinds to growth. For policymakers, this outlook has exacerbated the trade-off between needing to stabilise inflation while at the same time safeguarding growth prospects. Forecasts for global GDP growth have been lowered this year from 4.4% to 3.6% and in 2023 from 3.8% to 3.6%, with the Russian invasion of Ukraine, the withdrawal of monetary and fiscal support, a slowdown in China and the ongoing effects of the pandemic the factors cited as driving the downward revisions. At the same time, with the war adding to existing supply-driven inflation pressures through higher commodity, energy and food prices, forecast inflation in 2022 for advanced economies was lifted from 3.9% to 5.7%, and from 2.1% to 2.5% in 2023. 

The largest 2022 growth downgrades were in Russia and Ukraine stemming from the direct impacts of the conflict, while the spillover effects on supply chains and energy prices have dented growth prospects in the euro area (3.9% to 2.8%), particularly in Germany and Italy due to their significant manufacturing sectors. With the Fed hiking rates and the Congress unable to agree on the passage of fiscal stimulus, forecast US growth in 2022 was cut from 4% to 3.7%. With China persisting with its zero-Covid approach, the associated lockdowns and restrictions have seen its growth outlook fall from 4.8% to 4.4%. Against the run of play, Australia was one of the few major economies to receive a growth upgrade, with the 2022 forecast lifted from 4.1% to 4.2%.  

Source: IMF

RBA minutes detailed the Board's hawkish pivot 

The hawkish pivot from the RBA to remove its patient guidance came about due to the likely timing of the first rate hike being "brought forward" with inflation pressures rising and wages growth firming according to the April meeting minutes. Markets expect the cash rate to start rising in June, though they are giving some chance of liftoff in May and that could firm if next week's Q1 CPI data comes in stronger than expected (1.7%q/q, 4.6%Y/Y). Factors that will be key throughout the RBA's hiking cycle will be the evolution of price and wage pressures, with the former largely being driven by supply constraints and the latter picking up but yet to reach levels consistent with sustainable 2-3% inflation. The minutes also revealed international developments will also be influential. The observations from the Board were that tightening expectations had become more frontloaded but that policy rates were likely to peak lower than in previous cycles due to the risks to the downside risks to the global growth outlook. 

Fed Chair Powell endorses faster tightening

During an IMF panel discussion, US Fed Chair Jerome Powell made clear his intent was to step up the pace of monetary policy tightening to counter high inflation saying that it was "...absolutely essential to restore price stability". The key message Chair Powell wanted to get across was that the FOMC will be moving "expeditiously" in returning the policy rate to a more neutral level by the end of the year. This validated market expectations for a larger 50bps hike in May, which is expected to be followed up by two further 50bps hikes in June and July. Given the current inflation pressures, Chair Powell said it was appropriate to be removing accommodation more quickly than in the past, though there was recognition of the challenge the Fed is facing in trying to deliver a soft landing. For the time being, the strength of the US economy and tight labour market is giving the FOMC confidence that it can withstand substantial monetary policy tightening.      

Caution marks the outlook in Europe...

Compared to the US, the euro area economy is in a more fragile position, highlighted by the IMF growth downgrades, while also facing significant inflation pressures. The IMF panel discussion was also attended by ECB President Christine Lagarde who was more cautious in her outlook for policy saying that the supply shock-driven rise in inflation called for a gradual and sequential response. President Lagarde also noted that although headline inflation was 7.4%yr in March, the core rate was 2.9%yr (both readings were revised 0.1ppt lower this week), a more manageable situation than in the US. However, markets picked up on the hawkish shift from ECB Vice-President de Guindos who called for asset purchases to be brought to an end in July, opening the door for rates to start rising from then onwards.

... and increasingly in the UK as well 

Bank of England Governor Andrew Bailey spoke of the fine line the MPC was treading in hiking rates to bring down inflation at the same time as growth prospects were coming under pressure from the negative shock to real incomes. MPC member Catherine Mann said in a speech this week that the evolution of the BoE's hiking cycle hinges on the responsiveness of consumer demand to the surge in inflation. The early indications are that the impacts are material as retail sales volumes came in much weaker than expected falling by 1.4% in March as consumer confidence deteriorated to its lowest since 2008.