Australian dwelling approvals flat in June

Australian dwelling approvals posted a better-than-expected result in June and recording their first quarterly rise in a year. After an extended downturn, that may yet have further to run, both the house and unit segments contributed to the quarterly rise in dwelling approvals. 

Building Approvals — June | By the numbers

• National dwelling approvals (seasonally adjusted) were broadly flat in June (-0.7%m/m) at 16,461 against the median estimate for a 5% decline. Approvals have fallen by 17.2% over the year. In the previous month, approvals lifted by 11.2% (revised from 9.9%). 

• House approvals increased by 0.9% to 9,910 (-22.1%yr) following a 1.8% fall in May. 

• Unit approvals were down by 3.1% month-on-month to 6,552 (-8.4%yr). Approvals in the segment spiked in May rising by 37.6%.

Building Approvals — June | The details 

Having receded from their cycle high reached in early 2021, dwelling approvals stabilised over recent months to rise by 2.4% in the June quarter. Both house (2.2%) and unit approvals (2.9%) lifted in the quarter, their first quarterly increases since Q1 2021 and Q3 2021 respectively.  

The quarterly total for detached house approvals was 29.7k, well down from the peak in Q1 of last year at around 41k. Higher-density approvals came to 18.2k in the June quarter, broadly in line with pre-pandemic levels. The underlying data indicated that high rise approvals lifted strongly over the quarter; low rise approvals contracted and townhouse approvals were broadly flat.

On the alterations side, the value of alteration work approved declined in June (-2.2%) but still advanced by nearly 4% in the quarter. The surge in materials and labour costs has contributed to keeping alteration approvals very elevated long after the HomeBuilder stimulus has wound down.  

Turning to the states, dwelling approvals posted quarterly declines in New South Wales (-2.3%) and Victoria (-3.5%), the latter being driven by weakness in the higher-density segment (-13.6%). The other states all saw quarterly rises led by unit approvals: Queensland 2.5%, South Australia 13.5%, Western Australia 34.8% and Tasmania 10.9%. 

Building Approvals — June | Insights  

After declining sharply for more than a year, dwelling approvals showed signs of stabilising in the June quarter. That comes despite the already very elevated level of work in the pipeline, capacity constraints in the construction sector and housing prices starting to decline with interest rates on the rise. Dwelling approvals appear likely to come under renewed pressure given these headwinds. 

RBA hikes by a further 50bps in August

The RBA Board hiked rates by 50bps at today's meeting, lifting the cash rate target to 1.85% and the Exchange Settlement rate to 1.75%. This was the third consecutive hike of 50bps following the initial increase of 25bps in May. With rates still below the estimated neutral range and inflation now expected to reach a higher peak, further hikes remain in prospect.

The key message in today's decision statement from Governor Philip Lowe was that with inflation to keep climbing to reach a new forecast peak of 7¾% towards the end of the year, further rate hikes will be needed to ensure its return to the 2-3% target band "over time". Despite the RBA lowering the domestic growth outlook in 2022 from 4.2% to 3.25%, in part driven by a weakening global economy, the view of the Board is that the window to continue hiking remains open. Backing that assessment was the strength of the labour market, with the unemployment rate expected to fall further from its 50-year low of 3.5% based on the high level of job vacancies; household spending had been "resilient", business investment was on the rise and the terms of trade was supporting national income. 

The RBA's outlook becomes much more nuanced in 2023. Although inflation is projected to slow sharply next year, it is forecast to remain above target at above 4% (revised up from 3.1% previously). At the same time, domestic growth is expected to slow sharply to 1.75% (down from 2%), leading to a modest uptick in unemployment to around 4% by the end of 2024. With the growth outlook made more uncertain due to global factors including the the Ukraine war, Covid in China and the impact of high inflation, today's statement noted the Board was treading a "narrow path" as it tightens monetary policy to lower inflation while also looking to keeping the Australian economy on an "even keel".

Looking ahead, the Board reiterated that there are further steps to be taken in "normalising monetary conditions". Markets are priced for one final 50bps hike in September, followed by a pivot back to 25bps increases in October, November and December. The pricing for September looks justified in the context of the Board accelerating the return of the policy rate to the neutral range, estimated by the RBA to be around 2.5%. While the emphasis remains on the data flow, simply being close to neutral could be enough to trigger the October pivot markets look for. 

Australian housing finance on the decline in June

Australian housing finance commitments posted their steepest fall since the start of the pandemic, contracting by 4.4% in June as the RBA's rate hiking cycle accelerated pace. Lending to both the owner-occupier and investor segments contracted in the second quarter while refinancing activity lifted sharply as many borrowers sought lower interest rates. 

Housing Finance — June | By the numbers

• Housing finance commitments (ex-refinancing) fell by 4.4% in June (vs -3% expected, previous +1.8%m/m) to $31bn, its largest month-on-month decline since May 2020. Commitments are down by 2% over the year.  
• Owner-occupier commitments were down by 3.3% for the month at $20.5bn (-9.6%yr), more than reversing May's 2.2% rise. 
• Investor commitments declined by 6.3%m/m to $10.5bn, slowing annual growth from 23.7% to 17.3%.   
• Total refinancing accelerated by 6.2% in June to reach a new record high at $18.2bn (17.8%yr).

Housing Finance — June | The details 

Although monthly housing finance commitments alternated between rises and declines over the first half of the year, June's 4.4% fall was the largest contraction posted since the outset of the pandemic, pointing to the effect from the start of the RBA's rate hiking cycle. In June, the RBA lifted its pace of rate hiking to 50bps from 25bps in May. The overall level of commitments remains elevated, however, at around $31bn. 

Commitments in the owner-occupier segment were down by 3.3% in June, to be down by 2.2% over the second quarter.  Weakness in the quarter was driven by upgraders (-3.6%q/q) and first home buyers (-4.5%) due to a combination of affordability constraints and rising interest rates. Underlying volumes reflected this pullback in demand, falling by 4.2%q/q for upgraders and 5.3%q/q for first home buyers. Construction-related commitments advanced (2.5%q/q), though that most reflects the escalation in building costs, with the underlying volume of approvals flat (0.4%) in the quarter.  

Investor commitments saw their largest month-on-month fall since May 2020, down 6.3% in June. That left commitments 4.6% lower over the June quarter. As the chart above shows, this was the first quarter in 2 years in which lending fell to both major segments, likely marking the turning point in the cycle. 

As activity in the housing market slowed, refinancing volumes were rising as many borrowers responded to rising interest rates by switching lenders for more competitive offers. The value of refinancing lifted by 6.2% in June, driven by a 9.7% lift in the owner-occupier segment. Over the quarter, the value of refinancing lifted sharply by 8.4%. By volume, refinancing approvals surged by 9.8% to a record high at 24.4k in the month and increased by 11.7% over the quarter. 

The slowdown in the housing market is being driven by the two major states: New South Wales and Victoria, with weakness also evident in other states. Owner-occupier commitments in Q2 fell in NSW (-7.1%) and Vic (-3.9%), with Western Australia also down by 5.1%. Declining lending to first home buyers was a key factor in these declines: NSW -9.2%q/q, Vic -4.7%q/q and WA -7.3%q/q. In the investor segment, Queensland saw the largest quarterly fall (-17.2%) as NSW (-10.3%), Vic (-3.8%) and South Australia (-4.4%) also saw declines.   

Housing Finance — June | Insights

The housing market is starting to cool after a very strong period of conditions alongside the economic recovery from the pandemic. Rising interest rates and affordability constraints are weighing on housing finance demand, with housing prices starting to decline in several markets according to the latest data from CoreLogic. With further rate hikes on the way as the RBA looks to return inflation to its 2-3% target band, the housing market is likely to continue its slowdown over the months ahead.    

Source: CoreLogic 

Preview: RBA August meeting

After hiking rates by a total of 125bps since May, the RBA will take a further step in "normalising monetary conditions" at today's August meeting (decision due at 2:30pm AEST). I expect the Board to hike its key rates by 50bps for the third meeting in succession, increasing the cash rate target to 1.85% and the Exchange Settlement rate to 1.75%. Likely upgrades to the inflation and labour market outlook in Friday's quarterly monetary policy statement could put a larger hike on the table today; however, with the wages growth data for Q2 yet to come in and with inflation expectations still anchored in the target band, market pricing indicates the current pace of tightening can be maintained. 

---

This preview looks at what I see as the three keys at today's meeting.  

Outlook for inflation and the labour market  

This is where the Board's reaction function appears to be, with Governor Lowe's last two decision statements noting the outlook for inflation and the labour market will be shaped by the incoming data and determine the "size and timing of future rate increases". The decision to accelerate the pace of tightening to a 50bps rate hike in June came after the RBA raised its forecast for inflation to peak at around 7% later this year from 5.9% in the May Statement on Monetary Policy. 

Despite coming in below market estimates, last week's Q2 CPI report is likely to result in further upgrades to the RBA's inflation outlook, potentially revising the peak in Q4 to around 7.5% on headline CPI and around 5.5% for underlying (trimmed mean) CPI. As in June, that situation could prompt the Board to consider a larger rate hike today; however, the forecasts for 2023 and 2024 are arguably of more importance for policy. If the outlook from May remains broadly unchanged, with inflation forecast to slow sharply to a bit above 3% by the end of next year, then the Board may be content with the current pace of hiking. 

Labour market conditions have outperformed the RBA's earlier forecasts, highlighted by an unemployment rate that has fallen further than expected to 3.5% in June. It has also been referencing the high levels of job vacancies as pointing to this strength being sustained. The missing element in the strong labour market remains wages growth, with the RBA having limited visibility (other than the insights from its liaison program) given the official data are published quarterly. Wages growth was running at a subdued 2.4%Y/Y in Q1 and the next update is not due until mid-August. The prevailing uncertainty leads me to think the RBA will not be materially altering its forecast for wages growth to peak at 3.7% in 2024. 

Inflation Expectations

The importance of anchoring medium and longer-term measures of inflation expectations in the 2-3% target band was highlighted in the June minutes and in Governor Lowe's most recent speech. This current period of high inflation risked becoming more entrenched if the "inflation psychology" shifted and fed through to the wage-setting process. Given that Governor Lowe noted longer-term inflation expectations are anchored there doesn't appear to be any cause for alarm, suggesting that the current pace of tightening may be sufficient. 

Neutral rate 

In terms of where the RBA may be looking to take rates, the Board in the June minutes observed the cash rate was "well below" estimates of the neutral setting in Australia, indicating that further rate hikes were required to return inflation to the target band. Where exactly neutral sits is uncertain, but in his latest speech Governor Lowe said the RBA's research had tended to conclude the neutral rate "was at least positive". 

If inflation expectations are anchored at the midpoint of the target band, Governor Lowe suggested that 2.5% could be a floor for the nominal cash rate this hiking cycle. On that basis, current market pricing points to the cash rate heading to a modestly contractionary range, peaking just above 3% in early 2023. The market profile points to 50bps hikes in August and September before the pace eases to 25bps hikes at each of the 3 remaining meetings in 2022.

---

All in all, I expect the Board to hike rates by 50bps for the third meeting in succession. Likely upgrades to the outlook for inflation and the labour market in Friday's quarterly statement means the prospect of a larger hike of 75bps cannot be completely ruled out but in the absence of key wages data, with longer-term inflation expectations anchored between 2-3% and not under pressure from market pricing to become more aggressive, maintaining the current pace of tightening looks the more likely outcome.     

Macro (Re)view (29/7) | Inflation pressures growth

With the Federal Reserve indicating it will take a more data-dependent approach in hiking rates, weakness in US GDP saw markets taking greater confidence that rates won't reach the levels FOMC members expect, in turn supporting risk sentiment. This was despite US wage-price pressures showing no sign of easing in this week's data. Domestically, a softer-than-expected Q2 inflation report has seen markets settling on the RBA hiking by 50bps next week. 

Australian inflation was strong in the June quarter... 

Headline inflation was 1.8% in the June quarter, lifting the annual rate from 5.1% to 6.1%. Those outcomes were below market expectations, going against the run of play for upside surprises in global inflation prints, and markets responded by pricing out the chances of a 75bps RBA rate hike next week. Underlying inflation on the trimmed mean was 1.5% in the quarter, in line with consensus and Q1's outcome, as the annual pace elevated from 3.7% to 4.9%.

Overall, inflation in Q2 at 1.8% was a touch softer than in Q1 (2.1%) as petrol prices recorded a much more moderate increase this quarter due to the impact of the federal fuel excise tax cut. Another contributor was grocery prices rising at a slower pace after lifting very sharply in Q1; however, supply constraints associated with the recent foods and Covid disruptions mean price levels continued to increase. Meanwhile, new dwelling costs lifted further to be by around 20% over the year, with a large part of the increase reflecting the pass-through of higher materials and labour costs to consumers. Despite these cost escalations, consumer demand for new homes has been strong due to the support of construction subsidies and interest rate cuts following the onset of the pandemic. Reopening factors associated with international (19.9%q/q) and domestic travel (1.7%q/q) and rising prices for consumer durables due to strong demand, higher freight costs and supply chains pressures were also major contributors to quarterly inflation. For more on the Q2 CPI data see here 

... and consumer demand may be cooling 

Cost of living pressures and rising interest rates may be turning the screws on consumer demand as retail sales slowed to a 0.2% rise in June, its weakest outturn in 6 months with turnover growth softening sequentially in month-on-month terms over Q2. However, it is also clear that a rotation back to services is underway after the easing of Covid restrictions, so this could be contributing to weaker spending in durable goods that dominate retail sales (note the retail data do not include fuel). For Q2, nominal retail sales lifted sharply by 3.2% but next week's full release will be key as it will detail the price/volume split.   

Fed hiked rates by a further 75bps...

In the US, for the second meeting in succession, the Fed's FOMC met expectations delivering a 75bps rate hike, bringing the Fed Funds target range up to 2.25 - 2.5%. At the post-meeting press conference Chair Jerome Powell said that with the FOMC having made good on its pledge of "expeditiously" returning rates to a setting it considers to be in the neutral range, neither expansionary nor contractionary for economic activity, it would now move to a "meeting by meeting" approach to policy. Interpreted by markets as opening the door to a potential dialing down in the pace of rate hikes going forward, risk assets performed. 

That is somewhat surprising given Chair Powell made clear the focus was still very much on bringing down inflation and that the June summary of economic projections in which the median estimate for the terminal Fed Funds rate of 3.75 to 4% next year was still a good guide to where the FOMC believes policy needs to head. That comes as the Fed's preferred inflation gauge was above expectations for June, rising by 0.6% month-on-month and firming the annual pace from 4.7% to 4.8%. Meanwhile, the tight labour market pushed the employment cost index up by 1.3% in Q2 (vs 1.2% exp), indicating second-round effects from high inflation will continue to be closely monitored by the Fed.      

... as the US economy slows 

June quarter GDP was weaker than expected at -0.2%q/q following a 0.4%q/q contraction in Q1. Although net exports and inventories account for the largest part of those contractions, it is clear that domestic demand weakened sharply in Q2 (-0.1%) from Q1 (0.5%). Driving that slowdown was weakness in private investment (-3.6%q/q) and household consumption almost stalled over the quarter. Growth in real personal spending was 0.3% in Q2, down from 0.5% in Q1, with an increase in services consumption (1.0%) broadly offset by declining demand for goods (-1.1%). 

Euro area growth and inflation surprised to the upside

Despite euro area inflation coming close to hitting a 9% pace in July printing at 8.9%Y/Y and coming in stronger than expected (8.7%), second quarter GDP growth in the bloc at 0.7%q/q surprised well to the upside of consensus (0.2%). After growth of 0.5% in Q1, that left GDP up by 1.2% over the first half of the year, a surprisingly resilient outcome given the outlook has deteriorated significantly following the war in Ukraine, uncertainty over energy supply, household spending power squeezed by inflation and with the ECB now hiking rates.    

Alongside the rise in headline inflation, the core rate lifted from 3.7% to 4%Y/Y indicative of broadening price pressures beyond energy (39.7%Y/Y) and food (9.8%Y/Y). Goods inflation (ex-energy) (4.5%) continues to outpace services inflation (3.7%), though the latter is on the rise following the wider reopening of the sector.  

 

Australian Q2 CPI 1.8%, 6.1%Y/Y

Australian inflation lifted to a 6.1% annual pace in the June quarter on the back of further rises in fuel, grocery and home building costs. Underlying inflation also lifted reflecting broad-based price rises across the CPI basket. The RBA is set to keep hiking rates at pace over the next couple of meetings. 

Consumer Price Index — Q2 | By the numbers 

• Headline CPI was 1.8% in the June quarter — below the median estimate of 1.9% and softer than in Q1 (2.1%) — as the Y/Y pace lifted from 5.1% to 6.1% (vs 6.3% exp). Seasonally adjusted CPI printed at 1.7%q/q and 6.2%Y/Y.  

• The underlying CPI measures came in around consensus in the quarter and lifted sharply over the year. 

• Trimmed mean posted at 1.5%q/q — in line with expectations and Q1's outcome — elevating the annual rate up to a record high at 4.9% (vs 4.7% exp) from 3.7%.

• Weighted median came in at 1.4% in the quarter (vs 1.5%), lifting to 4.2% over the year from 3%. 
• CPI excluding 'volatile items' was a touch softer in Q2 at 1.6% than in Q1 (1.7%), though the annual pace elevated from 4% to 5.3%, its fastest since 2000.   

Consumer Price Index — Q2 | The details 

Inflation remained strong in the June quarter rising by 1.8%, though that was below market expectations and slower than Q1's 2.1% increase. Rising prices for fuel, groceries and the construction of new homes remained the major drivers of inflation in the quarter. Base effects drove the elevation in annual inflation from 5.1% to 6.1%, its fastest since the introduction of the national Goods and Services Tax in 2000.

Rising prices for fuel, groceries and the construction of new homes remained the major drivers of inflation in the quarter. These items represent just under one-quarter of the CPI basket by weight but account for around 70% of the rise in inflation over the past year. 

Inflation slowed over the quarter due mainly to the impact of the federal government's 50% cut to the fuel excise tax, effective from 30 March through to 28 September. The ABS reported the maximum effect on fuel prices was in April (-13.8%) but prices subsequently rose again in May (11.1%) and June (6.8%). Overall, fuel prices increased by 4.2% in the June quarter, down substantially from the 11% surge seen in Q1 after the onset of the war in Ukraine. Over the year, fuel prices lifted by 32.1%. 

Grocery price inflation, though still rising at a historically strong pace, was softer than in the March quarter. The pace of price increases slowed across several key items including: meat (0.8%q/q from 4.8% in Q1), dairy products (1.3% from 1.9%), non-alcoholic beverages (1.5% from 5.8%), non-durable household products (2.3% from 4.7%) and other products (1.1% from 2.8%).

Fruit and vegetable prices lifted by a further 5.8% in the quarter, in line with Q1's increase. Higher prices were being driven by supply disruptions associated with the east coast floods and Covid-related absences; rising input costs for fertiliser and transportation were also contributing. Bread prices were notably higher in Q2, up 3.1% from 1.8% in Q1, reflecting the constraint on global wheat supply from the war in Ukraine. Annual inflation in breads and cerals stepped up to 6.3%, its fastest since late 2008. 

New home building costs recorded another strong increase of 5.6% in the quarter, rising by 20.3% through the year. Shortages of building materials and skilled labour and the unwinding of the HomeBuilder subsidy scheme have all contributed to pushing up construction costs. Over the past year, price increases across the capital cities range from 15.8% in Sydney up to 30.2% in Brisbane.

In the Covid-affected categories, international travel costs picked up sharply in the quarter (19.9%) as strong demand following the easing of border restrictions was met by limited airline capacity. Voucher schemes in New South Wales and Victoria were moderating the pace of price rises in domestic travel (1.7%) and dining out (1.4%), with those services seeing strong demand over the Easter holiday period. 

Overall, Australian inflation remains heavily weighted to goods components (2.6%q/q, 8.4%Y/Y) than services categories (0.6%q/q, 3.3%Y/Y). Goods inflation is running substantially faster due largely to issues in global supply chains over the course of the pandemic and more recently accentuated by the war in Ukraine and China's return to lockdowns. The slower pace of services inflation can be linked to wage growth that is yet to reflect the strength of labour market and due to the impact of government policy decisions that have limited out-of-pocket costs. Inflation from rents also remains subdued (1.6%Y/Y), lagging the tightening in vacancy rates. 

Consumer Price Index — Q2 | Insights 

Today's report defied the global trend of inflation data continually surprising to the upside of expectations, with headline inflation slowing in Q2 to come in below the median estimate. That likely reduces the need for the RBA Board to hike rates by more than the 50bps discounted into market pricing ahead of the August meeting. With underlying inflation on the trimmed mean rising to 4.9% — nearly double the midpoint of the 2-3% target band — and the cash rate assessed by the RBA as sitting well below the neutral range, a fourth consecutive 50bps rise looks on the cards in September as well.    

Preview: Australian Q2 CPI

Australia's June quarter inflation report is due to be published by the ABS at 11:30am (AEST) today. Rising price pressures drove headline and underlying inflation above the top of the RBA's target band for the first time since 2008 in the March quarter, prompting the Board to hike interest rates by a total of 125bps since the previous CPI report. With further rate hikes in the pipeline, today's report will be a key input in the Board's assessment of the scale and pace of tightening required over the coming months. 

As it stands | CPI 

For the first time in 13 years, annual inflation on both a headline and trimmed mean basis is above the RBA's 2-3% target band. Headline inflation was 2.1% in the March quarter, lifting the annual rate to 5.1%. Broadening price pressures across the CPI basket pushed up the trimmed mean measure by 1.4% in the quarter to be 3.7% higher over the year.

Fuel and the construction of new dwellings remained major drivers of the CPI in the March quarter and rising food prices emerged as a new inflationary impulse. Constraints in global refining capacity and the war in Ukraine were pushing up prices for petrol and a broad range of commodities. Rising fertiliser prices, higher transportation costs and disruptions to supply due to the impacts from Covid and adverse weather were key factors contributing to rising food prices. Housing construction costs were up sharply again in Q1 as capacity constraints in the sector were leading to higher costs for materials and labour. Developers' base prices for new homes were rising due to fewer government HomeBuilder grants now being paid out after the scheme closed to new applicants in the first half of 2021. 

Global factors are predominantly driving the pick-up in inflation in Australia. Inflation in the tradable components was 2.9% in the quarter and 6.8% over the year, its fastest pace on record. Domestic sources have become a more pronounced driver of inflation over the past year, though at 4.2%Y/Y the pace is more modest.

As has been seen in many other comparable economies, Australian inflation has been led by rising goods prices as strong demand has run up against constraints in global supply chains. Services inflation lifted more noticeably in the March quarter (1.1%), but goods components continued to contribute far more substantially to overall inflation.

 

Market expectations | CPI

The median estimate on the headline CPI is 1.9% for the quarter; however, the range of estimates is very wide from 1.6% on the low side to 2.8% on the high side. Annual inflation is forecast to rise from 5.1% to 6.2%, which would be its highest since Q4 1990. 

Broadening price pressures are set to see a further pick-up in underlying inflation. Quarterly inflation is expected to come in at 1.5% on both the trimmed mean and weighted median measures. That would see annual inflation rising from 3.7% to 4.7% on the trimmed mean and from 3.2% to 4.3% for the weighted median.  

What to watch | CPI 

Most of the attention will centre around where headline inflation prints relative to the expected outcomes. Upside surprises would likely see markets pricing in a greater chance of a 75bps RBA rate hike in August, with a 50bps hike already fully discounted. Given the nature of inflation (with a few components making very large contributions), the underlying measures will be more impactful for the RBA. With today's report in hand, the RBA will revise its inflation forecasts ahead of next week's meeting. The current expectation is that trimmed mean inflation will peak in Q4 at 4.6%, though that estimate will be lifted. Depending on today's outcomes, the forecast peak could be lifted to around 5%, double the midpoint of the target band. Indications from Governor Lowe last week were that the RBA was looking to return rates to a 'neutral' setting (which it estimates roughly at 2.5% in nominal terms). In light of that and with the cash rate at 1.35%, the RBA looks set to keep hiking at pace for at least the next couple of meetings.   

Macro (Re)view (22/7) | ECB draws line in the sand

An important week has passed with the ECB making its stand on inflation and in backstopping fragmentation risk. The Fed will have its say next week but as central banks remain focused on bringing down inflation, markets are likely to focus on growth risks given the contractionary readings in the July PMIs in the US and euro area.   

ECB hikes rates; announces new transmission tool 

With headline inflation running at 8.6%Y/Y in June and the core rate confirmed at 3.7%Y/Y, "undesirably high" inflation prompted the ECB to hike rates for the first time in 11 years this week. The reports in the days prior to the meeting proved correct as the Governing Council went against its earlier guidance to deliver a larger hike of 50bps to its 3 key rates instead of 25bps. The particular significance of 50bps is that it lifts the depo rate (rate paid on banks' overnight deposits) straight back to 0%, accelerating the exit from a 7-year period of negative settings. It has also meant that the ECB has thrown in the towel on forward guidance on future interest rate moves, with the statement noting it will now take decisions on a "meeting-by-meeting" and data-dependent approach. President Christine Lagarde was clear at the press conference that "further normalisation" of rates is to be expected at upcoming meetings; however, the window for those hikes could be closing given a deteriorating growth backdrop as the euro area's composite PMI fell into contraction in July.   

In what has generally been viewed as a compromise solution, the council has agreed to a larger rate hike upfront given the inflation situation while the dovish members have secured the addition of the  Transmission Protection Instrument (TPI) to the ECB's toolkit. The TPI will stand as a backstop to guard against "disorderly market dynamics" interfering in the implementation of the ECB's monetary policy stance. The widening of Italian yield spreads following the collapse of its government appears unlikely to be viewed in this context. That being said, the accompanying release clearly leaves the ECB with a large degree of discretion to determine what would activate asset purchases under the TPI, while it says the size of such purchases is "not restricted ex ante". 

All euro area countries can qualify for TPI support if the ECB deems it appropriate, though some conditionality has been attached to that commitment, relating mainly to complying with existing EU fiscal rules and having "sound and sustainable"macroeconomic policies in place. Regardless of the formulation of the TPI, the ECB asserts that its "first line of defence" in preventing what it sees as an unwarranted widening of yield spreads will be to use the flexibility it has built into the reinvestment phase (which it is now in) as bond purchased in the PEPP (pandemic-related) program mature. PEPP holdings stand at €1.7tn and the ECB has committed to a reinvestment phase through to the end of 2024 at the least. 

Rising inflation risks a more aggressive BoE 

UK inflation surprised to the upside of expectations to print at 9.4%Y/Y in June. The peak is not likely to come in until later in the year as there is another increase in household energy prices coming through in October, and when it does the Bank of England anticipates inflation will be running above 10%. Meanwhile, the core rate matched estimates in easing from 5.9% to 5.8%Y/Y. 

When taken with the inflation data, this week's report on the labour market may well bring the BoE round to market pricing, which anticipates a step up to a 50bps rate hike in August after a series of smaller increases. A speech from BoE Governor Andrew Bailey confirmed that a 50bps hike will be under consideration at the next meeting, with the emphasis being around guarding against high inflation becoming entrenched by feeding through to the wage setting process. The UK labour market looks robust, with the unemployment rate holding at 3.8% in May and remaining below its pre-Covid level. Demand for labour is strong, highlighted by employment rising by a stronger-than-expected 296k for the most recent 3-month period while job vacancies - despite softening over the quarter - are also very elevated. With labour supply in the UK being restricted by the effects of Covid, a tight labour market has pushed up annual earnings growth to 4.3% compared to a pre-Covid pace of around 3%. 

RBA ponders neutral rates in Australia 

Since the May meeting when the RBA started hiking rates, its justification has been that the economic conditions no longer require emergency support and it has been in the process of normalising monetary policy. Assuming normalising means returning the cash rate to a so-called neutral setting (neither expansionary or contractionary for economic activity), the July meeting minutes showed the Board had a preliminary discussion around what this level might be. The key observations were that the cash rate was "well below" estimates of the neutral rate and that if inflation expectations were to shift upwards then more rate hikes would be needed to return inflation to the target band than otherwise.  

A speech by Governor Philip Lowe gave further insights, with RBA research tentatively suggesting the real rate of interest was positive. If inflation expectations are anchored at the midpoint of the 2-3% target, Governor Lowe said that would imply a neutral nominal cash rate of "at least 21⁄2 per cent". Building on analysis from the Financial Stability Review, Deputy Governor Michelle Bullock said household finances were well positioned to cope with the current tightening cycle. Next week sees the focus centred on the Q2 inflation report where the median estimate for headline CPI is 6.2%Y/Y and 4.7%Y/Y on the trimmed mean. Market pricing points to a 50bps rate hike in August, with only a small chance being given to a surprise 75bps increase. 

Macro (Re)view (15/7) | More upside surprises

An upside surprise on the key data point of the week took US inflation through 9%Y/Y in June, confirming the Fed and its global peers will remain hawkish for the foreseeable future. The Bank of Canada hiked aggressively by 100bps outdoing expectations for 75bps, while the Reserve Bank of New Zealand and Bank of Korea both hiked by 50bps. Growth concerns remained in focus in Europe, not helped by the slowdown in Chinese GDP from 4.8%Y/Y to 0.4%Y/Y (vs 1.2% expected) as Covid lockdowns returned in Q2.    

Strength to strength in the Australian labour market...

A strong labour force report for June was headlined by the national unemployment rate coming in from 3.9% to 3.5% (vs 3.8% expected), re-establishing a new low for the cycle dating back to 1974 (full review here). Employment has ramped up significantly rising by 88.4k in June (vs 30k expected) following the 60.6k increase in May. This came after a slowdown over March-April, impacted by the east coast floods and the Easter holiday period. The acceleration in employment is more in line with the underlying momentum in the economy and the high levels of job vacancies point to further gains. Encouragingly, strong labour demand has again seen the participation rate resetting to a new record high of 66.8%. 

Wages growth was still subdued as of Q1 (2.4%Y/Y), but the labour market conditions are set to see the pace lift in coming quarters. However, record high participation is a key reason why we should not see the sort of escalation in domestic wage pressures to the extent that the US and UK have experienced. While there is now speculation the RBA could speed up to hiking rates by 75bps at the August meeting, I stick with 50bps for now seeing the upcoming Q2 CPI data as the more influential factor for the Board. 

... but cost of living concerns weigh on sentiment 

Concerns around cost of living pressures and rising interest rates continue to far outweigh confidence in the labour market as the Westpac-Melbourne Institute Index of consumer sentiment fell by a further 3% in July to be close to the lows seen during previous economic downturns. The scale of the decline seen over 2022 (-19.6%) has been striking, though it has run counter to the economic conditions, with the spending data particularly strong. Business confidence in the NAB survey for June also fell sharply to a below average level. In contrast, the measures of current trading conditions are very strong, as are the outlook components in forward orders and employment intentions.

Another upside surprise on US inflation...

Annual headline inflation in the US printed with a 9 handle (9.1%) for the first time since 1981 after the increase in the month-month CPI came in at 1.3% in June, stronger than the 1.1% lift expected. The core rate (excludes food and energy) was posted at 0.7%m/m, also above the median estimate (0.5%), with the annual pace fading for the 4th month running, now at 5.9% (vs 5.7% expected) from 6.5% in March.

Supply constraints affected by refining capacity and the war in Ukraine saw gasoline prices surging in the month (11.2%, 59.9%Y/Y), driving the outcome for headline inflation. Further rises for food (1%m/m, 10.4%Y/Y) and shelter (0.6%m/m, 5.6%Y/Y) again underscored the cost of living pressures US households are facing. The inflationary pulse coming from services (ex-energy) continues to increase (0.7%m/m, 5.7%Y/Y), a concerning development given that price rises in these categories tend to be stickier than in goods. Speaking of goods, with last year's price surges continuing to fall out of the annual calculation, inflation in durables fell by 3ppts to 8.4%Y/Y, albeit with June's outcome (0.7%m/m) surprising after several weak prints.  

... leads to speculation of even faster Fed rate hikes 

The idea that the Fed could follow the BoC and hike rates by 100bps later this month gained some traction in the markets post the CPI data. Comments from Fed officials Waller and Bullard pushed back against those calls, with both in support of another 75bps rate hike. Governor Waller said a larger hike could be on the radar if supported by other data, including this week's retail sales report. That report showed June retail sales were strong, with headline (1.0%m/m), core (0.7%m/m) and control group sales (0.8%m/m) all above expectations, more than rebounding from weak outcomes in May. There are varying interpretations of June's outturns given that retail sales include the inflationary component from rising prices, but at the end of the day, the data shows nominal spending is rising not falling. 

Deteriorating outlook sees the euro breach parity 

The summer economic forecasts published by the European Commission predicting slower growth and higher inflation are headwinds that saw the single currency breach parity to the US dollar for the first time in 20 years this week. Forecast growth in the euro area for 2022 was revised down to 2.6% from 2.7% while the growth outlook in 2023 was cut from 2.3% to 1.4%. It is fair to say markets are significantly more pessimistic on prospects than those forecasts, due in part to uncertainty around whether Russia will turn the energy taps back on once the Nord Stream 1 pipeline reopens from maintenance works. 

In response to that risk, European natural gas prices have risen sharply, adding not only to growth concerns but also to the inflation outlook. The Commission raised its 2022 inflation forecast to 7.6% from 6.1% and to 4.3% from 2.7% in 2023. This all comes ahead of next week's ECB meeting where the Governing Council is expected to stick to its prior guidance and hike rates by 25bps. 

Over in the UK, the monthly GDP estimate for May was stronger than expected at 0.5%, rebounding from a contraction in April (-0.2%). The production (0.9%) and construction sector (1.5%) both expanded but it was a 0.4% rise in services output that drove the headline increase, led by a large rise in GP appointments. The weak point was a 0.1% fall in consumer services, suggesting that cost of living pressures were weighing on household spending. Although mainly of academic interest, a speech by BoE Governor Bailey discussed the structural drivers that have been pushing down interest rates over recent decades, arguing they are likely to limit the ability of central banks to raise rates unless reversed.