Macro (Re)view (7/10) | RBA pivots ahead of the Fed

A rally across risk assets was blunted by strong US labour market data at the end of the week, backing up commentary from Fed officials that rates will continue to rise at pace. That rally was given impetus partly by the RBA pivoting to a 25bps hike after a sequence of 50s. There was no let up across the Tasman with the RBNZ hiking by another 50bps. Developments in energy markets remain key to the inflation outlook, a situation not helped by OPEC+ agreeing to a larger-than-expected output cut, though leaders in the UK and Europe are working on plans to cap wholesale gas prices to alleviate pressure on their economies over the winter months.

Fed set to hike by another 75bps...

The September nonfarm payrolls data provided another solid read on US labour market conditions, with markets pricing in another 75bps Fed rate hike in November off the back of the report. A host of Fed officials through the week backed up the signal in the dot plot that indicates rates are likely to be hiked to a peak of around 4.5%, some 150bps above the current fed funds rate. Although there has been speculation that financial stability concerns could impede the Fed's progress, Governor Waller pushed back on that assertion in a speech this week. Fed officials Mester, Daly and Bostic also sought to dismiss the idea that rate cuts could be on the cards in 2023 as the economy slows.

... as the US labour market remains solid

On the labour market, employment showed a lift of 263k on nonfarm payrolls in September, coming in slightly better than the 255k expected. While data on job openings posted a decline of 1.1 million in August, they remain very elevated at just over 10 million and the pace of hiring is running at a very robust 372k on a 3-month average for nonfarm payrolls. Strong employment combined with a small fall in labour force participation (to 62.3%) led to the unemployment rate declining from 3.7% to 3.5%, in line with its level immediately before the Covid crisis. Prospects for an easing in wage-price pressures received an encouraging signal as average hourly earnings growth moderated from 5.2% to 5.0%yr, remaining on a softening trajectory after hitting their recent high of 5.6% in March. The main constraint remains on the supply side, with prime-age (25-54yrs) participation (82.7%) still around 0.5ppt short of recovering from its pandemic-induced fall.  

RBA pivots to a 25bps rate hike... 

After delivering 225bps of rate hikes since April, with the past four increases coming at the frontloaded pace of 50bps per meeting, the RBA Board elected to slow the pace of tightening, lifting its key rates by 25bps to 2.6% on the cash rate and 2.5% for exchange settlements (reviewed here). The outlook described by Governor Philip Lowe in his post-meeting statement of inflation remaining above target over the next couple of years meant that the guidance for further rate hikes being expected remained intact. However, the Board is also trying to keep the economy "on an even keel" and is mindful of the risk of overtightening when the outlook for global growth has deteriorated and with the RBA's Financial Stability Review outlining the adjustment from households to higher rates was still largely yet to play out. In that respect, the RBA has turned slightly more cautious, leading markets to lower their expected peak in the cash rate to around 3.5% from around 4% last week. 

... while the housing market showed more signs of cooling  

The sensitivity of the housing market to rising interest rates was on display in the week's data points. Housing prices fell by 1.6% on CoreLogic's national index in September to be down by 4.1% over Q3, driven by the Sydney market (-6.1%qtr). Declining prices and tighter borrowing conditions are weighing on housing finance commitments, down by 3.4% in August (reviewed here). Notwithstanding this and capacity constraints in the construction sector, headline building approvals surprised to the upside of estimates in August (28.1%) as higher density approvals rebounded off a weak July reading and detached approvals kept up their notable resilience (reviewed here). 

Meanwhile, retail sales have continued to advance, confirmed at a 0.6% rise in August's finalised report, indicating households continued to spend despite headwinds from weak sentiment and high inflation (reviewed here). The nation's trade surplus is well off its recent highs but was still elevated at $8.3bn in August as global demand for Australian commodities continued to underpin export earnings (review here). Import expenditure is up by more than 40% over the year, driven by a combination of robust domestic demand conditions, eased restrictions on offshore travel and the rising global inflationary backdrop. 

ECB to press on, potentially with QT in the mix   

The account of the ECB's September meeting indicated that the Governing Council is set to keep hiking rates at an accelerated pace, frontloading the removal of accommodative monetary policy. As part of this effort, there were signals that quantitive tightening (QT) is on the radar, with the account acknowledging the size of the ECB's balance sheet was providing "significant monetary policy accommodation" by compressing bond yields. 

Should this be unwound, the ECB has its new Transmission Protection Mechanism in the toolkit to help keep a lid on Italian (and other peripheral nations) bond yields from widening too severely, though on the other hand if there are signs at the next Governing Council meeting that the commencement of QT is imminent, this could amplify the already elevated volatility in bond markets. Only last week, the Bank of England had to defer its plans for selling down its gilt holdings and is instead now buying bonds to restore orderly function in the market. 

On rates, the account revealed the Governing Council's decision to hike by 75bps was not unanimous with "some members" arguing for a smaller 50bps increase in light of the rising risks of recession in Europe. Although the 75bps hike was not intended to signal this was the new normal hiking pace for the ECB at the moment, that is the course of action markets are anticipating at the next meeting at the back end of the month. 

Australian trade surplus $8.3bn in August

Australia's trade surplus came in further in August, defying expectations for a rebound after narrowing sharply in July. Export earnings saw a modest rebound but were outpaced by rising imports reflecting inflationary effects and robust demand.  

International Trade — August | By the numbers

• Australia's trade surplus came in at $8.3bn in August (vs $10bn expected), narrowing by a further $0.6bn following a sharp $8.5bn retracement in July. 

• Exports were up 2.6% in August at $56.8bn, partially rebounding from July's 10.4% fall.  
• Imports advanced by 4.5%m/m to $48.5bn, broadly in line with the increase in the month prior (4.8%).

International Trade — August | The details

The monthly trade surplus was slightly narrower in August (-$0.6bn) after falls in major export commodity prices and disruptions to shipments led to a sharp pullback in July (-$8.5bn). These outcomes left the trade surplus at $8.3bn in August, its lowest since February but still at a historically elevated level. The narrowing of the trade surplus in August was driven by imports (4.5%) outpacing the increase in exports (2.6%). 

On the export side, the increase in August was broad based with all categories rising. The largest contribution came from non-rural goods (2.1%) as coal (2.9%) and other mineral fuels (mainly LNG) (3.1%) partially rebounded from large falls in July on the back of increased shipments (though LNG prices also lifted modestly). Iron ore exports stabilised (-0.2%) after falling almost 13% in July. 

 

Rural goods continued to advance (6.4%) and are up strongly over the year (39.5%), benefitting from heavy rainfall in Australia boosting production, robust demand offshore and rising prices, notably for wheat amid the supply impacts from the Ukraine war. Accordingly, cereal exports have risen almost 56% over the year, while meat exports are up more than 20%. 

The services sector recovery continued, albeit with a modest rise in August (0.4%). Tourism-related earnings consolidated after a sequence of strong increases following the full reopening of the international border. 

For imports, spending on both goods (4.8%) and services (2.9%) advanced to drive the headline rise (4.5%). Consumption goods followed up a strong rise in July with a 7.1% lift in August. Of note, non-industrial transport equipment (vehicles) imports have risen sharply over the past two months (37%), pointing to eased global supply chain pressures. 

Intermediate goods lifted materially in the month (6.6%), largely driven by fuel imports (11.1%) on the back of high prices. Total fuel imports hit $6.9bn in August, a new record high. 

Services imports were up 2.9% in August, nearly doubling over the year (95.1%) driven by the easing of Covid travel restrictions. Tourism-related spending on overseas travel is seeing a strong recovery but is still down by around 40% on pre-Covid levels at the end of 2019. Strong demand and high fuel prices have seen spending on transport rise by almost 130% over the year.  

International Trade — August | Insights

Global demand for Australian commodities continues to underpin elevated trade surpluses, despite a recent pullback in prices. Imports are up by more than 40% over the year, partly reflecting rising prices, most notably for fuel, but also robust domestic demand conditions.  

Australian retail sales rise 0.6% in August

Australian retail sales posted another resilient outturn rising by 0.6% in August, advancing for the 8th month in succession. The support from accumulated savings and labour income continues to overcome headwinds from rising interest rates, high inflation and weak sentiment.  

Retail Sales — August | By the numbers 

• National retail sales advanced by 0.6% in August, unchanged from the preliminary estimate and above market expectations (0.4%).
• 12-month retail sales surged to 19.2% from 16.5%, with the base period coinciding with the Delta wave lockdowns in Sydney and Melbourne.   

Retail Sales — August | The details  

The 0.6% rise in headline retail sales was driven mostly by the food category (1.1%) as spending in the discretionary space (0.3%) took a backward seat. That profile is against the trend of what has played out so far in 2022 with discretionary spending (up 12.6%) outpacing the rise in headline sales (9.1%). 

The food category saw broad-based increases across supermarkets (0.9%), liquor stores (1.3%) and specialised food (2.9%), driven partly by rising prices. The weak points in discretionary retail were clothing and footwear (-2.3%) and other retailing (-2.5%), the latter including components such as cosmetics and recreational goods. However, spending at cafes and restaurants continues to rise sharply (1.3%m/m), which is both a function of consumption patterns normalising post Covid and the underlying strength of household demand. 

In the online segment, spending through the year so far is holding around a steady level averaging $3.7bn per month. In terms of market share, online retail is accounting for around 10.5% of monthly turnover, up from a pre-Covid level of around 7% in early 2020. The biggest uplift has been in the discretionary area (up 5-6ppts over the Covid period) compared to a smaller rise in food sales (up 2-3ppts). 

Looking at the state details, New South Wales drove the increase in national turnover as the state posted a 1.5% rise in August following a 1.3% lift in July. South Australia (1.2%) saw a similar increase to the previous month, though Victoria (0.1%), Queensland (-0.1%) and Western Australia (-0.2%) all saw weaker outcomes relative to July. Spending in Tasmania picked up sharply (2.2%) with the state seeing its strongest rise for the year so far. 

 

Retail Sales — August | Insights

Household spending was again resilient through August, albeit with a softer result from discretionary retail sales coming through. Households continue to spend despite rising interest rates, cost of living pressures and weak indicators of sentiment. A fall in household wealth associated with the declines in financial markets and property prices has also not deterred demand. The predominant factors appear to remain accumulated savings and the support to incomes from the strong labour market.   

Australian dwelling approvals rebound in August

Australian dwelling approvals posted a stronger-than-expected rise in August, rebounding from a sharp fall in July. House approvals have retraced from the Covid stimulus-driven surge but remain around levels seen at the peaks in prior cycles, showing resilience to the headwinds being faced by the home building sector. 

Building Approvals — August | By the numbers

• Dwelling approvals (seasonally adjusted) rose by 28.1% in August to 17,497, coming in well above expectations (10.0%) and rebounding from a large fall in July (-18.2%). Approvals are down 9.5% over the year. 

• House approvals posted their strong rise since Feruary lifting by 3.7%m/m to 10,526, but are down 14.9% from a year ago.  

• Unit approvals nearly doubled in August (98.6%) to 6,972, recovering from a steep decline in July (-47.3%). 

Building Approvals — August | The details 

National dwelling approvals continued their volatile pattern of late rising sharply in August (28.1%) on the back of a rebound in the higher-density segment (98.6%) and a strong outcome from detached approvals (3.7%). Averaging out the volatility, house approvals look to be rising gently higher while the higher-density segment is struggling to break out of its relatively low range. 

August's gain in house approvals was driven mainly by New South Wales (11.4%) while Western Australia (10.0%) also made a strong contribution. 

For higher-density approvals, the underlying trends point to a softening in the high-rise segment over recent months. Despite rebounding in August, much of the weakness in the high-rise approvals has been coming through from Sydney and Melbourne.

Turning to alterations, the value of residential work approved saw a 5.4% rise in August after falling over the two months prior. As the chart below shows, alterations remain at very elevated levels well after the withdrawal of policy stimulus. Aside from reflecting rising materials and labour costs, this is also likely boosted by a backlog of projects that have been previously held back due to capacity constraints. 

Building Approvals — August | Insights  

House approvals are holding up despite headwinds from rising interest rates, falling housing prices and capacity constraints in the construction sector. Approvals in the higher-density segment are very volatile from month to month, but the high-rise category looks to have softened over recent months. 

RBA hikes rates by 25bps in October

The RBA Board took stock of its tightening cycle at today's meeting and elected to scale back to a 25bps rate hike after a sequence of four 50bps rate hikes in succession, lifting the cash rate target to 2.6% and the Exchange Settlement rate to 2.5%. Although the Board expects further hikes are likely, the effort to frontload the pace of monetary policy tightening looks to have run its course. 

As had been foreshadowed over recent weeks, the downshift in the pace of RBA rate hikes has come, with Governor Philip Lowe noting in his decision statement that rates had risen "substantially in a short space of time" and the Board now needed to reassess the implications for inflation and growth. Including today's decision, the RBA has hiked rates by 250bps since April, a pace not vastly different to the Fed's hiking cycle (300bps since Janauary). But with rates now in the RBA's estimated range for the neutral setting for the cash rate (2½ to 3½ per cent) and therefore no longer providing accomodative support to the economy, the Board is taking a more balanced view of the risks in front of it. 

Today's statement reaffirmed the Board's focus on ensuring medium-term inflation expectations remain in line with its 2-3% target amid risks from rising labour costs in a strong labour market and increased pricing power by firms. From a growth perspective, Governor Lowe sounded caution from a deteriorating global backdrop and over uncertainty as to how household spending in Australia will hold up as the effects of the earlier rate hikes flow through. 

In looking ahead, Governor Lowe noted the Board expects to keep hiking rates "over the period ahead", with supply and demand needing to come into closer alignment to lower inflation. Following today's decision, market pricing for the terminal rate has been cut from around 4% pre-meeting to around 3.5%. Provided the RBA can keep inflation expectations anchored between 2-3%, the argument for rates to rise into restrictive territory (higher than market pricing has now adjusted to) is diminished.  

Australian housing finance falls 3.4% in August

Australian housing finance commitments posted a 3.4% fall in August, extending their decline from the peak at the start of the year to 17.5% as the adjustment to rising interest rates and declining housing prices continues to play out. At the same time, lending for refinancing has reached a new record high and has overtaken lending to owner-occupiers.      

Housing Finance — August | By the numbers

• Housing finance commitments (ex-refinancing) fell by 3.4% in August to $27.4bn, broadly in line with expectations (-3.0%) following after a sharp decline in July (-8.5%). Commitments are down 12.5% over the year.  
• Owner-occupier commitments contracted by 2.7%m/m to $18.5bn to be 15.1% lower than a year ago (prior: -7%m/m and -15.9%yr) 
• Investor commitments were 4.8% lower at $8.9bn after falling 11.2% in July, leaving commitments down 6.4% over the year (from 0%).  
• Lending for refinancing rose to a record high ($18.9bn) on the back of a 5.3% lift in August (9.8%yr). 

Housing Finance — August | The details 

Housing finance commitments fell for the third month running reflecting the effects of rising interest rates and declining prices in housing markets across Australia. August's 3.4% fall followed declines of 4.4% in June and 8.5% in July, seeing commitments down by 15.1% over this stretch and 17.5% off the peak in January. 

Lending to the owner-occupier segment saw a 2.7% fall in August, running 15.8% below December's record high. Across the sub-categories, commitments to upgraders fell 2.8% while construction-related (-2.7%) and alteration lending (-6.2%) also declined. Going against the trend, lending to first home buyers posted a 7% rise, reportedly due to the government's expansion of the First Home Guarantee scheme, albeit this comes after an 18.5% fall over June-July. 

Investment lending is falling at a sharp pace and is now down almost 24% from the peak in March. Lending to the segment saw broad-based falls across the states: NSW -4.9%, Vic -4.0%, Qld -2.7% and SA -9.6%, though both WA 3.0% and Tas 4.1% saw increases. 

In a rising interest rate environment, refinancing commitments continue to climb and hit a new record high in August ($18.9bn). Indicative of the shift underway in the housing market, the value of refinancing commitments has overtaken owner-occupier lending for the first time since June 2020.    

Housing Finance — August | Insights

The latest data from CoreLogic reported yesterday, housing prices continued to fall in September, down 1.4% on the month on the national index. This together with the pass-through from rising interest rates and their impact on loan sizes will lead to further declines in the housing finance series. It seems likely that refinancing activity will continue to rise. 

Preview: RBA October meeting

The RBA Board is set to deliberate between a 25 and 50bps rate hike at today's meeting (decision due at 2:30PM AEDT). There have been clear signals from the RBA that a downshift in the pace of rate hikes is nearing, but another 50bps hike looks more likely than not today, taking the cash rate target to 2.85% and the Exchange Settlement rate to 2.75%. 

At the September meeting, the Board delivered its 5th rate hike in succession, the past 4 hikes coming at a clip of 50bps after the initial 25bps increase in May. It is an open question how long the RBA will keep hiking rates at this accelerated pace. The September meeting minutes revealed the Board discussed whether to hike by 25 or 50bps, indicating it is starting to take a more balanced view of the situation. On the one hand, the Board is weighing up the risk of overtightening given the amount and pace of hikes already delivered and the lags associated with their transmission into the economy, while on the other still acknowledging there is work to do to ensure the return of inflation to the 2-3% target band. 

Ahead of today's meeting, Governor Philip Lowe said at the RBA's recent parliamentary testimony that the Board was likely to again discuss the arguments for a 25 and 50bps rate hike in October. At the hearing, Governor Lowe appeared to give just enough insights to suggest a 50bps hike is more likely. The key observation being that the "inflation psychology" to the acceptance of price rises was showing signs of adjusting and given the strength of the labour market, this could put upward pressure on wage-setting processes that would risk inflation becoming more sticky. 

Overall, with the cash rate still below the range the Board considers to be normal (2½ to 3½ percent), it looks likely to continue with its frontloaded approach to tightening by hiking rates by 50bps. Other key points to watch out for in today's statement are comments on the deteriorating global economic outlook and the risks it poses for the Australian economy, and the Board's latest assessment of developments in household spending.    

Macro (Re)view (30/9) | Leaving Q3 behind

A highly volatile Q3 for markets has drawn to a close leaving behind a deeply inverted US yield curve, stronger dollar and lower equities. The rapid regime shift away from ultra-low interest rates and asset purchases in response to high inflation is largely driving market volatility, but as developments in the UK gilt market have demonstrated there are also spillover effects coming into play. 

UK policy remains in the spotlight  

Concerns over the viability of the fiscal and monetary policy mix in the UK continue to amplify volatility in global markets. The government this week reaffirmed its intentions to press ahead with expansionary fiscal measures despite adding to the inflationary outlook, drawing the ire of the IMF. The repricing in the gilt market to much higher yields that came off the back of this uncovered insolvency risks in the UK's large pension fund sector, prompting intervention from the Bank of England. Daily gilt purchases (up to £5bn) directed at long-dated maturities (20yrs and above) are set to take place through to 14 October, effectively giving time for funds to reposition their exposures to account for higher interest rates going forward. All up, this implies a £65bn operation.  

Following the mini-budget, the UK's Debt Management Office announced the measures would require an additional £62bn of gilt issuance for the fiscal year. On top of that, the BoE had last week given the green light to start its gilt sales program, totalling around £40bn over a 12-month period. As part of this week's announcements, the BoE has said it will now delay gilt sales by 4 weeks until the end of October. However, the BoE is still formally targeting an £80bn reduction in its balance over the next 12 months, though those plans are now clouded by uncertainty. BoE Chief Economist Huw Pill said this week the MPC was not in favour of hiking rates over the inter-meeting period, but that a "significant monetary policy response" looks warranted at the November meeting in light of the government's fiscal stimulus plans.

US inflation reaccelerates 

After seeing some respite in July, US inflation pressures lifted in August as the Fed's preferred core PCE deflator rose from 4.7% to 4.9%yr, above the 4.7% pace expected. There was better news on the headline PCE measure, which has eased to its slowest since January at 6.2% reflecting declining gasoline prices. However, for the Fed, it is the core rate that is most influential for policy, and August's upside result supports the hawkish message from FOMC members during the week, including from the Vice Chair Lael Brainard in giving backing to restrictive monetary policy settings to return inflation to target.  

High inflation and the Fed's rapid hiking cycle have been headwinds to US consumers, but while demand has slowed since the beginning of the year it continues to hold up. Year-ended growth in personal consumption has moderated to 1.8%, an 18-month low. While that situation should help to ease inflation pressures, the composition of demand is now being driven entirely by services, a component in which inflation tends to be stickier than for goods. With the effects of the pandemic dissipating and consumption patterns continuing to rotate back to services, this may slow the pace at which inflation comes down. 

More signs of resilience from Australian households...  

The data points over the past week reaffirmed the resilience of the Australian economy to headwinds domestically and offshore. Retail sales posted their 8th consecutive month-on-month gain rising by 0.6% in August, an upside outcome on market expectations for 0.3%. The picture for discretionary spending was softer than the headline result as sales ex-food saw a 0.3%m/m rise, but that is against the trend of what has played out so far this year, with discretionary spending far outpacing headline retail sales. 

Although weak financial markets and falling property prices contributed to a reported 3.3% decline in aggregate household wealth in the June quarter, a strong labour market has been key in driving incomes and supporting spending. Job vacancies came in lower for the 3 months to August (-2.1%), but that looks consistent with other data that have indicated activity in the labour market slowed around the middle of the year due largely to seasonal factors and Covid disruptions. The key point remains that vacancies, both in absolute terms and as a share of the labour force, are very elevated, which points to a further tightening in the labour market via a lower unemployment rate. 

... could lead the RBA into another 50bps rate hike

The strength in the labour market and a very favourable terms of trade position on the back high commodity prices are key factors that narrowed the deficit in the Federal Budget for 2021/22 by $47.9bn from the earlier forecast to 1.4% of GDP. The RBA returns to the fold next week where markets lean to another 50bps hike in rates. My reading of the ABS's new inflation gauge suggests headline inflation is running around 7% in Q3, up from 6.1% in Q2 and is seemingly broadly consistent with the RBA's outlook for inflation to rise to the high 7s by the end of the year. The RBA has been openly discussing the idea of downshifting to hiking in 25bps increments, though the global backdrop of volatile markets and central bank credibility coming under pressure may make this difficult for the Board to pull off next week. 

Euro area inflation hits 10%

The euro area's deepening energy crisis drove stronger than expected inflation readings in September risking another 75bps rate hike from the ECB at the October meeting. Headline inflation lifted from 9.1% to 10%yr (vs 9.7% expected) and the core rate now stands at 4.8% (vs 4.7%) from 4.3% in August. The increase in energy prices over the year is almost 41%, pressures which are feeding through to push up prices of goods and services across the economy, seen in the core rate running well above the ECB's 2% target. Speaking before the European Parliament this week, ECB President Christine Lagarde said that rate hikes "over the next several meetings" are likely to be needed to guard against inflation expectations becoming deanchored.     

Macro (Re)view (23/9) | Relentless rise in rates

The Fed's relentless hiking cycle went up a notch this week as the FOMC signalled a more aggressive approach was required to curb inflation in the US. This pulled 4 other G10 central banks into delivering a total of 275bps of rate hikes this week, but those efforts were insufficient to 'out hawk' the Fed, sending the US dollar ever higher. Against the tide, the Bank of Japan continued to hold policy unchanged, but the situation prompted intervention in the FX market to defend the Yen for the first time since the late 1990s. Bond markets, already under pressure from rising rates, reacted poorly to the announcement of a significant fiscal stimulus package in the UK. Gilt yields soared in response, heaping more pressure on the Sterling, with markets also contending with the confirmation from the Bank of England that it will soon commence selling down its bond holdings.    

Fed presses on with rate hikes...

The Federal Reserve's FOMC ramped up its response to high inflation in the US, not only hiking rates by 75bps but also signalling a higher peak in the fed funds rate than expected by markets, some 125bps above its current level of 3 to 3.25%. Committee Chair Jerome Powell said in the post-meeting press conference the FOMC was "purposefully" raising rates to a "sufficiently restrictive" setting that will likely be needed "for some time" to lower inflation to its 2% target, with additional tightening to come from the reduction of its balance sheet that is now running at its top pace of $95bn/mth.   

Chair Powell said that with the strong labour market generating upward pressure on wages and prices, longer-term inflation expectations risked becoming unanchored from the Fed's target. Accordingly, a more aggressive approach from the FOMC was signalled, with its median projection for rates rising to 4.4% by the end of the year (up from 3.4% in June) and lifting further to peak at 4.6% in 2023 (3.8%). Although rates are seen on a falling trajectory from 2024, the updated projections indicate the fed funds rate is likely to remain in the restrictive zone until at least 2025. 

... but faces an increasing trade-off 

That is how long the FOMC sees it will take for inflation to return to target on both a headline (2.0%) and core (2.1%) basis. This comes after the inflation projections for 2022 and 2023 were revised higher. The trade-off is significant, with more rate hikes seeing the growth outlook slashed to 0.2% this year from 1.7% in June and then to 1.2% in 2023 (from 1.7%) and 1.7% in 2024 (from 1.9%). Growth running below potential for that sustained period—something Chair Powell said was needed to lower inflation—puts the unemployment rate on an upward path, rising from 3.8% by the end of the year to 4.4% by 2024.  

Bank of England hikes into a complex outlook  

The BoE hiked rates by 50bps to 2.25% as the UK's complex economic backdrop resulted in the first 3-way vote from the 9-member Monetary Policy Committee in over a decade. A majority of 5 votes sealed the decision over 3 members who voted for a larger 75bps hike. The incoming member on the MPC, Swati Dhingra (replacing Michael Saunders), cast a sole vote for a 25bps increase. The MPC also gave the green light to its earlier announced plan for balance sheet reduction, voting unanimously for an £80bn reduction over the 12 months to October 2023. This will include around £40bn of gilt sales, of which £8.7bn is planned for the first 3 months. 

At cross-purposes to the BoE hiking rates, the government announced around £160bn of fiscal stimulus measures to impact the economy through to 2025/26 under its Growth Plan 2022. This includes a provisional £60bn to cover the government's price cap on energy bills. In its decision, the MPC noted the energy price cap will likely lower the peak in inflation from 13% to 11% in Q4 and cut 5ppts from headline inflation in 2023. However, over a medium-term horizon, it would add to inflationary pressures as it will help support household demand. The Sterling deteriorated further and gilt yields surged on the back of this week's developments, reflecting rising inflation risks and concerns over UK public finances. 

Given the associated uncertainties, the guidance from the MPC remained that rates are "not on a pre-set path", pledging also to act "forcefully" to signs of inflation becoming entrenched into the price- and wage-setting process. The path for rates will depend heavily on the Bank's revised assessment of the economic outlook, taking into account the effects of the government's fiscal stimulus, to be published at the November meeting. 

RBA to weigh its options 

The minutes from the RBA's September Board meeting were notable in that they revealed the Board held a discussion over whether to hike rates by 25 or 50bps. Ultimately the Board decided on 50bps, but this is a significant development given speculation of a slowing in the pace of tightening only started after the meeting when Governor Lowe removed the reference to "normalising" rates in his statement. At last week's parliamentary testimony, Governor Lowe told members that as rates rise higher "...the need for big adjustments gets smaller" and that the same discussion over hiking by 25 and 50bps would take place in October. 

The overall impression is that the RBA is becoming more mindful of the risk of overdoing tightening, with the minutes noting the Board was "resolute" in the need to lower inflation to target but also needed to take into account the "risks to growth and employment". Adding to the sense of caution is the global economy where the effects of rising rates, the war in Ukraine and a slowdown in China due to Covid are presenting downside risk for Australia. As Governor Lowe noted in his address last week, a soft landing domestically would be harder to achieve if there was "further material bad news on the global economy". 

Macro (Re)view (16/9) | Inflation watch continues

An above consensus outcome on core inflation in the US drove an aggressive reaction in markets as expectations for more Fed tightening saw equities decline and the dollar rising. Yields at the front end in the US lifted sharply, leaving the 2-year yield at its highest since 2007. Next week, both the Fed and BoE have policy meetings. 

More work in front of the RBA 

At this week's appearance before the parliamentary Standing Committee on Economics, RBA Governor Philip Lowe reaffirmed the commitment to bring inflation back to the 2-3% target band while aiming to keep the economy "on an even keel". Governor Lowe said that with the cash rate now close to estimates of the neutral range, the Board has more optionality and will discuss whether to hike rates by 25 or 50bps at the October meeting. Further rate hikes are on the table with the RBA intent on ensuring high inflation does not become entrenched through the wage-setting process. Although there is little sign of that at the moment, Governor Lowe said the RBA would need to remain alert given the strength of the labour market.  

After a temporary slowdown around the middle of the year, activity in the labour market rebounded in August leading to rises in employment (33.5k), participation (66.6%) and hours worked (0.8%). Increased participation saw the unemployment rate ticking up slightly, though at 3.5% it remains at lows going back to 1974. Underemployment (5.9%) and overall underutilisation (9.4%) also stand at historical lows. For my full review of the August Labour Force Survey see here.  

Consumer and business survey data was also in focus domestically this week. According to the Westpac-Melbourne Institute index, consumer sentiment saw its first rise in 10 months after lifting 3.9% in September but remains deeply pessimistic at an 84.4 reading. Despite this, household spending has been robust, highlighted in last week's national accounts. The backdrop of strong demand fed into an upbeat NAB Business Survey with confidence and conditions rising further above their long-run average levels in August.       

Core inflation rises in the US 

Although headline inflation in the US has come off its highs, a pick-up in the underlying pace saw expectations for the Fed's tightening cycle repriced higher, including speculation of a 100bps hike at next week's FOMC meeting (75bps expected). Inflation pressures had eased in July and although headline inflation was again subdued at 0.1% month-on-month and the annual pace slowed from 8.5% to 8.3%, the core rate went the other way rising by 0.6%m/m to 6.3%yr (from 5.9%). 

Headline inflation has been held down over the past couple of months mainly by falling gasoline prices, which were off 10.6% in August following a 7.7% decline in July. Beneath the surface, a key dynamic continues to play out with the contribution to inflation from services components remaining on the rise. As inflation started to accelerate in 2021, goods were the main driver due to strong demand associated with the pandemic colliding with constrained supply chains. With those effects now unwinding, stickier services categories are taking over in driving inflation. Shelter and rent costs are up sharply over the year (6.3%) and that has played a major part in elevated core inflation.   

Close call next week for the Bank of England 

Next week's BoE meeting shapes as a closely run thing with the MPC set to weigh up hiking Bank rate by 50 or 75bps. Inflation and labour market data released this week were stronger than expected on the key details and suggests the MPC could opt for 75bps, though a very weak retail sales report (-1.6%m/m in August) is a sign of the pressure households are under and could therefore argue for 50bps. Adding to the complexity is that the government has said there will be a 'fiscal event' the day after the meeting where it will unveil more of the details on the 2-year energy bill price freeze and other support measures.  

Headline CPI inflation on a 12-month basis softened a touch from 10.1% to 9.9% in August (vs 10.0% expected). However, the core rate showed its fastest month-on-month rise (0.8%) since March, firming the 12-month pace from 6.2% to 6.3% (vs 6.2%). Signs of broadening price pressures across the CPI basket come as an unwelcome development, particularly as average weekly earnings growth exceeded expectations at 5.5%yr in July. 

Rising wages reflect a tightening labour market in the UK where the unemployment rate fell to 3.6%, its lowest in 48 years. That has been driven by strong demand for labour - the most timely gauge of employment reported a 71k increase in August (vs 60k) - but also by a constrained supply of workers due to the pandemic. The inactivity rate lifted to its highest since 2016 (21.7%), driven largely by a significant rise in the number of people away from work due to long-term illness over the Covid period, now standing at 352k.