Key insights from the week that was.
Critical data for Australia’s economy was mixed this week; elsewhere, the mindset of policy makers dominated the headlines.
The minutes of the RBA’s February meeting provided more colour around the Board’s decidedly more hawkish view. Most notably, the option of keeping rates ‘on hold’ was not considered in February having previously been an option in December. Further, debate between a 25bp and 50bp rate hike highlighted questions over the necessary scale of tightening to come and some lingering uncertainty around the timing of inflation’s peak “only [to] be confirmed in a few months’ time”.
Given time and pressure from policy are both expected to be required to bring inflation back to target towards the end of the RBA’s forecast horizon, and as the RBA has confidence in the state of the labour market and prospects for growth, as detailed by Chief Economist Bill Evans it now seems most likely that the Board will hike in March, April and May to a peak of 4.10% (previously 3.85%). At that deeply contractionary level, the RBA will be able to go on hold; however, it remains our view that the combined outlook for growth and inflation will not justify rate cuts until early-2024. Over the course of 2024 and 2025, we see 175bps of cuts to a low of 2.35% where the cash rate is expected to settle, with growth at trend and inflation at the top of the 2-3%yr range.
Given how tight Australia’s labour market is, it was surprising to see the WPI print materially to the downside in Q4 at 0.8% (consensus 1.0%). While the average wage increase among those who received a pay rise remained elevated at 4.0%, only 21% of private sector jobs received an increase in Q4, down from 46% in September and more in line with the seasonal norm. Individual arrangements are continuing to drive wages growth – reflecting robust demand for skilled labour – but the roll-over of minimum wage/award increases from September to December was not as strong as anticipated.
In the lead-up to next week’s Q4 GDP report, the ABS also released two partial indicators for investment.
Construction work done disappointed in the three months to December, falling 0.4% owing to a dip in private business construction and another decline in private home renovation. In contrast to Q3’s 3.7% rebound (revised up from 2.2%), the Q4 result clearly indicates a loss of momentum heading into year-end despite a sizeable pipeline of work and as supply constraints eased.
The Q4 CAPEX survey subsequently signalled a mixed outlook for investment. Of note from the detail on current activity, equipment spending posted a mild 0.6% gain as weakness in mining offset support from non-mining sectors. On spending intentions, in our view, the fifth estimate for the 2022/23 financial year implies a 14% gain in CAPEX (in line with the prior estimate). The first estimate for 2023/24 was also robust, up 11% on the first estimate from a year ago; however, the realisation ratio adjustment implies this equates to a much more modest gain of 5.5%. It bears remembering that all of these figures are nominal and price growth has been rapid of late, CAPEX costs up 10.5%yr at December 2022.
Despite the downside surprise in construction work and soft read on equipment spending, we have revised up our forecast for Q4 GDP from 0.6% to 0.7% as net exports look to have been stronger than initially anticipated. Our full GDP preview will be on Westpac IQ later today.
For those interested in medium and long-run trends, this week also saw the release of a deep dive into Australia’s historic surge in net migration which is set to continue through 2023 and 2024. Also worthy of consideration are the implications of the safeguard mechanism for Australia’s heavy emitters and carbon markets, topics taken up in the latest instalment of Commodities in Transition.
Over in New Zealand this week, the RBNZ delivered a 50bp increase as expected while retaining a hawkish outlook – guiding that they expect the cash rate to peak at 5.5% mid-2023 and remain at that level until late next year. Our NZ economics team expect this peak to be achieved through a 50bp increase in April and 25bps in May. We are more cautious on the outlook than the RBNZ however, believing that rate cuts will need to commence in early-2024 rather than near its end. As discussed by Acting NZ Chief Economist Michael Gordon, “it will take some time just to stabilise the average rate that homeowners are paying, let alone provide some relief as the economy cools off”. Note as well that the destruction caused by the recent cyclone is being looked through by the RNBZ, with disruptions to prices and activity expected to prove temporary.
In the US, the minutes of the February FOMC meeting were largely as anticipated. Broadly, they conveyed a sanguine view on economic momentum and the labour market, with the soft but positive pulse in domestic demand at Q4 welcome. The focus for policy makers therefore remained on risks to inflation and the appropriateness of financial conditions. While they believe progress is being made, the FOMC are not yet “confident” inflation is “on a sustained downward path” back to target. This will require a broadening of the disinflationary pulse to date concentrated in goods pricing. While partial data signals this next step is near, its scale and speed is yet to be proven.
While they wait for further data, the FOMC is intent on making sure that “overall financial conditions [are] consistent with the degree of policy restraint that the Committee is putting into place”. In our view, the Committee is aiming to hold up the long end of the Treasury curve, the 10-year yield between 3.50% and 4.00% as an example. In doing so, they will restrict the housing market and durables consumption (such as car purchases) while also holding back equity markets and household wealth. Unlike other major economies, the downside of the FOMC taking this course is limited, with the market able to reprice term interest rates household and businesses borrow at should the policy stance have a larger than anticipated impact on the economy. This ‘release valve’ for policy is a key reason why we believe that the fed funds rate won’t be cut until 2024, having been raised to 5.375% at June through 25bp increases at the March, May and June meetings.
