Cliff Notes: Confidence Over Inflation Requires More Time

Key insights from the week that was.

In Australia, partial updates on consumption came in on the softer side. Growth in nominal retail sales turned negative in March, down –0.4% (0.8%yr), the decline broad-based across sectors, with food retailing the only segment to record a gain. Downward revisions to prior months also weighed on Q1’s nominal result, leaving it materially below expectations at just 0.2%. Based on data from the Q1 CPI, prices look to be offering nominal growth less support, with outright price declines observed across clothing and several consumer durables in recent months.

Real retail sales (due May 7) are expected to again be weak, up a forecast 0.1%qtr. Further, our Westpac Card Tracker, including transaction data through to late-April, suggests the nominal spending pulse remained poor at the start of Q2. Our latest Red Book provides an in-depth assessment of the current health of the Australian consumer.

On housing, in April tension remained between the official unadjusted CoreLogic’s home value index and Westpac’s seasonally adjusted equivalent, a reported 0.6% gain moderated to just 0.2% once seasonality is accounted for. Annual growth is strong at 9.4% but is moderating. Conditions also differ by city, with Sydney and Melbourne experiencing soft growth as the smaller capital cities continue to post robust gains.

Additionally, the underlying trend for dwelling approvals remains uncertain. Volumes are holding in line with the cycle-lows of last year, and there is a material risk of a further deterioration. The ‘front-end’ of Australia’s residential project pipeline has shrunk materially and will have a long lasting effect on construction activity.

Finally, a note on trade. Australia’s goods trade surplus surprisingly shrunk to a three-year low of $5.0bn in March, extending the trend narrowing since November’s surplus of $11.5bn. The chief culprit was imports which surged 4.2% higher in March after a 4.4% gain in February, with the gains broad based across capital, intermediate and consumer goods. Meanwhile, export earnings were flat in the month, the recovery in iron ore volumes from Cyclone Lincoln offset by a moderation in commodity prices.

Offshore, the big event was the FOMC’s May meeting. Overall, a balanced view of the outlook was given. Risks to the inflation outlook were highlighted, the Committee noting that in “recent months, there has been a lack of further progress toward the Committee’s 2 percent inflation objective”. However, Chair Powell’s Q&A emphasised the FOMC still expect inflation to ease towards target over the remainder of the year, with the policy stance viewed as “sufficiently restrictive”. All together this points to the question being when (not whether) to cut. The starting point for the labour market and economic activity gives the FOMC scope to take their time assessing inflation risks. This week’s ECI and JOLTs surveys again pointed to a fully employed labour market, though the ISM manufacturing survey employment index again warned of a loss of momentum in job creation. As long as activity growth only slows to around trend and employment growth remains positive, we expect the FOMC to hold off on the first cut until September. Beyond that event, lingering inflation risks and the robust health of the US economy is anticipated to result in the FOMC only slowly easing policy, one 25bp cut forecast per quarter until a mid-2026 low of 3.375%, a terminal rate we regard as modestly contractionary.

Inflation in Europe remained at 2.4%yr in April, with services inflation down a tad to 3.7%yr from 4.0%yr the prior three months. Activity growth meanwhile recovered to 0.3%qtr in Q1, more than reversing the contraction suffered during the technical recession of H2 2023. While there are upside risks for inflation, progress continues to be seen. And there are also downside risks to growth from trade and credit conditions. This sets the stage for the ECB to deliver their first cut at the June meeting.

China’s NBS manufacturing PMI was broadly consistent with long-term average levels in April, the price sub-component an exception – 2 points below the 5-year pre-COVID average. This is consistent with overcapacity in many existing factories and industry’s drive to continue expanding. The services sector remains challenged, but the ‘expectations’ component 5-point gain points to optimism returning. The Government’s growth aim being achieved without aggressive policy stimulus likely helping matters.