Key insights from the week that was.
Policy actions and talk of recession have filled the headlines in Australia and across the world this week.
The July RBA meeting was as expected, with another 50bp hike decided upon by the Board. As detailed by Westpac Chief Economist Bill Evans, there was nothing in the statement to dissuade us of the view that the July hike will prove the second of three consecutive 50bp hikes June through August, necessary to combat historic inflation and associated risks. Arguing in favour of this forecast and our belief that a further 75bps of tightening will be delivered in 25bp increments November through February was the close attention paid by the RBA to the continued rise of Australian inflation as a result of global and domestic pressures; our tight labour market; and recent strength in consumer spending. Downside risks to growth here and abroad are being monitored closely but, at least for the time being, remain secondary to the inflation threat.
On the data front, regarding housing, both dwelling approvalsand housing finance surprised materially to the upside in May, largely due to idiosyncratic factors around lumpy high-rise approvals and the clearing of processing backlogs from April. The underlying detail still echoes a down-beat assessment for Australia’s housing sector however, with a broad-based decline in private detached housing approvals (-2.4%mth) and persistent weakness in owner-occupier financing due to affordability concerns (-3.7%ytd). The backdrop of rising building costs, an aggressive RBA tightening cycle and a housing market correction are set to sustain the down-trend in dwelling construction and home lending over the remainder of 2022.
Australian trade also materially beat expectations in May, the surplus widening to a record high of $16bn on strength in resource exports. Total exports gained 9.5% as resource earnings rose 12.0%. Of particular note for resources, coal export earnings soared 20% on higher prices and volumes. Smaller in scale but also of significance, service exports gained 4.8% as tourism earnings increased 10% following a 29% jump in April as border re-opening continues to take effect. Along with continued strength in domestic demand, the price of oil and a weaker Australian dollar saw imports up 5.8% in May, partially offsetting exports’ strength.
Offshore, the minutes of the FOMC’s June meeting were the focus. There was nothing new in the content or tone of the report, with a clear emphasis on the risks to the outlook for inflation and inflation expectations as well as robust belief in the health of the US economy. That said, for inflation, it was emphasised that a key driver of the current wave is supply not demand – limiting the FOMC’s ability to curb aggregate inflation with rate hikes; and regarding growth, at numerous times in the minutes evidence of building downside risks was provided. Both trends are consistent with our baseline view that another 75bp hike will be delivered in July and be followed by a 50bp hike come September; however, thereafter the pace and scale of rate increases will decrease abruptly, with only another 50bps of tightening occurring across the November and December meetings.
Of greater significance for term interest rates is that we see a series of rate cuts commencing from Q4 2023, totalling 125bps by Q4 2024. This will leave the fed funds rate at 2.125% into the medium-term, with the risk additional cuts will be required. Consequently, we see the US 10 year back at 2.00% from the end of 2024. Whereas historically high inflation in the US is proving transitory (slowly), increasingly it seems the primary risk for their economy is below-trend growth becoming an enduring force. On this risk, note that the US is already on the cusp of two consecutive negative quarters of GDP at June 2022, while the outlook for income, financial conditions and confidence is adverse. These are themes explored in depth in our July edition of Market Outlook, due for release later today on Westpac IQ.
Despite the ongoing deterioration in US economic prospects, the US dollar continues to ride high. Indeed, midweek it reached a new multi-decade high of 107.3 on a DXY basis, now 107.1. The primary trigger for the move was a gas worker strike in Norway which hit already-fragile belief in the security of Europe’s gas supply hard. The strike looks to have already ended, but the weight on Euro from global risk aversion will take a lot longer to lift. With the market effect of the Ukraine conflict receding, and given the resilience the Euro Area economy has shown to date, we believe Euro will rebound in the second half of this year and continue on this uptrend through 2023. The relative and absolute economic foundations of FX markets are also a key topic of discussion in Market Outlook.
