Key insights from the week that was.
This week has been all about monetary policy, in particular global central banks’ fight against inflation. Their rhetoric, the implications for global growth and the market’s reaction have led us to revise down our Australian dollar view.
The minutes of the RBA’s September meeting presented a relatively balanced view, highlighting the need to act against inflation and the risks around expectations while also recognising the cost to activity and employment from tight policy and the lags associated with changes in the monetary stance. Unlike August, at the September meeting, “the arguments around raising interest rates by either 25 basis points or 50 basis points” were discussed, with “the importance of returning inflation to the target, the potential damage to the economy from persistent high inflation and the still relatively low level of the cash rate” leading the Board to favour 50bps. Arguably, with the US August CPI and the rhetoric of global central banks since highlighting the uncertainties that remain with respect to inflation, the case for quickly taking policy to neutral and then above in Australia has strengthened. Westpac expects another 50bp increase in October followed by three 25bp hikes to a peak cash rate of 3.60% at February 2023.
Meanwhile in the US, Chair Powell and the Committee again made an aggressive stand against inflation at the September FOMC meeting, raising their peak fed funds rate forecast to 4.6% in 2023 and inflation projections for 2022-2024 while also remaining sanguine on the impact to activity and employment. The short time horizon to the end of this hiking cycle – likely January 2023 – leaves little room for the data to speak, and so a further 150bps of hikes has to be expected from here. The cost to the economy will be significant however. We now expect the US economy to experience an output gap circa 3.5% by end-2023 and near 4.0% by end-2024 following next-to-no growth in 2022 and 2023 and a below-trend gain in 2024. A rise in the unemployment rate in the order of 2ppts is anticipated as a result.
Nonetheless, the market pricing in rate cuts into term interest rates throughout 2023 along with the FOMC’s acute concern over inflation expectations will result in the Committee holding off on rate cuts until 2024, when we expect concerns over external inflation risks to have subsided as domestic slack suppress growth in wages and discretionary consumer spending. The consequences of this tightening cycle have the potential to restrain growth opportunities for the US into the medium-term, in stark contrast to the FOMC’s current expectations. As is evinced by the sharp reduction in the housing construction pipeline, this has the potential to create additional supply constraints (and inflation) further out.
Finally to the UK, the Bank of England decided to raise the bank rate by 50bps in September, from 1.75% to 2.25%. Despite not having lifted the pace of rate hikes, the shift in the Committee’s dissent profile was still perceived as a hawkish tilt by markets. Indeed, with three members having voted for a 75bp hike and five members favouring a 50bp move, the overarching consensus from the Committee is that inflation will remain uncomfortably high for many months, strengthening the case for further rate hikes into year-end.
The UK Government’s announcement of an Energy Price Guarantee was a welcome development, expected to improve household’s real income position and the inflation outlook – now expected to peak “slightly under 11%” – though uncertainties around its impact on demand, both within energy consumption and more broadly across the economy, led to a split decision between 50bps and 75bps. Regardless, this meeting largely served as a platform to reaffirm the Committee’s commitment to reducing inflationary pressures and reining in inflation expectations at the cost of economic activity. We continue to expect the Committee to hike into 2023, anticipating a Bank Rate of 3.00% at December 2022 and 3.25% by March 2023. To this view, there are clear upside risks which largely relate to whether the consumer will use the funds saved on energy to make additional purchases.
As above, in light of this week’s developments, Westpac has revised down our expectation for the Australian dollar at end-2022 to USD0.65 and for end-2023 to USD0.72. Chief Economist Bill Evans today outlined the reasoning for the change as well as the primary risks. Most notable is the outlook for the global economy and, of course, inflation. If the impact of policy tightening is more significant than we currently expect, particularly in Asia, or inflation proves more sticky than forecast globally, then our currency is likely to come under further pressure.
