Key insights from the week that was.
In Australia, the RBA was the key focus of market participants. Offshore, the RBNZ asserted their hawkish resolve while US data weakened noticeably.
The RBA decided to leave the cash rate unchanged at 3.60% in April, a decision that was in line with Westpac’s forecast. In accordance with the decision, the Governor’s statement incorporated a subtle change in guidance, suggesting that further tightening “may well be needed” versus “will be needed” in March. While this certainly still qualifies as a tightening bias, clearly the Board is increasingly wary of the need to assess the full spectrum of risks having delivered 350bps of interest rate increases over the last ten months.
In our view, the evolution of underlying inflation pressures is of critical importance for the near-term path for policy. Westpac anticipates that annual trimmed mean inflation will print 6.6% in Q1, a result which the RBA should deem as uncomfortably high in the context of a historically tight labour market, thereby warranting a policy response. Hence, we continue to forecast one final 25bp rate hike in May, raising the cash rate to a peak of 3.85% where we expect it to remain over the rest of 2023. As economic momentum continues to slow and inflation risks abate, a series of interest rate cuts will be able to be implemented through 2024 and 2025 to bring policy back towards neutral, facilitating a recovery in activity growth.
In terms of domestic data, this week’s housing updates were generally mixed. Most notably, the CoreLogic home value index seems to be indicating some form of stabilisation in house prices, rising by 0.8% in March after a mild dip of just 0.1% in February. The pace of monthly declines in housing finance approvals meanwhile continued to moderate in February; but, broadly speaking, this gauge continues to point towards a further significant slowing in housing credit growth as interest rate headwinds build. Meanwhile, monthly updates on dwelling approvals remain hostage to its own seasonalities: coming off extreme volatility in high-rise approvals and now with emerging issues around processing delays, February’s modest 4.0% rise looks to be concealing an underlying softening in the trend, as evinced by the 30% decline in approvals over the last year. On balance, we remain confident in the assessment that broadening headwinds, particularly with regards to interest rates and the wider economic outlook, will remain a material drag on the housing sector over this year, but we are alert to the possibility of a sustained stabilisation emerging.
Turning then to New Zealand and the RBNZ, their decision to hike by 50bps this week caught the market by surprise, the consensus expectation being a 25bp move. The tone of the statement was also hawkish, the RBNZ clearly wary of the potential inflation consequences of the post-cyclone rebuild given the economy is already stretched. As explained by our New Zealand team led by Chief Economist Kelly Eckhold, the RBNZ’s focus looks to be on quickly achieving the outright level of policy they believe is required to bring inflation back to target. The RBNZ also noted that the recent decline in wholesale funding costs could lower borrowing costs across the economy; the 50bp move was then seen as a way to help “maintain the current lending rates faced by businesses and households”. This situation highlights the tension which is building between monetary policy in New Zealand and the rest of the developed world where policy is seen at or very near peak levels. Our New Zealand economics team now expect a 25bp hike in May to 5.50% and for the RBNZ to retain a tightening bias thereafter, pending further information.
Turning to the US, three data releases stood out this week: the ISMs and JOLTs job openings.
Both the ISM manufacturing and ISM service PMIs surprised materially to the downside in March, with the manufacturing contraction accelerating (the headline index coming in at 46.3) and the services measure almost stalling at 51.2. Also of significance is that new orders amongst manufacturers were particularly weak (the index declining to 44.3), while those for service firms fell sharply (the orders index down 10pts to 52.2).
Not only do these outcomes point to persistent weakness in activity ahead, but also clear risks around employment for which the starting point is a contractionary read for manufacturing and only a marginally positive level for services. A sharp drop in JOLTS job openings in February provided further evidence of building downside risks for employment, available positions declining to 9,931k in February from a downwardly revised 10,563k in January and the 2022 peak of 12,027k. While highly volatile and often off the mark as a lead for nonfarm payrolls (due Friday night), ADP private payrolls was also soft in March.
We have long highlighted the risks for the US economy from tighter policy and the shock to household finances from high inflation. These concerns led us to remain of the view that the US is likely to experience a lengthy period of stagnation, with an output gap in the order of 3.0% by end-2024. As discussed last week, given recent developments in the US banking sector, the risks to this view are skewing to the downside. Most significant is the potential for US GDP growth to get stuck at a rate below potential beyond 2024. This is why we see need for the FOMC to act aggressively on policy in 2024, once inflation risks have abated; but also why it is necessary banking sector regulatory reform occur with haste to restore confidence amongst both borrowers and lenders. If the latter is delayed, the benefit of 2024’s monetary easing could be offset.
Our April Market Outlook will be released later today on Westpac IQ. A key theme of our economic forecasts is the opportunity present in Asia. We also see the region’s cyclical rebound and ongoing structural development as a source for sustained gains in risk appetite, benefitting the currencies of the region over the forecast period, including the Australian dollar.
