Key insights from the week that was.
This week, Australian Federal Budget 2023/24 gave the market a lot to consider regarding Australia’s outlook. Offshore, policy expectations remained the focus.
Beginning with Budget 2023/24, our bulletin and conversation with Chief Economist Bill Evans provides a full view of the Government’s fiscal position and economic expectations for the next four years. Most notable is the markedly improved starting point for Budget 2023/24, the strength of the economy delivering a $121.5bn windfall through to 2025/26. As a result, the profile for net debt has improved notably, the peak now forecast at 24% of GDP in 2025/26 compared to 28.5% of GDP in October’s Budget 2022/23. The Budget’s spending measures were focussed on cost-of-living relief – including an increase in rental subsidies and a reduction in energy bills for vulnerable households – alongside additional spending on welfare programs and essential services, particularly health and aged care.
Regarding monetary policy, we believe the budget will have little influence on the RBA’s assessment of the economy, at least for the remainder of the year. While cognisant of the medium-term risks around the expansionary nature of the budget, the Board will be focussed on near-term developments for underlying inflation and the labour market. Our central view is a clear downtrend in inflation and gradual easing in labour market tightness as a consumer-led slowdown in growth materialises, warranting policy to remain on hold though 2023 before rate cuts commence in 2024. However, if inflation risks were to assert, the timing of 2024’s rate cuts may need to be pushed out.
The latest NAB business survey was consistent with our baseline view, highlighting a further easing in business conditions – particularly across consumer sectors – as inflation and interest rate pressures impact. Also, following a 0.3% fall in Q4, real retail sales posted a larger 0.6% decline in Q1, thereby marking the largest six-month contraction in retail sales volumes since 1986 (excluding COVID and the GST’s introduction). Our Westpac Card Tracker has also shown that wider consumer spending activity is stalling, emphasising the broad-based nature of these headwinds. Additionally, the underlying weakening in dwelling approvals indicates that the recent stabilisation in house prices will take time to cycle through to new construction activity.
Of greatest importance offshore this week was the April CPI report for the US. Both the headline and core readings were in line with expectations (0.4% for the month and 4.9%yr/5.5%yr respectively over the year). Critical though was the detail. The all-important shelter component continued to slowly slip away from its peak level. Meanwhile, food prices were unchanged for a second month, suggesting the secondary impacts of commodity inflation have passed and also that wages are not driving another wave of abnormal price increases by business. Overall, goods inflation is now a benign force, with goods ex food & energy up just 2.0%yr in April. Ex shelter, a similar judgement can be made for services. We therefore regard US inflation as on track to return to a 2.0% annualised pace towards the end of this year, providing the FOMC with scope to ease policy, beginning with a 25bp cut in December.
This will just be the start however, with need for 200bps of further easing through 2024 – in our view. By 2024, the pullback in bank lending and tightening of standards we are beginning to see in the credit data and senior loan officer survey respectively will be having its full effect on the economy. Most notably, the just released April Senior Loan Officer Survey reported a tightening in lending standards and increase in spreads over banks’ cost of funds similar in breadth to that seen during the pandemic, GFC and 2000-01 tech wreck.
It is important to emphasise though that this survey reports on the percentage of respondents taking action (e.g. tightening standards) not the scale of the change; ergo, the effect of this tightening on the supply of credit is unlikely to be as significant as that seen during the GFC.
A caveat applies however, as the Senior Loan Officer Survey only captures a subset of banks, with 65 domestic banks reporting in this instance. The qualitative guidance by bank size makes clear that the complete market is likely experiencing tighter conditions and weaker lending than the survey implies, with the results for mid-sized and small banks notably worse than for large banks.
Following last week’s FOMC and ECB decisions, this week the Bank of England (BoE) followed suit, delivering a 25bp hike to 4.50% at their May meeting. As anticipated, their guidance was somewhere between the FOMC and ECB, but still best characterised as a conditional pause. Conditioned on the market path for rates, which includes a brief lift in Bank Rate to 4.75% from August 2023 to March 2024, the BoE continue to expect elevated inflation to give way this year and next, with a year-end forecast of 5.0% for 2023 and 2024 average of 2.25% followed by below-target inflation in 2025. This steady return to target is despite recent upside surprises for goods inflation (including highly-elevated food inflation) and a material upward revision to growth expectations, with recession no longer anticipated in 2023. Given available data and in light of the BoE’s revised projections, while there may be need for another hike mid-year, the BoE seems highly likely to be in a position to cut interest rates by mid-2024, following a similar path to both the FOMC and ECB.
Finally to China. While the trade balance surprised to the upside in April, the market took the report negatively given it included a sharp annual drop in imports, -7.9%yr, and as the upside surprise to annual export growth, 8.5%yr, was viewed as masking short-term weakness. Seemingly missed by participants was that the trade breakdown by country continued to show the strength of Asian demand, with the surplus from the region materially higher than a year ago. For our growth view, this is critical as we hold that accelerating growth in Asia will largely offset the negative effect of weak developed-world demand. Also critical is that Chinese manufactured goods demand is increasingly satiated by Chinese supply. Both factors will allow the trade position to hold up for the remainder of the year.
We were also unconcerned by the weak price detail announced this week. However, we are carefully watching the credit data. New loans and aggregate finance were both weak in April after a strong March. For investment growth to hold up, the private sector have to be willing to expand capacity. We believe they will, but there are risks around the timing and scale of growth.
