Cliff Notes: The Global Tightening Cycle Nears Its End

Key insights from the week that was.

Beginning in Australia, the Westpac-MI Consumer Sentiment survey delivered yet another sour update on confidence. At 79.7, the headline index has held at deeply pessimistic levels for over a year. This is despite a clear shift in the interest rate outlook, with the RBA now having left policy unchanged for three consecutive months. However, consumers continue to report unrelenting cost-of-living pressures, weighing heavily on current spending behaviour and their views of family finances.

Overall, the survey continues to speak to a very weak outlook for Australian consumer spending. For more detail on our views on the Australian economy and international developments, see the latest edition of Market Outlook. Key themes of the moment were also discussed by the team in our September Market Outlook in Conversation podcast.

The strength of Australia’s labour market has been one of the few bright-spots for households over the last year. The August labour force survey reinforced this support remains intact, the +64.9k lift in employment surpassing even Westpac’s near top-of-the-range forecast. Note though, despite the historic level of employment and a 9.4%yr rise in hours worked, the underemployment rate rose to 6.6% in August. This highlights households are willing to work yet more hours, arguably as a result of intense cost-of-living pressures.

Another point worth mentioning was the surprising strength in labour supply. At 67.0%, the participation rate has lifted to a fresh record high, resulting in an expansion in the size of the labour force on par with employment, ultimately seeing the unemployment rate remain unchanged at 3.7%. This highlights the capacity for labour demand to soak up the migration-driven surge in labour supply; if that were not the case, the unemployment rate would have risen further. This will remain an important dynamic in the year going forward. While we anticipate the strength in net migration flows to ease, the softening in labour demand will likely be greater, seeing the unemployment rate rise to a quarter-average rate of 4.7% by 2024’s end.

At least for now though, the overseas arrivals and departures data continues to highlight strength in migration and population growth. The momentum in permanent and long-term net arrivals is at a historic high, a three-month average pace of +39.3k/mth. The visa-related breakdown is also still reflective of strength, albeit off the highs seen earlier this year. Later in the week, official population estimates provided confirmation of our view for net migration, having posted a sizeable lift of +150k in Q1 2023.

Offshore, there was plenty of news.

The European Central Bank raised its three key policy rates by 25bps. This was a split decision, with President Christine Lagarde mentioning during the press conference that some members “wanted more patience”. We also received updated forecasts which see inflation at 3.2% in 2024 then back at target in 2025 at 2.1%. The upgrade came as a result of stronger energy prices. Underlying inflation meanwhile, which excludes food and energy, is expected to be lower in 2024 at 2.9%yr and broadly the same level in 2025, 2.2%yr. Most notably, growth projections were downgraded to 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025, downgrades of 0.2ppt, 0.5ppt ad 0.1ppt respectively.

This is likely to be the final ECB rate hike absent an inflation shock as the ECB stipulated “the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” That said, during the press conference Lagarde was more tight-lipped about explicitly stating if this was the end of the tightening cycle. We expect the ECB to remain on hold from now until mid-2024 after which we expect 150bps of rate cuts to the end of 2025, compared to 200bps for the US Federal Reserve.

In the US, the CPI rose 0.6%mth in August and 3.7% through the year. Energy was the biggest contributor on a monthly basis as a result of the sharp rise in motor fuel prices. Core inflation, which excludes food and energy, also ticked up in the month to 4.3%yr. While increasing transport prices — both through the transport services and fuel segments — pose an upward risk to the CPI, we continue to expect abating price pressures elsewhere bring annual inflation back down to 2.5%yr by March 2024 and 2.0%yr come June 2024. Key will be an easing in shelter prices. The shelter component is currently responsible for around 70% of annual inflation, but leading indicators continue to point to a material deceleration ahead. This should create the right conditions for a rate cut by March 2024.

Meanwhile in the UK, the ILO unemployment rate ticked up to 4.3%, rising above the Bank of England’s forecast of 4.1%. This came as a result of a large drop in employment, particularly amongst those aged 16-24. Wages came in at a sizzling 8.5%yr however, exceeding the Bank of England’s forecast of 6.9%yr for Q3. Private sector wages, of particular importance to the BoE, ticked down to 8.1%yr from 8.2%yr last month, but obviously a much larger reduction is necessary.

Given wages continue to overshoot as slack builds, there is growing support for the argument that the degree of slack needed to contain wages and prices growth is higher than previously thought. Governor Andrew Bailey is optimistic that wages will come down given anchored inflation expectations, but the BoE have repeatedly been surprised in this cycle. In contrast, Catherine Mann’s comments this week suggests there a lot more work to be done. She said, “…holding rates constant at the current level risks enabling further inflation persistence which will have to be unwound eventually with a worse trade-off.” This hawkish statement supports the case for a further hike at the September meeting next week, bringing the rate to 5.5%. In the absence of supportive data, we are likely to see one more hike thereafter, then a length pause for policy.