Cliff Notes: Policy on Hold as Risks Evolve

Key insights from the week that was.

The Monthly CPI Indicator rose 0.6% (5.2%yr) in August, above the 0.3% (4.9%yr) print in July but still broadly in line with a trend deceleration since the peak of 8.4%yr in December 2022. While the print for headline inflation was in line with Westpac’s forecast, the component detail provided some surprises. Inflation in the housing segment was much weaker than anticipated – up 0.1% (6.6%yr) – driven by a fall in electricity prices (–1.3%mth) associated with the Energy Bill Relief Fund rebates in Melbourne. There were some key upside surprises too, including a 9.1% lift in fuel, a 1.3% increase in alcohol and tobacco prices, and a much more muted –0.1% fall in clothing and footwear than we initially anticipated. Underlying inflation momentum remained steady in August, with the Monthly Trimmed Mean holding flat at 5.6%yr. These developments, which in part reflects a stronger oil price (via fuel prices) and a weaker AUD (via imported components) – trends which seem to have persisted through to September – point to some upside risk to inflation over the near-term.

Turning to the labour market, job vacancies were reported to have fallen by 8.9% between May and August, a pick-up from the more modest decline of 2.5% over the prior three months. The tone of the survey is consistent with other evidence on labour market conditions, which suggests that the labour market has moved past its tightest point – a consequence of the significant improvement in labour supply and a gradual moderation in labour demand from very strong levels. That said, the total stock of job vacancies remains is still 72% above pre-pandemic levels and the vacancy-to-unemployment ratio remains at a historically elevated 0.72, implying that that labour market conditions remain very tight for now and there is further scope to ease over the next year.

However, as discussed by Chief Economist Bill Evans, the Monthly CPI Indicator is unlikely to have a major influence the RBA’s decision next week at the October Board meeting. As has been the case over the past year, the Board’s preference is to inspect the more comprehensive quarterly update on inflation – due next month – so it is therefore unlikely to change policy on the basis of the Monthly Indicator in the interim. Like the last two months, the RBA should continue to view the argument for remaining on hold as being the “stronger one”. This sentiment will be supported by the constructive flow of data developments over the last week, including another subdued print for nominal retail sales, with spending rising by only 0.2% in August, and emerging signs of a turning point in the labour market, suggesting that the impact of the RBA’s rapid tightening cycle is clearly working its way through the economy. Westpac remains of the view that the RBA will remain on hold until August 2024, wherein the next rate cut cycle is expected to begin in order to restore balance to demand conditions and support growth’s return towards trend.

It was a quiet week offshore, with mostly second-tier data releases in the US.

In the US, regional surveys pointed to a mixed picture. The Chicago Fed National Activity Index suggested the economy was growing below potential with a negative reading of –0.16 in August following a positive reading in July. All sub-indicators were in the red, though August’s weakness looks to be centred on a souring in personal consumption and housing. The employment indicator remained negative for a fourth consecutive month, reflective of emerging slack in the labour market.

The Richmond Fed Manufacturing index broke a 16-month streak of negative readings, coming in at +5pts for September. On current conditions, strength came from shipments, capacity utilisation and new orders. For the region, employment in the sector was optimistic overall, with number of employees rising as wages continued its ascent. Expectations remained upbeat, but less so than August. Meanwhile, the Kansas City Fed Manufacturing index fell to –8pts in September from flat in August, although a semblance of optimism for expectations six months ahead persevered. Of note, the prices paid and received sub-indicators for current vs previous month were both positive. The rise in oil prices through September likely contributed to higher producer prices but further readings are necessary to confirm whether its impact will persist.

Durable goods orders were firmer than expected in August, headline orders rising 0.2%mth and the measure excluding transport orders lifting 0.4%mth. Most of the strength was a consequence of defence spending however – excluding this, durable goods orders declined 0.7%mth. This supports the continued pessimistic outlook for manufacturing from the private sector, with firms’ investment intentions remaining under pressure. Weakness in non-defence goods orders, alongside autoworkers’ strikes, points to some downside risk for private investment in GDP for Q3.

Regarding the consumer, there was a notable slip in confidence according to the Conference Board’s September survey, from 108.7 to 103.0, to be only slightly above the optimism/pessimism threshold. Underlying this is a clear divergence between households’ views around the present situation and expectations, the former still very optimistic at 147.1, whilst the latter soured nearly 10pts into deeply pessimistic territory, at 73.7.

FOMC members were also active this week. Many, Bowman and Kashkari in particular, were advocating for an additional rate hike on the basis of inflation risks; however, comments from Barkin and Goolsbee emphasised the importance of assessing the materialising impact of policy tightening. Of note, Goolsbee spoke on the trade-off between inflation and unemployment, positing that it may be weaker in the post-COVID era and hence, there is a greater risk of over tightening.