Cliff Notes: The Promise of Disinflation

Key insights from the week that was.

In Australia, the Q4 CPI printed 0.6% (4.1%yr) for headline inflation and 0.8% (4.2%yr) for core trimmed mean inflation, meaningfully lower than the RBA’s forecast of 4.5%yr across both indicators. The detail of the report confirmed disinflation’s pace is faster than expected and it has breadth. Indeed, the proportion of expenditure classes that are tracking a pace above 3.0%yr has fallen drastically, from 71% in September to 56% in December. The largest downside surprise in the quarter was utilities (0.6% vs. 5.0% forecast) – State Government rebates clearly still effective in shielding households from specific cost-of-living pressures – in addition to tradable goods (–0.7%, 1.5%yr), as the disinflationary pulse from easing global supply chain disruptions continues to materialise. Some categories have moved only slightly below recent peaks, namely housing-related expenses such as rents (+7.3%yr) and dwelling purchase costs (+5.1%yr), while some have reached new heights, with insurance premiums (+16.2%yr) now tracking its highest rate of price growth since March 2001.

As detailed by Chief Economist Luci Ellis, these results are consistent with a softer set of data prints over recent months, not only with regards to inflation but also the labour market and economic growth. All-in-all, we continue to anticipate that there will be no change to the RBA’s policy stance next week; however, given the Board’s sensitivity to upside surprises, it is unlikely that the RBA will entirely rule out further rate hikes in their post-meeting communications. In time, the Board will be encouraged by the ongoing downtrend in inflation, and with growth likely to continue hovering well-below trend – a consequence of weak consumption (see below) and stalling business investment – there will be scope to lessen the contractionary setting of monetary policy. We are forecasting a rate cutting cycle to begin in Q3 2024, at a measured pace of 25bps per quarter until Q3 2025, to a terminal rate of 3.10%. Markets are on a similar page, now pricing in the first rate cut by Sep-24, two before Dec-24, and nearly four in total by Jun-25.

Other updates on the Australian economy this week were soft. On housing, the CoreLogic home value index reported a 0.4% lift in house prices in January, a further step-down in the pace of monthly gains. Moderation is clearest in markets where affordability is exceptionally stretched – Sydney and Melbourne in particular – a consequence of limited supply and contractionary policy. With dwelling approvals struggling to produce any signs of headway (–24%yr), affordability will continue to weigh on national price outcomes near-term, while state performances are likely to diverge based on how these factors evolve.

On the consumer, it was a disappointing end to the year for nominal retail sales, December’s decline (–2.7%) more than offsetting November’s Black Friday bounce (+2.2%). Shifting seasonal patterns aside, on balance these results continue to speak to a fragile consumer sector, with disposable incomes being hit by the trifecta of high prices, elevated interest rates and a rising tax take. For an in-depth assessment on the current state of the Australian consumer, see our latest Westpac Red Book.

In the US, the FOMC’s first meeting made clear they are in ‘risk management mode’. While inflation prints have been constructive, Chair Powell was looking for more of the same to ‘feel more confident’ that inflation risks are behind them. Headline and core PCE inflation prints of 2.6%yr and 2.9%yr in December saw Chair Powell characterise inflation as ‘elevated’. This is despite both headline and core PCE inflation having annualised at the 2.0% target throughout the second half of 2023. Much of the disinflation has come from goods, a function of easing supply chains, leading to some concerns around the stickiness of services inflation.

While the FOMC is not expecting the labour market to weaken materially, should downside risks assert, they will not hesitate to act with rate cuts. For the first time, Chair Powell outlined that rate cuts will come ‘some time this year’, but suggested that March may be too soon for the Committee to have the confidence they need. There are two payroll prints before the March meeting and we believe they are likely to decide when the first cut is seen. You can read more about our views here. Other indicators of the labour market were on the softer side this week, 0.9%qtr growth in the employment cost index the lowest quarterly increase since Q1 2021, and a modest deterioration in the ISM Manufacturing PMI’s employment sub-index despite a rise in the headline index.

Across the pond, the Bank of England also opted to keep rates steady at 5.25%; while the majority were for no change, votes were cast for both a hike and a cut. While inflation and wages data came in softer than the Bank expected in November, there is concern around inflation’s persistence. CPI is expected to remain elevated as energy subsidies roll off, and geopolitical conflicts skew near-term risk up. Growth is still expected to be very weak and the labour market deteriorating. Forecasts indicate that the BoE is likely to sustainably reach their inflation target later in the forecast period despite a near-term downgrade. While a cut can be expected, market pricing, which sees the base rate at 4.2% in 2024, is too aggressive for the BoE’s taste. The Bank remains concerned of inflation becoming stuck above 2% and so will be patient. This is also likely to prove the case in Europe. Their CPI eased to 2.8%yr in December, with food the principle driver; services stayed robust at 4.0%yr however, and core inflation ticked down to 3.3%yr overall.

Finally in Asia, China’s NBS PMIs showed slight increases, manufacturing at 49.2 (+0.2pts) and non-manufacturing at 50.7 (+0.3pts), likely aided by 2024’s mid-February timing of Lunar New Year. Employment and prices in China remained weak however, highlighting the difficulty authorities face in accelerating growth outside high-tech manufacturing and infrastructure investment.