Key insights from the week that was.
In Australia, the RBA Board once again left the cash rate unchanged at 4.35%. The Board’s statement emphasised that there remains considerable uncertainty around the economic outlook, particularly as it relates to policy lags, the path for consumption, and consequently inflation’s path back to target. Strong population growth has provided considerable support for aggregate demand, GDP up 1.1%yr in the March quarter despite per capita activity declining 1.3%yr, but capacity is constrained. This context puts the Board in a challenging position on the narrow path back to target inflation, requiring it “to remain vigilant to upside risks to inflation” and “not rule anything in or out” with respect to policy.
Critical to the RBA outlook for the remainder of the year will be forthcoming updates on inflation. As detailed earlier this week, there is likely to be greater-than-usual volatility in headline inflation over the coming twelve months, as various cost-of-living policy initiatives from both federal and state governments lower measured inflation. The RBA Board are likely to ‘look through’ this volatility in headline inflation and focus on developments in core inflation. Supporting our view for a further deceleration in trimmed mean inflation, to 3.5%yr by Dec-24 and 3.0%yr by Jun-25, is a constructive outlook for many of the risks the RBA Board is currently focused on. That includes the more modest decision on minimum and award wages from the Fair Work Commission, the significant moderation in unit labour costs growth to date, and the ongoing improvement in labour productivity.
Overall, we view the Board’s language as striking a delicate balance. Rate cuts are unlikely to be delivered until late in the year, November being our forecast for the first move, with policy relief ensuing at a measured pace thereafter – 25bp per quarter, taking the cash rate to 3.10% by Q4 2025. Should stickiness in price pressures persist, the risk that policy relief will be pushed back will grow.
Offshore, the Bank of England kept rates steady at 5.25% in a 7-2 vote, but gave their first hint of a near-term rate cut. On the whole, economic conditions were viewed as consistent with progress being made, with a number of those who voted for no change noting that their decisions were “finely balanced”. The decision came a day after the release of the May CPI which, on a headline basis, came in at target — 2%yr. However, core inflation rose 3.5%yr while services remained sticky at 5.7%yr. Helpfully, inflation’s breadth is narrowing — 59% of the basket was running above the 2% target in May compared to 64% in April. The BoE’s analysis also suggests price setting behaviour in the services sector should continue to ease, albeit from a still elevated level.
The UK labour market has been hard to gauge given data quality issues, but the Decision Maker Panel survey implies wage and inflation expectations are decelerating, helping to balance risks to the inflation outlook. Inflation is expected to print just above 2%yr through the second half of 2024 as energy subsidies cycle out. For the BoE to feel confident CPI will sustainably return to target thereafter, further progress on underlying services inflation is required along with easing wage pressures. It is important to recognise that one cut will not take policy from contractionary to neutral, and so we are most likely to see cutting commence before the 2.0%yr target is sustainably attained. The August meeting is best considered live, particularly as revised forecasts will be received by the MPC at that meeting. As in other key jurisdictions, the coming rate cutting cycle for the UK will be measured in timing and scale, with each step determined by incoming data.
Last Friday, the Bank of Japan left policy rates unchanged, but noted they would reduce bond purchases with a detailed plan to be outlined at their July meeting. Commentary around the outlook for the economy remains unchanged — real wage growth is expected to sustainably support demand and prices, leading to at-target inflation into the medium term. Remaining upbeat but patient will improve the chances of this expectation becoming reality. Also supportive is the weak Yen, as discussed in our note. However, meaningful and persistent increases in real wages and investment are necessary to justify policy normalisation.
Elsewhere in Asia, Chinese partial data remained mixed in May. Authorities belief that downside risks are being neutralised by policy was challenged by the data, the price of new and used homes declining by 0.7% and 1.0% respectively in May. Investment in the sector also remained 10% lower year-to-date. Consumer spending is best considered resilient (but certainly not strong or strengthening), retail sales up 4.1% year-to-date in May, the same as April. Fixed asset investment continued at a circa 4% pace year-to-date as growth in property investment remained deeply negative and high-tech manufacturing investment growth slowed to a robust but sustainable pace after the rapid gains of recent years. Highlighting the benefit to China from trade, particularly with Asia, industrial production continued to grow around 6% year-to-date.
Finally to the US. FOMC speakers this week again emphasised the prudence of waiting for further progress with respect to inflation’s return to target. That said, it was evident in their remarks that this view was predicated on US growth remaining above trend and no further slippage in the labour market. Data out this week instead highlighted the downside risks for activity. Retail sales again surprised to the downside in May, +0.1%, and April was revised down from flat to -0.2%. Both headline and control group sales point to goods spending being essentially unchanged year-to-date. Despite still robust momentum in services spending, total consumption growth looks to have slipped to a below-trend pace in Q2. Forward looking housing data was also very week in May, with starts now 20% lower than a year ago and permits down 9%yr. Initial claims meanwhile continues to indicate little-to-no job shedding, but all measures of labour demand indicate it is softening, to varying degrees. As we continue to highlight, the FOMC need to be mindful of the evolution of risks that the US faces. This will be as true a year from now as it is today.
