Key insights from the week that was.
In Australia, the Q2 CPI reported a 1.0% (3.8%yr) gain in headline inflation and a 0.8% (3.9%yr) lift in underlying trimmed mean inflation, the latter a material downside surprise relative to consensus. The detail was nuanced, with some prices pressures continuing to abate as others showed persistence. Disinflation was most apparent in policy-sensitive sectors of the economy, discretionary inflation (ex tobacco) easing to just 2.1%yr, a low back to December 2021. However, stickiness in big-ticket non-discretionary items such as rents buoyed various measures of services inflation, offsetting the disinflationary impulse from other market services components and keeping services inflation elevated overall.
As detailed by Chief Economist Luci Ellis, the main takeaway is that Australia remains on the disinflation path, like many of its global peers; but there is still some way to go before policy can be normalised. We affirm our call that policy will remain on hold over the next few months, as the RBA Board closely monitors trends in underlying inflation to abstract from the temporary disinflationary impact of government energy rebates. Come November, we believe the RBA will begin reducing policy’s restrictiveness at a measured pace of 25bps per quarter, reaching a terminal rate of 3.10% by Q4 2025. Markets have removed what was a meaningful risk of a rate hike in 2024, and now price a circa 75% chance of a rate cut by year end.
Developments in economic activity will also prove critical to the RBA outlook. This week’s update on retail sales continued to point to a weak consumer, retail volumes declining –0.3% in Q2 following a –0.4% contraction in Q1. While we lack visibility around services consumption, this result, alongside other partial data, points to downside risk to total consumer spending in the June quarter. Externally, the goods trade surplus looks to have narrowed since the start of the year, the sharp decline in export earnings reflecting an uncomfortable mix of broadly stagnant volumes for key resource exports and declining prices. Services will prove crucial to the final wash-up for net exports, but are not reported on in this release.
Before moving offshore, a final note on housing. The latest CoreLogic home price data continued to highlight divergence across the states. In part this reflects variations in affordability, with prices little changed in the month in Sydney and Melbourne but still growing strongly across the smaller capital cities. The absence of momentum in dwelling approvals highlights a risk around residential construction activity once existing projects are worked through. This development does not bode well for supply or affordability dynamics in the medium to long-term.
Offshore, markets were kept busy this week by three central bank meetings, each one delivering a different outcome.
Most closely watched was the FOMC who kept rates steady in July but indicated that a cut could be delivered in September, if inflation continues its downtrend. The Committee continues to believe they have time on their side to gauge inflation’s pace and risks. In our view, there is already a strong justification to cut in September, with annual CPI ex-shelter inflation having held within a 0.8%–2.3% range and averaged less than 2.0% since June 2023. Shelter inflation is also now tracking lower and current market estimates of rent growth remain flat to down. On the labour market, the statement noted the “unemployment rate has moved up but remains low” and that current momentum is believed to be consistent with a rebalancing of labour demand and supply not an outright weakening. Increasingly though, the market is becoming concerned over downside risks for the labour market, particularly given persistent weakness in the employment indexes of the ISMs. While we have been highlighting downside risks to the labour market throughout 2024, inevitably we expect the US economy to prove resilient, warranting a steady but measured easing cycle beyond September – a cut per quarter taking the fed funds rate to a 3.375% terminal rate by mid-2026. Note, at that time policy would still be modestly contractionary. This terminal forecast highlights that we anticipate capacity constraints and trade policy to remain enduring inflation risks into the medium-term.
The Bank of Japan, in contrast, raised its policy rate by 15bps to 0.25% this week and announced a new tapering schedule of bond purchases. Policy and financial conditions remain ‘accommodative’, with the economy expected to grow above potential until fiscal 2025. However, their inflation forecasts were lowered for fiscal 2024 following the introduction of government energy subsidies for households, due in August and September. Enduring optimism over the virtuous cycle between wages and prices means that at-target inflation is still expected in the outer years. Risks around firms’ price and wage-setting behaviour remain though, particularly as small and medium-sized firms continue to report difficulty in passing on costs. Future hikes are on the table, with the BoJ noting, “…if the aforementioned outlook for economic activity and prices is realized, the Bank will accordingly continue to raise the policy interest rate and adjust the degree of monetary accommodation.” Increments are likely to be in 25bps, signalling the BoJ’s ‘normalization’ of policy and consistency with its peer central banks. Whether inflation can remain at or above target and wage growth endure remain open questions, however.
On the BoJ’s revised schedule for bond purchases, monthly purchases are set to decline from 5.7 trillion per month to 2.9 trillion by 2026, allowing short-term rates to increasingly be determined by the market. The stock of JGBs will remain high, but is expected to decline by 7-8% over the next two years. This plan will be reassessed in June 2025.
Finally, the Bank of England began its easing cycle overnight, cutting their policy rate by 25bps in a 5-4 decision. This follows annual CPI inflation hitting the 2.0% target in May and June, with “the Committee expecting the fall in headline inflation, and normalisation in many indicators of inflation expectations, to continue to feed through to weaker pay and price-setting dynamics.” While growth has recently been stronger than anticipated, business surveys point to more modest gains. Nonetheless, “there is a risk that inflationary pressures from second-round effects will prove more enduring in the medium term.”
As the vote shows, this was a finely balanced decision, with the Committee deeming it “appropriate to reduce slightly the degree of policy restrictiveness,” recognizing that the stance would remain highly contractionary after the cut. The resurgence of inflation to 2.75% in the second half of 2024, as base effects become unfavourable, is therefore expected to be temporary, with the modal inflation forecast at 1.7% in two years and 1.5% the year after that—outcomes significantly below the 2.0% medium-term target. Note, this forecast assumes the market-implied path for interest rates which includes a series of rate cuts through to end-2025.
 gain in headline inflation and a 0.8% (3.9%yr) lift in underlying trimmed mean inflation, the latter a material downside surprise relative to consensus. The detail was nuanced, with some prices pressures continuing to abate as others showed persistence. Disinflation was most apparent in policy-sensitive sectors of the economy, discretionary inflation (ex tobacco) easing to just 2.1%yr, a low back to December 2021. However, stickiness in big-ticket non-discretionary items such as rents buoyed various measures of services inflation, offsetting the disinflationary impulse from other market services components and keeping services inflation elevated overall.){kind=link}