Cliff Notes: A Step Behind, But With Goal in Sight

Key insights from the week that was.

In Australia, the Q3 CPI reported a 0.2% (2.8%yr) increase in headline inflation and a 0.8% (3.5%yr) lift in underlying trimmed mean inflation, both of which broadly met expectations. The impact of rebates was apparent in the headline detail, a –17.3% fall in electricity prices in Q3 the main reason why headline inflation managed to return to the band, alongside softness in auto fuel prices (–6.7%). Abstracting from these big moves, the underlying narrative has not changed materially since Q2. Price pressures in policy-sensitive components of consumption remain benign, discretionary inflation (ex tobacco) holding at a 2.1%yr pace in Q3. However, inflation is only gradually abating across non-discretionary items (excluding energy) such as rents and insurance.

Following this data release, Chief Economist Luci Ellis affirmed Westpac’s view that the RBA’s rate cutting cycle will begin in February 2025. Importantly, Q3 trimmed mean inflation was broadly in line with the RBA’s own forecasts; together with the recent revisions to activity data pointing to a better picture around supply capacity and productivity than previously assumed, the inflation detail suggests the risks of further increases in interest rates have dissipated. That said, there looks to be little appetite for the RBA Board to reverse their guidance that rate cuts this year ‘do not align with its thinking’. From February, we believe the RBA will begin slowly reducing policy’s restrictiveness, a cut per quarter to leave the cash rate at a terminal rate for this cycle of 3.35% in Q4 2025.

Developments in economic activity will also prove critical to the RBA outlook. This week’s update on retail sales continued to highlight the price sensitivity of consumers, retail volumes up a modest 0.5% in Q3, only the second increase in volumes in two years, with spending concentrated in items where prices have fallen. While we lack visibility around services consumption, this result, alongside other partial data, points to some downside risk to total consumer spending in the September quarter. For deeper insights on the current state of the Australian consumer, see Westpac’s Red Book.

On the international scene, politics were front and centre. Ahead of next Tuesday’s US Presidential and Congressional elections, opinion polls continue to indicate Donal Trump and Kamala Harris are neck and neck. While Trump seems to have edged ahead in some of the key swing states, his lead remains within the margin of error. Prediction markets in contrast imply close to a 2/3 probability of a Trump victory, and financial markets this week continued to position for such an outcome. Though it has to be said, US data this week was also consistent with a positive outlook for growth and the US dollar (more below).

Political uncertainty is also on the rise in Japan, the coalition government, led by the LDP, losing its majority in the lower house election last weekend. PM Ishiba, elected to lead his party only a month ago, is staying in his position hoping to find political support from other parties, likely in exchange for a commitment to higher future government spending. Turning to monetary policy, the BoJ kept the policy rate unchanged at 0.25% at its October meeting; but in the post-meeting communications, the Governor sounded more optimistic about the global outlook, particularly the US, and assessed that, domestically, wage increases remain supportive of consumer inflation. Another rate hike therefore arguably remains on the agenda for coming months, particularly if further Yen weakness is seen.

In the UK meanwhile, the new Labour government announced their first Budget, delivering a significant increases in public investment and spending worth around 2% of GDP per year. Looser fiscal policy is expected to boost UK GDP growth in the near term. According to official forecasts, GDP growth is on a trajectory to reach 2%yr next year, with around 0.5ppts coming from fiscal policy, before easing slightly in subsequent years. The extra spending will be funded almost equally by higher borrowing and taxes, the latter as a share of GDP forecast to rise above 38%, a record high and 5ppts above the pre-pandemic level. Financial markets showed concern over the fiscal outlook, the rise in projected government borrowing seeing Gilts yields rise across the curve.

In terms of the economic data flow, US GDP data confirmed the US economy carried robust momentum into the second half of this year, expanding 2.8%qtr annualised in Q3, only very slightly below the growth rates of Q2 and 2023 as a whole. Growth’s composition didn’t reveal any material changes to underlying trends, with personal consumption, business equipment investment and public spending leading the way. While net exports, inventories and residential investment were drags in Q3, lower interest rates should start supporting the latter, particularly if sentiment in housing and the labour market outlook remains firm.

Q3 Euro Area GDP also did not disappoint. Surprising market expectations, which had been weighed down by recent soft readings for economic sentiment, activity rose by 0.4%qtr in Q3. This was the strongest gain in two years and left annual growth at a more promising 0.9%yr. Temporary factors contributed – the Olympic Games supported growth in France, while a 2%qtr jump in Ireland surely is a one-off which will, at least partly, reverse – but there was also some positive news about underlying growth in key member states. Germany’s economy escaped recession, activity rising 0.2%qtr to partially reverse Q2’s 0.3%qtr decline. And Spain showed no signs of slowing down, GDP posting another 0.8%qtr increase, taking annual growth to 3.4%yr. Looking ahead, stronger Euro Area growth momentum should temper market expectations of steep ECB policy rate cuts over the coming year. We continue to expect a 25bp Deposit Rate cut at their final policy meeting of the year, followed by one cut per quarter through H1 2025.