Key insights from the week that was.
Confidence in the economy (and financial instruments) has been a key talking point for markets this week.
For Australia’s business sector, NAB’s April survey showed a decline in confidence in the month despite a further pick up in conditions to a level materially above average. This confidence measure is still best considered consistent with a generally positive mood amongst business however, despite global risks – which escalated in May – and the additional uncertainty created by a Federal election.
From the conditions detail, the re-opening of Australia’s economy is clearly a big positive and is expected to remain that way with forward orders continuing to show strength. However, of concern is that upstream price pressures and labour costs hit new record highs in the month, highlighting the lasting consequence of the pandemic on global goods supply and migration to Australia – for an update on the latter, see below.
Rolling forward a month and across to the household sector, our May Westpac-MI consumer sentiment report made for sombre reading, a 5.6% fall in the month leaving the index at just 90.4. This is the lowest reading since August 2020, when households were concerned over Victoria’s second-wave lockdown, and is also 8.4% below the average of 2019, when consumer spending was essentially flat over the year.
This pronounced deterioration in sentiment stems from the dramatic rise in Australian inflation to March 2022 and the RBA’s response to this development – May’s 25bp rate hike. Consumers are anticipating both of these headwinds will have a lasting effect on their finances, with views on family finances for the year ahead down 11% in the month to be 13% below average. Also note, ‘time to buy a major household item’ is now 27% below average, having falling 6% in May.
As detailed by Chief Economist Bill Evans in his video update, some of the biggest moves seen recently in the survey relate to housing. ‘Time to buy a dwelling’ is 25% lower than a year ago and 34% below average. House price expectations are similarly 26% lower than a year ago, albeit only 4% below average. Westpac continues to expect a 13% decline in capital city house prices from mid-2022 to mid-2024; a full discussion of the sector’s outlook was included in the team’s latest Market Outlook in conversation podcast.
April’s arrivals and departures meanwhile reported an acceleration (+200.9k and +275.8k respectively), pointing to strong momentum in the recovery of overseas travel. The component detail for March showed a doubling of short-term visitor arrivals over the month to 162k. On departures, Australian residents leaving on a long-term basis reached a series high at nearly 61k – reflecting the pent-up demand for overseas travel/work, likely among young Australians. Given that New Zealand represents the largest source of monthly foreign arrivals, New Zealand’s full reopening by end-July is a welcome sign that Australia-NZ travel should return to normal operations quickly.
Offshore, the primary data release of the week was April’s US CPI. The headline inflation result was more or less in keeping with expectations, the monthly pulse falling from 1.2% to 0.3%. However, the core CPI (excludes food and energy) was materially above expectations at 0.6% (consensus 0.3%), supporting fears of persistently high inflation.
Nonetheless, it is clear US inflation is slowing. Taken together, March and April imply an annualised inflation pulse of 5.5%, down from 7.0% in the five months to February, and 10% at this time a year ago. Further, looking at the component detail of the CPI basket, it is evident the imbalances caused by the pandemic are abating, with fiscal support for demand long past and the supply-side recovering.
With annualised core inflation still a multiple of the FOMC’s 2.0%yr target however, there is a long way to go in resolving the US’ inflation concerns. A wealth effect is unlikely to slow demand and inflation hence, but the hit to real incomes from inflation should. In our view, it is likely to take until late-2023 for real incomes to recover the losses of the past year. By that time, remaining supply-side concerns related the pandemic and Russia’s invasion of Ukraine should have abated, while 2022’s abrupt tightening of financial conditions will, by then, have had a year to impact. With inflation risks having subsided, the FOMC will be able to cut the fed funds rate back to 2.125% in 2024 to maintain growth near potential and a robust labour market into the medium-term.
The most significant risks to this view are a further escalation of global tensions which feed into inflation and wage expectations. And/or a doubling down by the FOMC or market on the outlook for rates, tightening financial conditions to an outright contractionary level. The possibility of the latter was flagged this week by the US 10yr falling back to 2.85% having run up to 3.20% following the FOMC and Bank of England meetings last week.
Increasingly it seems the risks the US faces may become the baseline expectation for the UK and Europe, with both central banks increasingly intent on raising interest rates despite growth looking as though it has stalled and will remain weak for an extended period. While UK GDP growth in Q1 overall was robust at 0.8%, the monthly data shows an abrupt change in the economy over the period, a 0.7% gain in January followed by no growth in February and a 0.1% decline in March.
This deterioration makes the uncertainty highlighted last week by the Bank of England for late-2022 and 2023 immediate, and also emphasises how skewed to the downside the risks have become. Like the US, real incomes in the UK have been hit hard; unlike the US, there is another wave of pain to come as higher wholesale energy prices feed through to the consumer and the labour market deteriorates.
The data flow for Europe has been very light this week, but a number of regional monetary policy officials including ECB President Lagarde have continued to raise concerns over inflation and the appropriateness of the ECB’s policy stance. Consensus at the ECB is often difficult to gauge, particularly in periods of heightened uncertainty; but an end of asset purchases in June now seems highly probable. It also seems a growing group of Governing Council members want rate hikes to follow quickly.
Arguably, the initial step of returning the deposit rate to zero from -0.50% could prove neutral (or even positive) for the economy as long as a succession of additional refi rate hikes are not expected immediately after. So, absent a clear decline in activity in Q2 data, we now look for the ECB to move the deposit rate back to zero in Q3. We still believe best policy would be to leave refi rate hikes to 2023, but the intent of the Council looks instead to be a move to 0.25% at the December meeting assuming contraction is avoided in Q3.
With inflation coming down quickly through 2023, additional rate hikes are likely to be limited to another 50bps, allowing activity growth to recover quickly. For the Bank of England, we believe it would be best to similarly limit their response to inflation to minimise the cumulative impact on activity and the labour market. A peak in the Bank Rate of 1.75% continues to be forecast.
These developments and the risks have weighed heavily on Euro and Sterling in recent weeks, seeing spot trade at USD1.04 and USD1.22 respectively overnight. However, we continue to see a move higher to year end for both currencies as risks abate with respect to inflation and the policy response as well as the conflict itself. A slowing US economy with reduced inflation risk should further support this trend. Full detail on our long-term forecasts can be found on Westpac IQ.