Key insights from the week that was.
This week’s Australian data highlighted the growing disparity between current activity and confidence.
According to NAB’s latest business survey, while business conditions continue to show strength across the economy, confidence has fallen below its long-run average. Arguably this deterioration stems from the availability and price of labour and other inputs as well as growing uncertainty over the global outlook. The rapid turn in monetary policy is also cause for concern for business, though at the moment the impact on activity is limited given support from the labour market and the full re-opening of the services sector. In the second half of 2022 and into 2023, business conditions are likely to come under greater pressure.
While the Westpac-MI consumer sentiment survey continues to signal confidence in the labour market and the longer-term economic outlook, households’ near-term personal financial outlook is of great concern given historic inflation and rapidly rising interest rates. Highlighting this, underlying the seventh consecutive fall in the headline index to a level only seen during times of significant economic disruption are views on family finances 20ppts below average and an economic view for the year ahead 12pts below average.
Unsurprisingly, the ‘time to buy a dwelling’ index is now 32ppts below average and house price expectations continue to deteriorate. Also of concern for the growth outlook, ‘time to buy a major household item’ is now 30ppts down on its average level – note though this indicator is also picking up the rotation from goods to services as the economy re-opens. After its release, Chief Economist Bill Evans provided a video update on the implications for the economy and RBA of these trends.
At least the labour market outlook should remain an enduring positive, with June’s employment print coming in materially higher than expectation at a strong 88k. The employment outcome also saw the unemployment rate fall 0.4ppts to a 48-year low of 3.5% despite a 0.1ppt rise in participation. Australia’s labour market is clearly in unprecedented territory, with there now being one unemployed person per job vacancy and a record-high employment-to-population ratio. Gains over the remainder of 2022 will depend on how much further participation can rise as well as the outlook for immigration.
Australia’s arrivals and departures data suggests material changes in labour supply through immigration will take time, with a robust increase in arrivals to 737k in June offset by a very strong lift in departures to 885k, reflecting the normalisation of visitor flows as recent short-term visitor arrivals cycle out as departures. This lack of positive net arrivals is also evident in the underlying detail. Travel on a permanent/long-term basis and visa-related travel over recent months has shown as many arrivals as departures.
Turning then to New Zealand. As expected, the RBNZ delivered another 50bp hike at their July meeting, taking the cash rate to 2.50%. Our New Zealand economics team provided a full update on the decision and outlook after the announcement, highlighting in particular that the “RBNZ’s focus remains on the risk of homegrown inflation pressures becoming persistent, with strong demand running up against capacity constraints” and that the team continues to expect another 50bp increase in August, taking the cash rate near the level likely to prove the peak for this cycle.
Moving further afield, inflation and the required response of monetary policy remained front of mind for the US. In June, the headline CPI surprised to the upside again, prices rising 1.3%/9.1%yr. Core inflation was also stronger than expected, 0.7%/5.9%yr. Price pressures are certainly strong and broad based. But, in the detail of the report, there were no new breakout price moves. As supply constraints are worked through and demand remains under pressure from declining real incomes and tighter policy, we expect inflation will moderate back near the FOMC’s target.
In terms of the timing and implications for monetary policy, while July has so far seen a significant decline in the price of oil and food commodities, we expect the FOMC will feel compelled to continue tightening at a rapid rate in July and September – we forecast hikes of 75bps and 50bps. However, by the November and December meetings, when we expect two 25bp hikes to conclude the tightening cycle, declining commodity prices and the (already evident) reduction in price growth for goods ex energy and food should combine to give the FOMC comfort that the inflation threat is passing, allowing an on-hold stance to be adopted at a contractionary level of 3.375% from December.
In our view, the implications for activity of the above outturn for policy are concerning, with economic stagnation or recession to remain a material risk through 2022 and 2023. As we outlined this week, the Atlanta Fed’s nowcast for Q2 GDP currently suggests GDP contracted through the six months to June as the headwinds from declining real incomes, the rapid tightening of financial conditions, and historically-low confidence began to take effect.
In addition to the full impact of these forces being felt in coming quarters, it is also now clear that employment growth is slowing abruptly and nominal wages growth decelerating ahead of inflation. These trends bode ill for the business investment outlook as does the 20-year high for the US dollar. If the FOMC does not progressively shift its view on the risks from inflation to activity, not only is stagnation likely during 2022 and 2023, but potentially also into the medium-term. To combat this risk, we anticipate 125bps of easing from December quarter 2023 to December 2024, leaving the fed funds rate at 2.125%.
