Key insights from the week that was.
This week, Australian data was broadly constructive on the outlook. Meanwhile, considerable volatility was present financial markets after the announcement of the UK Government’s expansionary Fiscal Update.
Australian retail sales came in slightly above expectations in August with a solid 0.6% lift gain largely centred on food retailing (+1.1%) and cafés/restaurants (+1.3%). Though it is likely that higher retail prices are concealing a softening in sales volumes, the preliminary detail implies that retail volumes are tracking above-trend pace for Q3, suggesting that the RBA’s aggressive tightening cycle is still yet to significantly impact demand.
The Q3 ACCI-Westpac Business Survey also highlighted the strength of demand within Australia’s manufacturing sector. The ongoing ‘burst’ in activity after virus and weather-related disruptions earlier this year materialised as an acceleration in output and new orders, both reaching series highs in the September quarter. That said, it’s clear that the upside for growth is being constrained by significant and persistent headwinds. Of note, an unprecedented 67.5% of respondents reported that labour was “harder to find” – the tightest conditions in the series’ history – and material shortages are at levels still comparable to the mid-1970s oil shock. Cost pressures remain acute, putting upward pressure on finished goods prices and hence consumer inflation.
On inflation, the ABS released further detail around the Monthly CPI on Thursday. While several components within the basket are only measured in the last month of the quarter, the annual growth rates for the months of July and August imply a lift in the headline CPI of 0.5% and 0.2% respectively, the latter reflecting a clearer softening in dwelling prices. As such, we have revised down our Q3 headline CPI forecast to 0.7%, though our trimmed mean CPI forecast remains at 1.5%.
The Federal Government’s Final Budget Outcome also revealed a dramatic improvement in the fiscal position for the 2021/21 financial year. Lower utilisation of COVID-19 business support measures saw higher-than-expected company tax receipts, resulting in a $24bn upside surprise on revenue. Additionally, lower demand for other COVID-19/health-related support saw a $20bn downside surprise on expenses, leading to a much lower deficit than forecast in March, at -$32bn. This represents a marked $48bn improvement, placing the Government in a more favourable fiscal position as the Australian economy navigates a sharp slowdown in growth over 2023 and 2024, which we forecast to be 1% and 2% respectively.
Turning then to New Zealand. Recent developments around the exchange indicates that the imported component of inflation will not be as quick to recede as previously expected, pointing towards further inflationary pressure over the medium-term. As such, our New Zealand economics team have revised up their forecast for the RBNZ’s Official Cash Rate, with a 50bp rate hike expected at the upcoming October policy meeting, followed by two further 50bp rate hikes in November and February, taking the cash rate to a peak of 4.5% for the cycle.
Moving offshore, financial markets were rattled by the UK Government’s Fiscal Update. The update outlined a suite of fiscal stimulus centred on income and corporate tax cuts, removal of insurance and health/social care levies and an increase in stamp duty thresholds. Given the expected cost of these measures (£25-45bn per annum over five years) in addition to the energy guarantee plan announced last week (£60bn first six months), and the Government’s funding strategy on based on borrowing and expected growth over the forecast horizon, markets were fraught with concern over the Government’s fiscal credibility.
In the days following, the Bank of England began purchasing long-dated Gilts and announced a postponement of their balance sheet reduction as FX and fixed income markets demonstrated considerable volatility. Indeed, mid-week the GBP/USD tested lows of 1.05, now settling back around 1.11, and 30yr Gilt yields spiked to multi-decade highs of 5.15%, before retreating to 3.97 currently. The Bank of England’s actions, alongside the UK Government’s subsequent announcements of further planned updates over October and November, served to cool tensions in financial markets, though volatility will likely remain in the near-term.
The Bank of England’s Chief Economist stated that the fiscal stimulus would likely have to be met with a significant monetary policy response. This also comes after last week’s split decision between a 50bp-75bp rate hike, the difference largely stemming from uncertainty around the impact of the energy guarantee plan on demand, both within energy consumption and more broadly across the economy. In response, markets have begun to price in a much more aggressive rate hike cycle for the Bank of England, reflecting heightened concerns about the inflation outlook and recessionary risks.
On the whole, US data received this week was mixed. The final estimate of GDP for Q2 was unchanged, printing at -0.6% annualised, as a firmer gain in personal consumption was offset by weaker investment and net trade. On the partial data released this week: August’s durable goods orders suggest the drag in equipment investment is extending into Q3; regional manufacturing surveys, albeit volatile, are generally pointing towards subdued production conditions; and the FHFA and S&P/CS home price indexes posted their first monthly decline in July, highlighting a broad-based weakening in housing across the nation. These materially weak developments have seen the Atlanta Fed nowcast for Q3 GDP hold at 0.3% annualised, down from an initial estimate of 2.5%.
All of the above suggests Chair Powell and the FOMC should remain mindful of the risks to activity. Though, as evinced by the suite of Fedspeak throughout the week, the FOMC’s focus remains squarely on inflation, necessitating the continuation of further financial tightening well into restrictive territory.
Finally, to China. The official manufacturing PMI posted a stronger-than-expected lift, from 49.4 to 50.1, meanwhile the services PMI slid by more than expected, from 52.6 to 50.6 in September. Taken together, the official composite has weakened to 50.9, reflecting a delicate near-term outlook. Government stimulus and the restoration of power supply provided key support to manufacturing however, ongoing virus-related risks are still impacting the services, leaving both sectors just within the ‘expansionary zone’. The Caixin manufacturing PMI meanwhile reported weaker conditions for the sector, at 48.1, highlighting the risks facing the sector, especially as global demand begins to cool into year-end.