Key insights from the week that was.
With much of Asia taking time to celebrate lunar new year and the US/European data calendar light, inflation data for Australia and New Zealand received a lot of attention.
Before the inflation data though, NAB’s latest business survey revealed conditions for Australian firms are cooling at an appreciable rate, the 8pt decline at the turn of the year broad based by industry and state. However, conditions are still above average. And, in this survey, an easing in labour costs and upstream prices pressures contributed to a modest improvement in business confidence, up 3pts to -1 – only a slightly pessimistic read.
The Q4 Australian CPI report subsequently provided an upside surprise, headline inflation printing at 1.9% (7.8%yr), well above the market’s expectation and our own. Despite stronger-than-expected gains in dwelling prices and utilities, housing made a relatively minor 0.06ppt contribution to headline inflation’s surprise. The key contributor was instead a 5.4% rise in recreation prices, as pent-up demand for holidays jolted travel costs 10.9% higher into year end.
Critically though, trimmed mean inflation was broadly in line with Westpac’s expectation at 1.7% (6.9%yr), indicating that underlying inflation pressures are generally evolving as anticipated. The Q4 report confirms for us both that the RBA has more to do in the first half of 2023, with three more 25bp hikes expected at the February, March and May meetings, but also that domestic inflation pressures will subside through 2023 and return back to target in 2024. At that time, the RBA will be able to begin unwinding their contractionary policy stance, supporting a modest recovery in GDP growth back to trend in 2025.
New Zealand’s Q4 CPI also surprised to the upside, albeit only at the margin (1.4%; 7.2%yr). Like in Australia, travel costs were a key driver of inflation in Q4; so was food. However, pressures were broad based overall. Critically for policy, the annual rate showed that inflation continued to crest in Q4 instead of accelerating further as the RBNZ had anticipated. This has led our NZ team and the market to become less hawkish on the path for policy in H1 2023.
February’s RBNZ meeting is now expected to deliver a 50bp hike instead of 75bps to be followed by another 50bp move in April, resulting in a 5.25% peak for the cycle (previously 5.50%). Note as well that April’s 50bp hike is dependent on the state of the economy at that time. If the downturn in activity is sharper than anticipated, or inflation cools quicker, a 25bp final hike to 5.00% could instead be in order.
Turning to Europe and the US, the S&P Global PMIs gained momentum across the board in December. However, the respective levels in both jurisdictions continue to highlight that the greater risk for growth is in the US not Europe. In December, the US service and manufacturing PMIs remained well below the 50 expansion/ contraction threshold at 46.6 and 46.8. Although European manufacturing contracted further in the month (48.8), the service sector measure rebounded into expansion, 50.7. Seasonally warm weather will have contributed, but arguably so did improving sentiment over the outlook and global tourism’s progressive re-opening.
Other data for the US also highlighted the uncertainty the nation faces heading into 2023. As we anticipated, headline Q4 GDP growth was robust at 2.9% annualised. But, as was the case in Q3, consumption growth was modest, circa 2.1%. The composition of consumption was also notable, with growth in services consumption continuing to slow – the 3.2% annual rate at December less than half the cycle peak of H2 2021. Goods consumption also effectively stalled in H2 2022, and residential construction continued to contract at a rapid rate, -19%yr. Had it not been for intangibles spending (R&D etc), business investment would have also contracted in Q4. The support from trade seen through mid-2022 also looks to be giving way.
Over 2022, annual growth in US domestic demand has slowed from 5.5%yr at December 2021 to 1.3%yr currently. And, in 2023, our baseline expectation is that domestic demand will stall, with risks heavily skewed to the downside. With US inflation already in rapid retreat, the foundation for aggressive rate cuts by the FOMC back to a more neutral level during 2024 is in place. Even though two more 25bp rate hikes are priced by Westpac and the market before mid-2023, increasingly the timing and scale of the subsequent cutting cycle is becoming the market’s focus. Next week’s FOMC decision and press conference are therefore keenly awaited, particularly after the Bank of Canada called an end to its tightening cycle this week, assuming the outturn is in line with their expectations. In closing, note that, for the US, this is without a material disruption from the latest iteration of debt-ceiling uncertainty which looks set to continue through the first half of the year.