Key insights from the week that was.
The main data release for Australia this week was the Monthly CPI Indicator which provided a mixed read on current inflation trends. The headline index surprised to the downside in May, the 0.4% monthly decline seeing the annual rate ease from 6.8%yr in April to 5.6%yr. The detail was broadly as anticipated, with prices for many services still rising on a monthly basis; however, a large decline in holiday travel and accommodation prices (–11.3%mth) more than offset this.
Measures of underlying inflation were more resilient however, the recently reinstated annual trimmed mean only falling from 6.7%yr to 6.1%yr, while the index that excludes volatile items (including holiday travel) was little changed. If anything, the May update reinforces the fact that the Monthly CPI Indicator is a volatile gauge, making it difficult to obtain a clear read through the quarter.
The decline in job vacancies was modest. From a high level, the 2.0% fall over the three months to May leaves vacancies just 10% below their May 2022 peak and still almost twice the level observed before the onset of the pandemic. This is consistent with other labour market indicators, including the Labour Force Survey and business surveys like the Westpac-ACCI Survey on Industrial Trends, which suggest the labour market remains historically tight with only tentative signs of easing evident.
It is also interesting to note that retail sales surprised to the upside in May, rising 0.7%mth after a poor run since December. Considering the context — high inflation and strong population growth — nominal spending in May is still best considered weak. We estimate that sales volumes were flat in Q2.
As outlined by Chief Economist Bill Evans, the persistence of service sector inflation and labour market strength warrant the RBA tightening further in July and August; and, as important, thereafter holding the resulting 4.60% cash rate peak into 2024. That said, from May 2024 to end-2025, there will be need for concerted policy easing as activity growth remains materially below trend and the unemployment rate rises above the RBA’s estimate of full employment.
Offshore, attention was focussed on the ECB Forum on Central Banking in Sintra, Portugal. Overall, the policy panel, which included the heads of the Bank of England, Bank of Japan, the European Central Bank and the US Federal Reserve, made clear that further tightening is likely to prove necessary in coming months.
The ECB’s Lagarde signalled a hike in July remains the Council’s expectation; however, she pushed back on the idea that a follow-up move in September was certain, citing the slew of data to be released between now and then. Sticky underlying inflation and labour market strength justify the ECB’s hawkish bias.
Looking back to the June decision, the BoE’s Bailey clarified that the step up to a 50bp hike occurred because the Bank believed data to hand warranted two further 25bp hikes. Bailey also pointed out that policy transmission was slower in this tightening cycle, with circa 85% of all mortgages being fixed rate loans. The UK’s tight labour market is expected to remain a concern for inflation, with many businesses expected to hold on to labour through the impending downturn.
Unsurprisingly, FOMC’s Chair Powell also highlighted strength in the labour market, although he pointed out that momentum was heading in the right direction and risks coming into balance. The Committee’s median expectation of two more hikes in 2023 was referenced, but Chair Powell also made clear the FOMC’s actions would remain data dependent. (Note, Chair Powell subsequently spoke at a Bank of Spain event, although the primary focus was financial stability.)
In stark contrast to the above speakers, BoJ’s Governor Ueda subsequently justified holding policy steady, referencing moderate ‘underlying inflation’ and a continued belief that headline and core inflation would return below target towards the end of 2025.
Coupled with the light but constructive data flow for the US and other markets, the above comments on policy led the market to price in a greater chance of ‘higher rates for longer’, the US 2 and 10-year yields, as examples, currently 12bps and 10bps higher than the end of last week, respectively 4.86% and 3.84%. With respect to the short-term risks for policy rates, the market’s concern is acute for the UK, with 5 more hikes priced by December/February versus the 1-2 moves for the FOMC and ECB.
Turning then to the international data received. While modest in scale, the market was most surprised by the revision in the third estimate of Q1 US GDP from 1.3% to 2.0% annualised. This update occurred because of a mix of modestly stronger consumption; slightly less inflation; and better exports. The market’s response also looked to be supported by initial jobless claims retreating near their historic lows.
Earlier in the week, the US saw a substantial 12% gain in new home sales in May as existing home supply remained constrained – pending home sales 21% lower than a year ago in May and S&P CoreLogic CS’ April house price gain of 0.9% attesting to the latter. Durable goods orders also gained 1.7% in May, though much of the orders uptick reportedly came from the transportation sector as easing supply chain pressures prompted car manufacturers to ramp up production.