Key insights from the week that was.
At its first meeting of the year, the RBA Board decided to leave the cash rate unchanged at 4.35%. Since its last meeting in December, the key development was an encouraging quarterly update on inflation, the annual rate moderating from 5.4%yr in Q3 to 4.1%yr in Q4. Mirroring this progress, the tone of the Board’s decision statement shifted on the inflation outlook, “Whether further tightening of monetary policy is required…” was replaced with “… a further increase in interest rates cannot be ruled out.”
That said, the Board still characterised inflation as high and the level of demand too strong for supply, even though growth “remains subdued”. The simultaneous release of the Statement on Monetary Policy confirmed the RBA expects inflation to only move into the 2-3% target band in 2025 and be near the mid-point by June 2026.
As discussed by Chief Economist Luci Ellis in a video update mid-week, the RBA Board are not “ruling anything in or out” for now as they seek assurance on inflation’s sustainable return to target. Additional reads on the pace of disinflation and the health of the economy need to be received and evaluated before policy’s appropriateness is reassessed. Consistent with our revised inflation forecasts, we suspect that level of comfort will be achieved by September 2024. At that time, headline inflation is expected to be around the top of the target range on both a headline and trimmed mean basis.
The RBA Board are also wary of downside risks to domestic demand, something that was clearly on display in the September National Accounts and, more recently, Q4’s soft real retail sales result. The first half of this year will be challenging for the broader economy, but particularly households as the trifecta of high inflation, restrictive interest rates and a rising tax take weigh on real disposable incomes and discretionary spending.
Before moving offshore, a quick note on trade. Australia’s goods trade balance pared back slightly at year-end, from $11.8bn in November to a still-elevated $11.0bn in December. Taking the last few months together, the goods trade balance looks to have improved from $23.5bn in Q3 to $30.6bn in Q4. An increase in the terms of trade was the chief driver behind the improvement. Note, the services detail will only be available upon the release of the quarterly Balance of Payments, due March 5.
In the US, the ISM non-manufacturing survey saw a 2.9pt rise to 53.4pts supported by employment, prices and new orders. Relative to long-run averages, employment remains sub-par but prices are outperforming. These results encapsulate the risks present for the FOMC vis a vis activity and inflation.
FOMC members post-meeting return to market headlines reaffirmed Chair Powell’s key points from last week’s press conference – progress to date with inflation has been encouraging, but the strength of the economy provides time to make sure inflation risks do not linger. The flow of incoming data and the financial and credit conditions the economy face will also continue to be closely scrutinised, particularly given continued uncertainty over the health of commercial and multi-family property. On credit conditions, the latest Senior Loan Officer Opinion Survey confirms credit standards have tightened further in recent months while financial conditions were broadly unchanged.
Though, arguably of greatest significance in 2024 to the timing and pace of US policy easing will be momentum in the labour market. As detailed in our recent video, hours worked, household survey employment and the various business surveys all give cause to be wary about ongoing momentum. Indeed, the business surveys point to an outright decline in employment. We do not anticipate an abrupt decline, but rather a slowing of employment growth to a negligible pace. That would see slack build in the labour market and consumption slow to a sub-trend pace. These are conditions which warrant a timely moderate cutting cycle. We now expect the first cut by the FOMC in June, to be followed by July and September. From December, one cut per quarter is expected out to end-2025.
The pace and scale of FOMC rate cuts is largely expected to be mirrored by the ECB and Bank of England, and so we expect growth differentials and political uncertainty to act as the swing variables for FX markets over the forecast period. Both factors are likely to weigh on the US dollar, bringing it from well above long-run average levels to broadly in line by end-2025. Our just released February 2024 Westpac Market Outlook provides the full detail of our views on Australia, the world and financial markets.
Finally to China. In January, headline CPI inflation surprised, declining to –0.8%yr as food prices fell 5.9%yr. Excluding food, CPI inflation was up 0.4%yr and is seemingly finding its floor. Services inflation is supporting this process, rising 0.5%yr. Producer price inflation meanwhile remains very weak, -2.5%yr in Jan from -2.7%yr in December. These outcomes are a combination of soft demand and excess capacity which continues to be increased as Chinese firms build scale to compete against imports in their domestic market and expand their export footprint.
Large and targeted support for the property sector is needed to boost demand directly and via confidence. Further measures are also warranted to steady then strengthen equity markets. This week brought both action and rumours of further action on this front, but it won’t be until after the Lunar New Year holidays that we will find out its scale and effectiveness. Even when confidence and discretionary spending appetite returns, it is unlikely that consumer inflation will surge higher. China’s continued expansion of its capacity and focus on efficiency and productivity are laying the foundation for a lengthy period of disinflation for goods.
