Key insights from the week that was.
As expected, after last week’s US CPI confirmed an unwelcome degree of persistence in consumer inflation, the FOMC voted to raise the fed funds rate by 25bps to a mid-point of 3.875%. Updated Committee forecasts were broadly in line with market expectations, with a second hike expected by year end and 8 of 18 contributors to the dot plot anticipating a third hike in 2027. Chair Warsh also focused attention on the risks to the inflation outlook during the press conference.
The Committee’s PCE inflation forecasts are little changed since June despite today’s rate hike and the additional tightening forecast (from 3.7%yr in 2026 to 2.3%yr in 2027, then 2.1%yr in 2028). This profile implies the FOMC feels a need to act against renewed inflation risks now, but believes policy will prove effective in time. Limiting concern over the implications of tighter policy for activity is the Committee’s entrenched belief in the underlying health of the US economy, represented in September’s forecasts by GDP growth remaining above trend over the forecast horizon and the unemployment rate holding at a level consistent with full employment.
Westpac is more cautious on downside risks to the US labour market and growth, but only at the margin. We also believe it will take time for headline annual inflation to slow given geopolitical uncertainty and the limited interest rate sensitivity of domestic US inflation, most obvious in the shelter component. Another rate increase by year end should give market participants confidence that policy will prove effective within the forecast window. The Committee is likely to stand ready to deliver a third hike, but this is less than a 50/50 chance on current data, in our view. Rate cuts will not be seen until 2028, however, and they are likely to only reverse the current tightening sequence, with limited spare capacity in the US economy outside the tech sector biasing inflation above 2.0%yr in to the medium term.
In contrast to the FOMC’s September decision, in the UK the Bank of England decided to hold Bank Rate at 3.75% in a 6-3 decision. The Committee is cognisant that headline inflation is well above target at 3.1%yr, but holds this as almost entirely due to energy prices, with “little evidence of significant knock-on effects on prices and wages”. That said, the longer the conflict persists, the higher the likelihood of secondary inflation effects for the consumer, requiring tighter monetary policy. Also arguing for a measured and careful response to the current inflationary threat is that, absent the crisis, the Bank of England was projected to have been easing through 2026. Monetary policy is therefore tighter than it would have otherwise been, with implications for both inflation and activity. We expect the Committee will decide to hike into year end, but likely only once.
Coming back to Asia, China’s August data round (yet) again highlighted the need for urgent pro-active stimulus at scale to restore sentiment and bolster domestic demand. Annual growth in retail sales slowed to just 0.4% in August, while the year-to-date decline in fixed asset investment accelerated from -6.7% to -7.2%, with property investment down 19.9%. New and existing home prices fell another 0.2% and 0.3% in the month, continuing the trend of recent years.
As highlighted in our September Market Outlook, consumers and local businesses in China have the capacity to increase spending, but they are reticent to do so. Confidence must be restored, built on a belief that income and wealth will grow consistently and equitably, not just for those directly connected to the technology trade.
