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Daily Pivots: (S1) 167.83; (P) 168.37; (R1) 169.41; More...

Intraday bias in EUR/JPY remains neutral at this point. On the upside, break of 169.38 will resume the rebound from 162.26. As the second leg of the corrective pattern from 171.58, this rise should target 171.58 next. On the downside, break of 166.73 support will argue that corrective pattern from 171.58 has started the third leg. Deeper fall would then be seen back to 164.01 support and below.

In the bigger picture, a medium top could be formed at 171.58 after brief breach of 169.96 (2008 high). As long as 55 W EMA (now at 157.89) holds, fall from there is seen as correcting the rise from 153.15 only. However, sustained break of 55 W EMA will argue that larger scale correction is underway and target 153.15 support.

Markets

Triggered by Fed chair Powell ruling out a hike, then reinforced by sub-consensus payrolls & ISM’s and by an in-line easing of CPI earlier this week, the US Treasury rally grinded to a halt yesterday. That happened despite a slew of (secondary) US data disappointing to the downside (jobless claims, housing data, IP and others). Given how a similar setting a day earlier triggered further UST gains, it suggests the correction lower may have run its course for now. Front end US yields took the lead. Markets on Wednesday fully priced in a rate cut in September and are unwilling to move this even closer in time. Focus is instead gradually shifting to what to expect in 2025 (currently three cuts priced in, following two this year) as the dominant driver of the front. The US 2-yr yield tested support between the May (post-payrolls) low of 4.70% and the 38.2% retracement on the 2024 upleg (4.689%) before rebounding throughout the session towards 4.8%. Longer maturities added between 1.2 and 3.5 bps with the 10-yr seeking to hold above 4.35-4.37% support. German Bunds outperformed. Yields rose 3.2-4.3 bps across the curve. Together with some fatigue hitting the stock markets (after hitting new intraday record highs in the US), the dollar bottomed as well. EUR/USD returned from 1.0884 to 1.0867.DXY recovered from the 104.08 low point to 104.46 in the close. Fed speak included Barkin, Mester and Bostic striking a cautious tone on inflation despite the “welcome tick down” (Mester) in the monthly CPI figures. They argue for patience with services and shelter still being inflationary. Bostic did add that it could be appropriate to reduce rates toward year end.

Apart from China’s monthly economic update (see below), there’s little to inspire markets today. The country also did its inaugural special bond sale to kickstart the economy/property market. We look out in core/US markets whether the aforementioned key technical levels in yields will hold into the weekly close. If they do, the dollar could show additional signs of bottoming out, especially if stock markets take some chips of the table ahead of the weekend. EUR/USD’s first meaningful support is located around the 1.08 big figure (1.0793, 50% USD recovery on the 2023Q4 decline).

News & Views

Chinese data published this morning showed a mixed, rather unconvincing picture on the country’s economic recovery. On the positive side, April industrial production accelerated to 6.7% Y/Y from 4.5%, better than the 5.5% expected (YtD growth 6.3%). The rise, amongst others, was driven by chip production and autos which suggests some positive impetus from foreign demand. However, more worrisome for the domestic growth story was another dismal performance of retail sales. Housing/property related data also showed ongoing weakness. Retail sales growth slowed more than expected from 3.1% Y/Y to 2.3% (vs 3.7% expected). Fixed asset investment growth (YTD Y/Y) also slowed from 4.5% Y/Y to 4.2% while a small further gain was expected. Property investment remains under pressure (-9.8% YTD) with residential property sales even slumping 31.1% YTD (from 30.7%). The data today confirm the picture of an very uneven recovery of the Chinese economy with especially the need to address factors that are weighing on domestic confidence/demand. In this respect China this morning successfully sold a first tranche of the special sovereign bonds program (CNY 40 bln) with a bid-cover ratio of 3.91. The funds of the program will be used to support infrastructure spending.

As the BOJ policy is entering a new phase, recently a debate is developing on how the BOJ should handle the big asset portfolio, including its holdings of exchange traded funds (ETF’s). The BOJ holds a portfolio of about 37 trillion yen of ETF’s which has an important latent profit. Unwinding portfolio in a broader policy normalization move, could realize a revenue that might be used to support spending when it would be returned to the government. However, on this topic, governor Ueda today indicated that the BOJ is in no rush to sell risky assets anytime soon. BOJ caution on selling assets amongst others is inspired by considerations that it might unsettle markets that are affected by the sales.

Graphs

GE 10y yield

ECB President Lagarde clearly hinted at a summer (June) rate cut which has broad backing. EMU disinflation continued in April and brought headline CPI closer to the 2% target. Together with weak growth momentum, this gives backing to deliver a first 25 bps rate cut. A more bumpy inflation path in H2 2024 and the Fed’s higher for longer strategy make follow-up moves difficult. Markets have come to terms with that.

US 10y yield

The Fed in May acknowledged the lack of progress towards the 2% inflation objective, but Fed’s Powell left the door open for rate cuts later this year. Soft US ISM’s and weaker than expected payrolls supported markets’ hope on a first cut post summer, triggering a correction off YTD peak levels. Sticky inflation suggests any rate cut will be a tough balancing act. 4.37% (38% retracement Dec/April) already might prove strong support for the US 10-y yield.

EUR/USD

Economic divergence, a likely desynchronized rate cut cycle with the ECB exceptionally taking the lead and higher than expected US CPI data pushed EUR/USD to the 1.06 area. From there, better EMU data gave the euro some breathing space. The dollar lost further momentum on softer than expected early May US data. Some further consolidation in the 1.07/1.09 are might be on the cards short-term.

EUR/GBP

Debate at the Bank of England is focused at the timing of rate cuts. Most BoE members align with the ECB rather than with Fed view, suggesting that the disinflation process provides a window of opportunity to make policy less restrictive (in the near term). Sterling’s downside turned more vulnerable with the topside of the sideways EUR/GBP 0.8493 - 0.8768 trading range serving as the first real technical reference.

All major US indices advanced to fresh ATH yesterday; the S&P500 and Nasdaq 100 traded at the uncharted territory, while the Dow Jones Industrial index hit the 40’000 mark for the first time – sparking the good, old discussions about ‘how long did it take the Dow Jones to walk the last 10’000 points’. It took the index only 872 trading days to gain 10’000 points – the Federal Reserve’s (Fed) aggressive policy tightening didn’t have a long-lasting effect: that’s the major takeaway for the future.

But anyway, all three indices ended yesterday’s session slightly lower than when they started – despite hitting a record during the session. Fed members insisted that the Fed’s rate policy is in a good place right now, and that it will probably take longer for inflation to slow to the 2% target.

The elephant in the room

And it will probably take US inflation some more time to go back to the 2% unless there is a severe economic meltdown. Note that one of the major risks to global inflation – the Chinese recovery – is probably getting underway this year. The Chinese growth will mostly be driven by a robust government support to industrial production rather than improved consumer-based demand, but it doesn’t really matter who drives growth for the prices of global commodities. In the past, the Chinese growth model relied on government-fueled industrial growth. And Xi Jinping wanted this model to shift toward a consumer-based growth, but his less-than-subtle tactics hammered consumer confidence and obliged him to go back to the good, old growth tactics. So, it’s no surprise that China revealed a better-than-expected industrial production in April despite slower retail sales and a bigger fall in house prices. But hey, China will also be buying houses at distressed prices to slow down the meltdown in its property market. Consequently, China will go back to growth and that’s not great news for global inflation.

Indeed, copper futures are up by 40% since the February dip, iron ore recovered more than 24% since April dip and is now consolidating in the bullish consolidation zone, and even the nat gas prices are up by more than 40% since the beginning of the month. Crude prices, on the other hand, have been falling since April but are still up by 9% since the beginning of the year. And more importantly, all these commodity prices are supported by the perspective of interest rate cuts from the major central banks starting from June in Europe… and the Chinese demand will only make the upside pressure worst.

Regardless

But regardless, the bulls remain in charge of the Western market: earnings season has been robust so far and the earnings forecasts for the US companies are rising at the highest speed in two years. In this context, Walmart was the latest big name to announce earnings yesterday, and the earnings announcement went well. The revenue growth exceeded the company’s own forecast, its CFO said that ‘many consumer pocketbooks are still stretched’. The latter could’ve been bad news for the Fed doves who need the US consumer spending to slow, to temper inflation. But don’t worry, because Walmart shoppers are spending more of their paychecks on essential items and less on general merchandise, and that more than half of checkouts contained at least one of its private brand – where 70% of the items are priced under $5. Moreover, the biggest growth comes from upper income levels, who also visit the Walmart shops more frequently because it costs less. So Walmart shares jumped 7% to an ATH yesterday, but Walmart’s success was seen as another hint that the US consumers come under a rising pressure of higher prices, and that’s a positive for the Fed doves, along with disappointing quarterly results from both Home Depot and Deere and Co.

And as per the Fed policy, despite the Fed members’ cautious approach, the Fed said earlier this month that its next move is probably not a rate hike, and data this week showed stagnating retail sales, gloomy housing markets, a weak Philly Fed manufacturing index, weak industrial production data, an initial jobless claims number above 200’000 and above all, a weaker-than-expected core CPI figure. So all in all, this week is set to end on a more dovish note compared than when it started although I insist that inflation is nowhere close to the levels where the Fed could reasonably and publicly hint at an upcoming rate cut.

The USD index rebounded from the 100-DMA yesterday, and is back above the 200-DMA and the 38.2% Fibonacci retracement that distinguishes between the continuation of the ytd positive trend and a bearish reversal. If the index doesn’t fall sustainably below this major Fibonacci level, the buying pressure on the major peers will remain limited, as I think should be the case given the clear divergence between a cautious Fed and well-determined European Central Bank (ECB) to cut rates for example. In this context, the EURUSD is back to its bearish ytd trend after having spent a few days above the major 38.2% Fibonacci retracement of its own (near the 1.08 level). The USDCHF holds ground near the 50-DMA and the USDJPY is back above 155, and remains bid after the Bank of Japan (BoJ) decided not to follow up with lower bond buying as they did earlier this week and the Governor Ueda said that they have no plans to sell the ETF holdings in the close future.

In focus today

In the euro area, we receive the final euro area inflation data for April. We will especially look out for what drove the still strong service inflation and the measures of domestic inflation as these are key for the monetary policy outlook.

Economic and market news

What happened overnight

In Japan, Kazuo Ueda, Bank of Japan (BoJ) Governor, stated that the central bank has no immediate plan to unload its marked holdings of ETFs, which has garnered increased attention as a potential source of revenue for funding government initiatives. The remarks follow an increasing debate over how the BoJ should manage the legacy of its deflation-ending efforts through extensive money printing, which has left them with a massive balance sheet. However, the central bank has yet to outline a plan for reducing its holdings of ETFs and government bonds, partly due to concerns about destabilizing financial markets.

In China, the monthly batch of data was a mixed bag. Retail sales disappointed falling from 3.1% y/y in March to 2.3% in April (cons: 3.7%). The underlying trend in the level of sales still points to around 5% growth, though. Some consumers may await the trade-in schemes buying new goods for old goods, but it is unclear how much of the scheme is rolled out and how much is in the pipeline since it is up to local governments to implement it. New home prices disappointed as the monthly decline fell to a new cycle low at 0.58% m/m from -0.34% m/m. It broke a trend of smaller declines in previous months. On a more positive note, new home sales continue to show signs of moderate improvement when we look at our own seasonally adjusted series. Sales are hovering around 100 million square metres now after hitting levels below 75 million square metres at the end of 2023. Construction starts also continue to show improvement as social housing projects are increasing. Finally, industrial production surprised to the upside rising from 4.5% y/y to 6.7% y/y (cons: 5.5%). Overall, the data highlights China's continued muddling through scenario that still relies a lot on government stimulus. Markets showed a muted response with off-shore equities actually slightly higher, adding to recent gains. The CNY has also hardly moved.

What happened yesterday

In the US, April industrial production fell slightly below market expectations, printing at 0.0% m/m SA (cons: 0.1%). Unexpectedly, manufacturing output declined in April by -0.3% m/m SA, driven by a decrease in motor vehicle output, while the March figure was revised down to 0.2%. This aligns with the ISM manufacturing PMI released earlier this month. Additionally, capacity utilization for April edged down to 78.4% SA, 1.2 percentage points below its long-run average (1972-2023).

Initial jobless claims fell by 10k to 222k SA (cons: 220k). This follows last week's reading of 232k, an eight-month high, fuelled by a surge in applications in New York state tied to school spring break. In general, labour markets are becoming more balanced, but layoffs remain quite low with little signs of rising.

In Norway, Mainland GDP came in at 0.2% q/q in Q1, as expected, and was hinted at by most leading indicators. Hence, growth is currently stronger than what Norges Bank expected in the Monetary Policy Report from March (0.0%). That said, we still see the case for a significant recovery as limited if rates remain at current levels. Therefore, we expect growth to slow down already in Q2, and capacity utilization to remain at subnormal levels. Additionally, the Q1 figures are heavily influenced by seasonality around Easter, making the figures harder to interpret.

The Q2 Expectations Survey from Norges Bank was very much in line with expectations. Inflation expectations for the 12 months ahead were marginally lower, while wage expectations for this year were a tad higher but in line with the results from the central wage negotiations. Interestingly, employers now expect wage growth of 5.2% in 2024, whereas employees expect 4.8%. Additionally, there were no significant changes to the 2Y and 5Y expectations.

In the equity space, the Dow briefly exceeded the 40,000 mark for the first time, though it concluded yesterday's session somewhat lower. Part of the uptick can be attributed to Walmart, which reported strong Q1 results. Similarly, the S&P 500 and Nasdaq also climbed to intraday highs.

Market movements

FI: There were modest movements in US Treasury bond yields yesterday as the 10Y US yield moved upward a few bp. This morning it has been stable in Asian trading hours. There was more action in the 2Y segment where yields rose almost 10bp. However, the 5% continues to be a top for the 2Y segment and 4.75% for the 10Y segment as the Federal Reserve does not contemplate rate hikes. However, the curve steepener trade continues to struggle when the central banks continue with the"“higher for longer them"”. Instead, we like the carry trades such as being long 30Y 5Y Danish callable mortgage bonds as well as being long EU versus France as EU as an issuer is gradually being seen more as a sovereign rather than a supra.

FX: Yesterday's session was relatively quiet. Much of the post-US CPI movement partially retraced as US yields rose across the curve, led by the front-end. EUR/USD remains in the mid-1.08 to 1.09 range. USD/JPY moved back above 155. The Scandies were the two worst performers in the G10 space, with both EUR/NOK and EUR/SEK trending above 11.60 again. The DKK missed the latest rally in Scandi currencies. Oil prices have stabilized around USD 83-84 per barrel in May.

Daily Pivots: (S1) 195.66; (P) 196.29; (R1) 197.54; More...

GBP/JPY's rebound from 191.34 resumed after brief recovery and intraday bias is back on the upside. Rise from 191.34 is seen as the second leg of the corrective pattern from 200.53. Sustained break of 197.07 will pave the way to retest 200.53. On the downside, firm break of 195.02 will argue that the third leg has started, and target 191.34 support and possibly below.

In the bigger picture, a medium term top could be in place at 200.53 after breaching 199.80 long term fibonacci level. As long as 55 W EMA (now at 183.41) holds, fall from there is seen as correcting the rise from 178.32 only. However, sustained break of 55 W EMA will argue that larger scale correction is underway and target 178.32 support.

Yen's selloff resumed after brief recovery yesterday and continued to weaken throughout Asian session. Markets largely ignored comments from former BoJ chief economist Toshitaka Sekine, who suggested the next rate hike could happen as soon as in June. The general understanding is that BoJ will at least wait for Q2 data to confirm if Q1 GDP contraction was merely a temporary setback before making any policy changes. However, downside risk for Yen appears limited, given the likelihood of intervention by Japanese authorities if Yen approaches the critical 160 level against Dollar.

Conversely, Dollar recovering broadly today, supported by hawkish comments from several Fed officials. Overnight, the record run in US stock indexes stalled, with minor decline, while 10-year Treasury yield saw a recovery. Despite encouraging April inflation data, one month of data is insufficient to confirm a sustained disinflation trend. But given recent market reactions, risk would be skewed to the downside for Dollar for the near term.

For the week, Swiss Franc is currently the worst performer, followed by Yen and Dollar. In contrast, New Zealand Dollar leads the pack as the strongest performer, followed by British Pound and Australian Dollar. Euro and Canadian Dollar are positioned in the middle.

Technically, EUR/CHF's rally from 0.9252 resumed by breaching 0.9847 resistance. Immediate focus is now on 61.8% projection of 0.9304 to 0.9847 from 0.9563 at 0.9899. Decisive break there could prompt upside acceleration to 100% projection at 1.0106, which is slightly above 1.0095 key structural resistance. In case of retreat, outlook will now remain bullish as long as 0.9728 support holds.

In Asia, at the time of writing, Nikkei is down -0.55%. Hong Kong HSI is up 0.20%. China Shanghai SSE is flat. Singapore Strait Times is down -0.34%. Japan 10-year JGB yield is up 0.0225 at 0.949. Overnight, DOW fell -0.10%. S&P 500 fell -0.21%. NASDAQ fell -0.26%. 10-year yield rose 0.021 to 4.377.

Fed's Mester, Bostic, and Barkin signal extended restrictive stance

Some Fed officials have emphasized overnight the need for a extended period of restrictive monetary policy as they seek clearer signs of sustainable inflation reduction.

At an event, Cleveland Fed President Loretta Mester stated that incoming economic data suggests it will "take longer" to gain the confidence needed to start lowering interest rates. Mester emphasized that "holding our restrictive stance for longer is prudent" as Fed seeks clarity on the inflation path.

Atlanta Fed President Raphael Bostic, speaking at another event, acknowledged that the April inflation report provided some important insights, particularly noting a slowed rise in shelter costs. However, he cautioned that "one data point is not a trend," highlighting the importance of watching the May and June data to ensure figures don't reverse.

In a CNBC interview, Richmond Fed President Thomas Barkin reiterated the need for patience, noting that achieving 2% inflation sustainably "is going to take a little bit more time." Barkin pointed out that there is still significant movement on the services side of the economy.

ECB's Schnabel: June rate cut possible, another in July not warranted

In an interview with Nikkei, ECB Executive Board member Isabel Schnabel indicated that a rate cut in June "may be appropriate" based on current data. However, she noted that another cut in July "does not seem warranted." Schnabel emphasized that the outlook beyond June is "much more uncertain," pointing out that the "last mile" of disinflation is the "most difficult."

Schnabel explained that the disinflation process has slowed significantly after most supply-side shocks were reversed, making it a "quite bumpy" global phenomenon. She highlighted that in Eurozone, part of this difficulty is due to base effects and the reversal of fiscal measures.

Importantly, Schnabel underscored that inflation driven by "second-round effects" has become "more persistent." She advocated for a cautious approach, stressing that "after so many years of very high inflation and with inflation risks still being tilted to the upside, a front-loading of the easing process would come with a risk of easing prematurely."

Mixed signals in China's economic data: Industrial production surges, retail sales lag

China's economic data for April revealed a mixed picture, with industrial production rising by 6.7% yoy, surpassing the expected 4.6%.

However, fixed asset investment for the year to date grew by 4.2% yoy, falling short of the anticipated 4.6%. Notably, real estate investment declined significantly, dropping by -9.8% in the first four months of the year.

Retail sales, a critical indicator of consumer spending, increased by only 2.3% yoy, below the forecast of 3.8%.

According to the National Bureau of Statistics , production and demand saw a stable increase, with employment and prices showing overall improvement. The NBS stated that the economy was generally stable, continuing to rebound and progress well.

GBP/JPY Daily Outlook

Daily Pivots: (S1) 195.66; (P) 196.29; (R1) 197.54; More...

GBP/JPY's rebound from 191.34 resumed after brief recovery and intraday bias is back on the upside. Rise from 191.34 is seen as the second leg of the corrective pattern from 200.53. Sustained break of 197.07 will pave the way to retest 200.53. On the downside, firm break of 195.02 will argue that the third leg has started, and target 191.34 support and possibly below.

In the bigger picture, a medium term top could be in place at 200.53 after breaching 199.80 long term fibonacci level. As long as 55 W EMA (now at 183.41) holds, fall from there is seen as correcting the rise from 178.32 only. However, sustained break of 55 W EMA will argue that larger scale correction is underway and target 178.32 support.

Economic Indicators Update

Key insights from the week that was.

On Budget 2024-25, our bulletin and conversation with Chief Economist Luci Ellis provides a full view of the Government’s fiscal position and economic plan to 2028. In terms of policy initiatives, the focus was split between immediate cost of living relief for households and long-term plans to expand Australia’s productive capacity. While these policies will see spending exceed revenue across the forward estimates, the Federal Government projecting a return to deficits from 2024-25 to 2027-28, it is not a given that inflation risks will increase, with current momentum and the degree of spare capacity at the time the policy initiatives become active to determine the consequence for inflation. This is a topic taken up by Chief Economist Luci Ellis in her weekly essay.

In terms of the week’s data, a below expectations Q1 WPI of 0.8% was constructive, seeing annual wage inflation moderate from 4.2%yr in December to 4.1%yr in March, ahead of the RBA’s expectation (growth or 4.2%yr through mid-2024). Last year’s strength in public wages – associated with new enterprise agreements and changes to wage caps – is cycling out. Private sector wage growth is also moderating, in line with the gradual easing of labour market conditions evident in April's Labour Force Survey.

At 2.8%yr on a three-month average basis, employment growth is slowly tracking towards the more typical 2.0-2.5%yr pace observed pre pandemic. Individuals remain eager to enter and participate in the labour force, but securing a job is becoming more challenging, seeing the unemployment rate edge higher. This trend is expected to continue through the remainder of the year to a quarter-average unemployment rate of 4.3% at year end.

Over in New Zealand, ahead of the RBNZ meeting next week and Budget 2024 at month end, our New Zealand team released their latest quarterly, providing an in-depth assessment of current conditions and the outlook.

Further afield, comments by US FOMC members through the week, including from Chair Powell, reiterated the need for patience and thorough analysis of price risks. Having experienced a strong first quarter of 2024, a number of months of data signalling further progress towards the 2.0% inflation target needs to be seen for the Committee to be comfortable easing.

The price data for April began this journey, the headline CPI printing below expectations at 0.3%, allowing the annual rate to edge down to 3.4%. More importantly, the detail of the release showed inflation is being driven by supply constraints and historic inflation – rents and motor vehicle insurance being the clearest examples. Meanwhile, goods inflation is absent, and discretionary demand driven components such as accommodation away from home and airfares are benign or in retreat.

Notably, annual headline CPI inflation excluding only shelter has been around 2.0% for 12 consecutive months, printing a range between 0.7% and 2.3% and averaging 1.7% over the period. Annual shelter inflation has also decelerated from 8.0% at May 2023 to 5.5% in April 2024. Although the PPI surprised to the upside in April, revisions to March offset; also, the components of PPI used as inputs for PCE inflation, the FOMC’s preferred measure of consumer inflation, were broadly neutral. Taking both the CPI and PPI detail into consideration, April’s PCE result will likely be benign.

US retail sales for April were also constructive for the inflation outlook, headline sales flat in the month and the control group down 0.3%. More importantly, both benchmarks are essentially flat over the first four months of this year, pointing to a stalling out of consumer goods demand. Services demand still has momentum, but its slowing. This sets the scene for a gradual deceleration in GDP growth over the course of 2024 to around trend, our baseline view. Such an outturn will allow the FOMC to begin cutting in September and continue doing so through to mid-2026, albeit to a still mildly-contractionary 3.375%. If the labour market suddenly deteriorates, the FOMC can accelerate or lengthen the cutting cycle; but this is a risk not our baseline view.

Data and policy guidance out of both Europe and the UK were also constructive for the price and activity outlook this week. Both the ECB and BoE look to be on track to cut in June, though the timing and pace of easing thereafter is yet to be determined with growth to pick up and inflation risks to persist. Conversely, the growth outlook for Japan remains challenged. This week, GDP was reported to have contracted in the March quarter by a larger than expected 2.0% annualised. That is the second contraction in three quarters, and there is a clear risk of further weakness given the consumer is financially constrained after a sustained decline in real incomes. The BoJ continues to anticipate an acceleration in consumer demand through mid-year as the latest wage increases take effect and inflation continues to abate. But consumer confidence and the health of small business pose significant risks. Japan is also arguably not in as strong a position as China, Korea and developing Asia to benefit from global growth in investment. While another small increase in Japan’s policy interest rates has to be expected in 2024, the end-point of this tightening cycle is likely within a 0.0-0.5% range versus 1.0% or above. The US dollar and US interest rates are therefore likely to dictate the Yen’s path rather than Japan’s domestic situation.

Finally to China, the April data round again highlighted that authorities are achieving on their objective to increase industrial capacity and, through trade, national income. However, also evident in the disappointing retail sales result is that households are, in aggregate, yet to see material benefit. At the same time, there remains a need for additional policy support for the property sector, which reports this week suggest are under discussion. Chinese growth is set to remain uneven and susceptible to shocks. But authorities’ 5.0% growth guidance for 2024 is certainly achievable; and, looking to the long-term, all the investment being undertaken is developing a strong foundation for a sustainable robust uptrend in national income.

In an interview with Nikkei, ECB Executive Board member Isabel Schnabel indicated that a rate cut in June "may be appropriate" based on current data. However, she noted that another cut in July "does not seem warranted." Schnabel emphasized that the outlook beyond June is "much more uncertain," pointing out that the "last mile" of disinflation is the "most difficult."

Schnabel explained that the disinflation process has slowed significantly after most supply-side shocks were reversed, making it a "quite bumpy" global phenomenon. She highlighted that in Eurozone, part of this difficulty is due to base effects and the reversal of fiscal measures.

Importantly, Schnabel underscored that inflation driven by "second-round effects" has become "more persistent." She advocated for a cautious approach, stressing that "after so many years of very high inflation and with inflation risks still being tilted to the upside, a front-loading of the easing process would come with a risk of easing prematurely."

China's economic data for April revealed a mixed picture, with industrial production rising by 6.7% yoy, surpassing the expected 4.6%.

However, fixed asset investment for the year to date grew by 4.2% yoy, falling short of the anticipated 4.6%. Notably, real estate investment declined significantly, dropping by -9.8% in the first four months of the year.

Retail sales, a critical indicator of consumer spending, increased by only 2.3% yoy, below the forecast of 3.8%.

According to the National Bureau of Statistics , production and demand saw a stable increase, with employment and prices showing overall improvement. The NBS stated that the economy was generally stable, continuing to rebound and progress well.

Both the government and RBA are walking a fine line, but some budget decisions might not be as inflationary as they seem at first glance.

Households in Australia are collectively doing it tough. Their cash flows are being squeezed by the high cost of living, high level of interest rates and a rising tax take. Consumption per capita has fallen more than 2½% since the RBA started raising rates. Australia stands out from its peers on this front.

At the same time, inflation is too high and the labour market is tight, though not quite as tight as late last year. The labour force data for April confirmed this gradual easing, helping to cut through the noise of the first three months of the year. And the Wage Price Index release, also this week, shows that wages growth is starting to roll over from its recent peak, as was widely expected. To be fair, these are lagging indicators. But there is nothing in these data – or more leading indicators – pointing to even higher inflation pressures down the track.

The trade-off between a household sector under pressure and ongoing inflationary dynamics is the context the government faced in framing this week’s budget.

Structuring some of the support measures to reduce measured inflation makes sense in that context. The last thing the Government wants is to be blamed for a coming rate rise. Ideally, it would want to see the first couple of rate cuts ahead of the next election. The same imperative drove the reshaping of the Stage 3 tax cuts earlier in the year. Then, the government took care to keep the reduction in revenue within the envelope of the original version, and make sure everyone knew this. Because the original version was already in everyone’s forecasts, the modified version could not then be used to justify tightening monetary policy.

The government is walking that fine line between providing support and services to a household sector under pressure and avoiding adding to that pressure by boosting inflation and possibly interest rates.

Even still, the commentary after the budget has been very focused on the potential inflationary consequences. It is true that a dollar not spent on rent or electricity is a dollar available to be spent on other things. (This of course assumes that electricity companies and landlords do not raise underlying prices to offset some of the subsidy.)

And in principle, if some of that dollar is spent, that represents higher demand that could push up prices elsewhere. There are some unstated assumptions behind this reasoning, though. It assumes that most of the extra spending power is indeed spent, and that there is little spare capacity in the area where it is spent, so the main result is higher prices not a higher quantity sold. In other words, it assumes that the economy will be fully employed later this year when these support measures come into effect.

Furthermore, even though the reduction in measured inflation is temporary and in some sense artificial, households’ experienced cost of living will be genuinely lower as a result. This should, at the margin, help keep inflation expectations anchored, and will moderate the following year’s increases in those prices that are typically indexed to CPI.

The assumptions behind those inflation concerns also underpin current discussion around monetary policy. The presumption is that the problem is that the level of demand exceeds the level of supply, and so policy needs to be restrictive to dampen demand and get it back in line with supply. Again, there are some unstated assumptions here. One of these is that demand is the only thing that can move. It is like seeing a pair of scissors and thinking that only one blade does the work. In fact, the other blade – supply – might still be contending with the ripple effects of the pandemic. Some recovery in supply could play a role in rebalancing itself to demand.

And again, it assumes that a currently fully employed economy will still be fully employed when the time comes to start cutting rates. However, this cannot and should not be presumed.

One lens on this assumption is the economics profession’s own forecasts. Every quarter ahead of its Statement on Monetary Policy, the RBA polls private sector economists about our forecasts and views of the economy. Recently, it has expanded the sample of respondents from around 20 to around 40; aggregated results are compiled into a new
statistical table on its web site. This round, the RBA added the output gap to the list of questions. Importantly, it only sought an estimate for the December quarter 2023, the latest available published data for GDP. The estimates ranged from –1.2% of GDP to +1.0%, with a median of 0.3%. That spread should tell you how uncertain these invisible concepts are. (Full disclosure: my guesstimate in the survey was +0.5%, and it is just a guesstimate.)

But taken together with the estimates of potential output growth (range 1.8% to 3.0%, median 2.5%) and economists’ forecasts for actual GDP growth over 2024 (range 0.2% to 2.3%, median and Westpac 1.6%), we can reasonably conclude that some economic slack is expected by the time the fiscal support and rate cuts occur. It’s a little bit more complicated than that because the potential output estimates were for ‘over the next couple of years’, and potential output growth could be boosted this year because population growth – and so labour supply – will still be stronger than average. (Westpac Economics expects population growth to slow from 2½% last year to 2% this year, normalising to around 1½% over 2025). But the direction is clear.

If we as a profession are to take our own forecasts seriously, the economy will not quite be fully employed by year’s end. Withdrawing some of the restrictive stance of policy at that point – or putting $75 in each household’s pocket each quarter – might not be as inflationary as it would be if done today. There are risks to this strategy, and both the RBA and the government will need to walk a fine line. But neither of them is pursuing the policy equivalent of running with scissors.