Cliff Notes: assurance over inflation a matter of time
Key insights from the week that was.
In Australia, the Minutes from the RBA June Meeting provided more colour around the Board’s deliberations, in particular its considerations for monetary policy in the context of lingering inflation pressures. The case for another rate hike was premised largely on the RBA’s assessment that demand had continued to outstrip supply and that this imbalance could continue –the former could hold up better than expected, or the latter could be more constrained than currently assumed – increasing the possibility that inflation will take longer to sustainably return to target. The case for leaving policy unchanged was deemed stronger, the Board of the view that “the economy was still broadly tracking on a path consistent with returning inflation to target in 2026, while preserving as many of the gains in employment as possible.”
Chief Economist Luci Ellis highlighted that it is the ‘gaps’ between demand and supply, whether that be in the labour market or the broader economy, that are receiving a greater focus in the Board’s policy deliberations. Here, it is noted that both labour market tightness and the output gap are assessed as narrowing, but given the difficulty in precisely estimating such dynamics, there remains uncertainty in judging when the ‘gaps’ might actually close. For now, the Board expects inflation to continue decelerating towards target as demand and supply come into better balance, but it needs more confidence in this view before debating the timing and scale of easing. Last week’s partial inflation data may have unnerved market participants but it had no impact on our inflation forecasts nor our view on the interest rate outlook. We continue to believe the Board will have this confidence by November, allowing the RBA to embark on a measured rate cutting cycle, 25bps per quarter to 3.10% in Q4 2025.
Other data received this week were largely focused on the consumer and housing. On the former, retail sales beat expectations, rising 0.6% (1.7%yr). However, most of the strength can largely be attributed to inflation and population growth, with real per capita sales likely tracking in the realm –2.5% to –3.0%. Meanwhile, growth in dwelling prices continues to forge ahead at a solid pace, up 0.7% across the nation’s eight major capital cities. While the latest increase in dwelling approvals was certainly welcome, the outlook for new dwelling investment remains fragile, at odds with needs of a rapidly growing economy.
Offshore, the focus was on the US with the June ISM PMIs. The ISM non-manufacturing index fell 5pts in June from 53.8 to 48.8. This is the second sub-50 reading in three months, but more importantly the June read is almost 7.5pts below the decade average. The employment index also fell back to April's weak level (6pts below average) after rebounding in May. Business activity and new orders also dropped sharply in June. The level of these sub-components speak to the risk of outright contraction against our base expectation of modest growth, warranting close monitoring ahead. The ISM manufacturing survey edged lower from 48.7 to 48.5 against expectations for a modest lift to 49.1. Production deteriorated, from 50.2 to 48.5, but new orders gained in the month, from 45.4 to 49.3. Both sub-indexes are below their respective six-month averages, signalling a continuation of the sector's deceleration. At 49.3, the employment sub-index was again consistent with outright job loss. Prices paid fell back to 52.1 in the month, below both the six-month and long-run historic averages.
The FOMC also released its minutes for the June meeting which were consistent with the Committee's positive forecasts for the economy. Policy is viewed as restrictive and as working toward bringing about desired inflation outcomes in time. That said, there were some notes of caution over momentum in the labour market, in particular "several" participants noted that nonfarm payrolls may be overstating job creation. Anecdotes on the labour market and consumer behaviour were also used to justify the view that both wage inflation and consumer inflation is continuing to decelerate. That said, “some” participants were willing to raise rates should inflation remain elevated. That raising rates was not considered and inflation looks to be on its downward trajectory suggests this scenario remains improbable. Despite the shift to only one cut this year in its published forecasts, the Committee looks to be ready to begin easing as incoming data give confidence in inflation's downtrend and/or should downside risks materialise. We maintain our view that rate cuts will begin in September 2024. For more detail, see our latest edition of Market Outlook, published earlier today on WestpacIQ.
The June JOLTS survey provided further evidence of labour demand and supply coming into balance. The job opening count was a touch higher than the market expected at 8.14mn, but the job opening rate was little changed from May and within 0.5% of the pre-pandemic level. The hiring, separation and quit rates were also all near their pre-pandemic averages.
In Europe, the European Central Bank held its annual conference in Sintra, the key event being a panel with ECB President Lagarde, FOMC Chair Powell and Bank of Brazil's Campos Neto. Lagarde and Powell's remarks were both constructive on inflation and the health of their respective economies. Powell in particular noted that the US is back on a "disinflationary path", but that further confidence is necessary amongst Committee members before acting. Powell also made clear that the risks the US faces are increasingly balanced, with downside risks to the labour market coming into view.
Euro Area inflation was as expected in June, prices rising 0.2% in the month and 2.5% over the year. Core inflation was a touch stronger than consensus at 2.9%yr as services inflation held around 4%yr, a rate held since the start of this year. Overall, this flash release indicates goods remain the predominant disinflationary force and further progress on services will be needed for inflation to remain sustainably at target. The unemployment rate remained at 6.4% in May. Labour market conditions are heterogenous across the region with services-oriented industries seeing labour market tightness persist while others see slack building.
In Asia, the Bank of Japan's Q2 Tankan Survey reflected a constructive outlook with some risks emerging on the horizon. The outlook on general prices remains little-changed around 2.0% for the 3-year and 5-year horizons, suggesting inflation expectations are holding firm. Forecasts for employment conditions declined further, suggesting businesses are expecting it to be difficult to secure labour ahead. Persistent sentiment around labour scarcity will support wage negotiations ahead. Expectations for investment continue to grow – at present they sit around where they were prior to the Asian Financial Crisis when capacity was expanding rapidly. Profits however are expected to decline. This creates risk to both the investment and wages outlook as strong profitability has supported both over the last year. Wages and investment need to remain strong for inflation to persist and for policy to normalise further.
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