Key insights from the week that was.
In Australia, the RBA Board once again decided to leave the cash rate unchanged at 4.35% after reflecting on recent data. The new information included the Q4 National Accounts, which confirmed the economic slowdown broadened into year-end, and the Q4 Wage Price Index, which revealed an underlying slowdown in private sector wages growth associated with a softening labour market (more below) and benign inflation expectations.
Consistent with the Board’s objectives, these results led to language changes in the final paragraph: “a further increase in interest rates cannot be ruled out” replaced with “the Board is not ruling anything in or out”; and the removal of the Board “will do what is necessary to achieve that outcome” – a significant decision given versions of this language have been in the media release since the first rate hike in May 2022. Concern over upside risks to inflation have not fully dissipated however, keeping the Board open to a range of possibilities.
As discussed by Chief Economist Luci Ellis in a video update mid-week, the tone of RBA communications suggest they will remain on hold for some months yet, with more progress towards target necessary to extinguish concern over lingering risks. We continue to expect a gradual easing cycle from September, a 25bp cut per quarter to take the cash rate to 3.10% at Q3 2025.
Before moving offshore, a quick note on the Australian labour market. The February Labour Force Survey was an eventful update, a much stronger-than-expected +116.5k gain in employment reported alongside a material fall in the unemployment rate, from 4.1% to 3.7%, following weak results over December and January. Abstracting from this volatility, the labour market continues to soften at a modest pace, with employers seeking to adjust labour usage predominately doing so by reducing average hours worked (–1.9%yr). Though we expect employment growth to moderate below the pace of population growth, material economy-wide employment declines seem unlikely.
Offshore, the Bank of Japan raised its policy rate to the range of 0% – 0.1% having “assessed the virtuous cycle between wages and prices” and judged “that the price stability target of 2 percent would be achieved in a sustainable and stable manner toward the end of the projection period”. This was the BoJ’s first hike in 17 years and was accompanied by the scrapping of the YCC target and ETF/ J-REITs purchases. However, government bond purchases will continue broadly at the same pace as before, and the BoJ made clear it will guard against a rapid rise in long-term interest rates.
In a subsequent press conference, Governor Kazuo Ueda noted that they made the move now to avoid “large and rapid rate hikes” in the future. This suggests the BoJ believe inflation is not only expected to achieve the medium-term target, but that it could exceed it sustainably. While this is possible, we believe the inflation pulse is more likely to disappoint, keeping the policy rate at or very near its current level. Momentum in services inflation can only persist if household spending grows robustly, which is not currently the case. And, for consumers to feel comfortable spending, Japan’s deeply entrenched saving mindset must be dislodged by sustained real wage growth.
Over in the US, the FOMC kept rates steady as expected. More importantly, their refreshed forecasts pointed to both a soft landing for activity and inflation at target. GDP growth projections were updated to 2.1% in 2024 and 2.0% in 2025 and 2026 from 1.4%, 1.8% and 1.9%, seeing the economy grow above its potential rate through the entire projection period. The members’ inflation projections are little changed however, recent upside surprises seeing 2024’s core inflation forecast upgraded to 2.6%, but still set to give way to a return to target inflation in 2025-26. It is also important to recognise that Chair Powell saw no material change in inflation dynamics in the recent data, the return to target inflation waiting on shelter’s normalisation.
The fed funds rate profile suggests the FOMC see a degree of medium-term inflation risk. Three rate cuts continue to be forecast for 2024, but the median number of rate cuts in 2025 has been reduced by one to three. The longer run rate was also lifted 10bps to 2.6%. We continue to anticipate four rate cuts in both 2024 and 2025, beginning in June 2024 and ending late-2025 at 3.375%. Our higher terminal rate reflects concern over inflation pressures from tight capacity across housing and infrastructure as well as the likelihood of reshoring delivering higher prices for some goods. A modest contractionary stance will be required to manage both inflation risks and expectations. Activity growth and employment are likely to wear the cost, a higher unemployment rate circa 4.5% forecast through at least 2025.
Finally, the Bank of England also kept rates steady at 5.25% this week. Of significance though, it was an 8-1 decision, the two members who had previously dissented in favour of a hike now with the ‘on hold’ majority. The lone dissenter in March argued instead for an immediate cut. Contained in the minutes were diverse views on wages and inflation, particularly for services. Overall though, outcomes were seen as evolving broadly as expected, and there was a degree of comfort that downside risks for activity were contained. The BoE Agents Report, which gathers the views of businesses across the country, was constructive on both inflation (albeit with lingering concerns over services pricing) and activity. The BoE will be hoping these views prove prescient and allow the UK to experience its own version of a soft landing. We continue to expect the BoE to follow the FOMC and ECB through this cutting cycle, though there is a higher chance of sticky inflation causing delays in the UK.
