Download the PDF
This week has seen policy meetings by the world’s two major central banks: the US Federal Reserve (Fed) and the European Central Bank (ECB). Next Tuesday, we also get the Reserve Bank of Australia’s (RBA) rate call. Unsurprisingly, both the Fed and ECB lifted their policy rates by 25 basis points (bps) at their meetings. The question is, are they now at the peak of the tightening cycle?
Let’s start with the Fed. Following this week’s Fed rate hike, the market and QIC remain of the view that the peak of the US monetary policy cycle has been reached with fed funds futures topping out at around the mid-point of current fed funds target range of 5.375%. The post-meeting statement from the FOMC was little changed from its June meeting statement. Our interpretation of the statement is that the Fed maintains a mild tightening bias.
However, as we expected, Fed Chair Powell delivered a strong signal of data dependence for the September meeting in his press conference. A few times he noted, the next two CPI reports and next two employment reports will inform the September decision. What does this mean for those data points? In our view, for the Fed to remain on hold in September, we would need to see core CPI to print at around 0.2% to 0.3% over the coming two months and employment growth would need to slow to sub-200k per month pace.
As with the Fed, the ECB also signalled data-dependency for future rate decisions. Unlike the situation in the US, markets are pricing in a possibility (over 50%) of another 25bp rate hike by year end. Our view is that the July rate hike will be the peak of the current ECB tightening cycle. While the drop in economic activity is less than feared towards the end of last year, growth in the region has slowed sharply with the region’s largest economy, Germany, in recession and growing at slightly negative annual pace of -0.2%.
This brings us to Australia. Certainly, the June quarter CPI result was a surprise on the downside for us, the market and the RBA. The CPI result has made us, and the market, stop and take stock of what the RBA’s move next on Tuesday will be. Given the strength in the June labour market report, with the unemployment dipping back down to 3.5% and wage claims in the pipeline threatening a wage outbreak, we had pencilled in a resumption of RBA hiking at next week’s meeting following July’s pause. So, how should we weigh up the situation?
Looking at the composition of the CPI data, we note that service-sector inflation continues to rise reflecting the strength in demand for services. And of course, these service-producing industries are labour intensive, which hints towards a continuation of the strength in the labour market. A nod towards tightening? In contrast, June retail sales dropped by 0.8%, way below expectations of a flat print. The consumer is clearly entering a much tougher environment due (largely) to the rate hikes already imposed by the RBA. A nod towards keeping rates on hold?
So, the outcome for next Tuesday is finally balanced. Like the Fed, and now the ECB, the RBA has also committed to data driven decision making. The data are also finely balanced, and the prospect of the Australian economy entering an extended period of below trend growth is looming.
Therefore, our view is that the RBA will choose to pause, just as they did in July, waiting until the data provide more clarity on which way they should jump.