Key insights from the week that was.
This week delivered a very weak update for Australian consumer sentiment, highlighting the impact of declining real income and high interest rates. In stark contrast however, market confidence surged in the US today following a better-than-expected CPI print and a broadly neutral outcome in Tuesday’s mid-term elections.
Beginning in Australia, the Westpac-MI Consumer Sentiment survey reported a sharp decline in confidence, the headline index down 6.9% in November. It’s clear that inflation, having reached 7.3%yr at September 2022, and interest rates remain the key issues weighing on the minds of consumers. At 78.0, the headline index has sunk below GFC-era pessimism, suggesting that the cost-of-living pressures facing households will have a material impact on real spending capacity into year-end.
Indeed, on Christmas spending intentions, almost 40% of consumers expect to reduce spending on gifts this year – the highest proportion in the history of the series back to 2009. Consumers expect this pressure to be long-lasting too, with the ‘family finances, next 12 months’ sub-index posting a steep 11.2% fall in the month to its lowest level since 2014. Pessimism is also beginning to spread into consumer’s views on the labour market which, albeit still constructive versus the long-run average, have deteriorated markedly, unemployment expectations rising 17.8% in two months.
The labour market has been one of the few areas of support to consumers since the RBA begun hiking rates in May, but the recent shift in confidence is consistent with signs the labour market is nearing a turning point. Chief Economist Bill Evans provided a full discussion of these results and other salient themes from the survey in a video update mid-week. The outlook for inflation is also a key area of discussion in Westpac Economics’ latest Market Outlook in Conversation podcast.
NAB’s latest business survey meanwhile suggests that business conditions for Australian firms are beginning to crest as the economy slows under the weight of high inflation and rising interest rates. Down 1pt to +22, conditions are still supportive, but the strength of output growth into year-end remains an open question. Business confidence has weakened significantly, down 5pts in October to a below-average reading of 0, reflecting a deteriorating global backdrop and some signs of slowing in parts of the domestic economy.
Following these releases, RBA Deputy Governor Bullock again emphasised the need to quell inflation pressures and risks, but also growing uncertainty around the activity outlook and a desire to maintain the strength of Australia’s economy and labour market for the medium-term. Both sets of risks will be monitored closely by the RBA into 2023 as they continue to raise the cash rate further into contractionary territory – Westpac believes to a peak of 3.85% in May 2023.
Over in the US, expectations of a red wave across Congress were not met, with the Senate likely to remain divided and the new Republican majority in the House of Representatives slim. If history is a guide, Congress will therefore have limited reform capacity this term; the risks around the next debt ceiling debate, due early-2023, have also increased.
The key event for the US this week however was the release of the October CPI. After a string of upside surprises, October finally delivered a weaker-than-expected result with constructive underlying detail. Despite a rebound in energy prices and further strength in food in the month, headline prices rose ‘just’ 0.4% against a 0.6% expectation. Ex food and energy, prices rose 0.3%, half the pace of September.
Notably, the core outcome was despite another robust print for shelter which gained 0.8%, goods ex energy and food offsetting as it declined 0.4% following a flat outcome in September. Medical care service costs also declined in October, -0.6%, further reducing the significance of shelter’s gain.
Looking ahead, the mix of inflation pressures in both September and October point to a marked deceleration in end demand and consequently reduced pricing power amongst firms. As policy’s full effect is yet to be felt and the FOMC are intent on continuing to tighten into 2023, there is reason to be confident that inflation will trend lower from here. Eventually, this price trend and underlying weakness in economic activity will beget a need to ease monetary policy back to near-neutral levels. Having peaked at 4.625% in February, we anticipate 200bps of easing from early-2024 through mid-2025 to 2.625%.
Turning finally to China. This week’s data again emphasised that inflation is not a concern, with annual inflation decelerating to 2.1%yr in October, a fraction of the US’ 7.7%yr and Europe’s 10.7%yr. Price controls and the slack created by COVID-zero are factors here, but so too is the nation’s productivity and efficiency – underlying strengths which will allow authorities to keep policy accommodative as the domestic economy recovers fully from COVID-zero. Of concern though is that export demand continues to weaken, the October trade balance coming in well below expectations, albeit in line with the previous month, as exports fell 0.3%yr.
With developed-world demand to be held back by policy for an extended period, if it is to experience continued growth in trade income, increasingly China will have to depend on the geographic expansion of its export markets through Asia as well as increasing the output of disruptive industries such as electric vehicles. China’s dual circulation strategy is constructive here, reducing the need for imports and also aiding in the development of new products which can also be exported. For aggregate demand, it is not only the income received from trade that matters, but also the investment it incentivises. We suspect this wave of capacity expansion will be large in scale and long in duration.