Economic data released in June showed weak global economic growth, still tight labour markets and patchy progress reducing inflation. Some central banks cut their official interest rates for the first time in the current high interest rate cycle, notably the European Central Bank (ECB) at its June meeting. Most major central banks, including the US Federal Reserve (Fed), Bank of England and the RBA, left their official interest rates unchanged at their various peaks, hinting at rate cuts down the track while warning that more evidence of receding inflation is needed to permit rate cuts. The RBA is the most hawkish, indicating that the stickiness of Australian inflation if it persists or worsens could present a reason to hike the cash rate further. Our view is that the slow-growing Australian economy presents a high bar for the RBA to hike, but sticky inflation means that the first rate cut is a 2025 – probably mid-2025 – realistic expectation.
In the United States, GDP on revision was relatively soft in Q1, growing at 1.3% annualised pace. Most GDP trackers for Q2 using recent economic data point to growth lifting in Q2 above 2%. Essentially, US manufacturing is weak other than in high-tech, while the service sector, accounting for close to 90% of US output, is running strongly. The strength of services in the US (and elsewhere) helps to explain why comparatively soft GDP growth coexists with persistently tight labour market conditions.
The US labour market was still very strong in May, with non-farm payrolls up 272,000 and average hourly earnings up 0.4% m-o-m, taking annual wage growth up to 4.1% y-o-y from 3.9% in April. A rising participation rate saw the US unemployment rate edge up to 4.0% from 3.9% in April. If the US labour market remains as tight as it has been recently, annual wage growth is likely to stay around 4% y-o-y, too high as far as the Fed is concerned. If inflation is to return sustainably to its target of 2%, the Fed is wanting to see wage growth nearer to 3.5% y-o-y.
Wage growth above US inflation (CPI 3.3% y-o-y in May) adds to factors such as strongly growing government spending supporting domestic spending growth in the US, slowing progress reducing inflation. There are some signs that the US labour market may not be quite so tight in the months ahead. Job openings are falling and weekly initial jobless claims are running higher; nearer to 240,000 rather than 210,000 a month or two back. The Fed indicated at its June policy meeting, when it left the Funds rate at 5.50%, that it may start cutting rates later this year. We see a chance of a 25bps cut late this year and then a slow run of cuts in 2025 that may stop at a relatively high base of 4.00% given a sticky US inflation outlook.
In China, forces remain evident driving excess capacity, faltering economic growth and low inflation bordering deflation. May economic readings were mostly comparatively soft. Exports were an exception to the soft trend, up 7.6% y-o-y in May from 1.5% in April, but import growth, up 1.8% y-o-y in May and down from 8.4% in April, speaks of soft demand inside China. Fixed asset investment spending, the mainstay of Chinese growth and economic recoveries in the past is faltering, decelerating to 4.0% y-o-y in May from 4.2% in April. Industrial production decelerated to 5.6% y-o-y in May from 6.7% in April. Cutting against the decelerating growth trend in May, retail sales lifted 3.7% y-o-y in May from 2.3% in April but need to rise to nearer 10% y-o-y to give China any chance of growing GDP 5% in 2024 contained in official forecasts. Chinese households face a continuing strong headwind to their spending from wealth destruction as the continuing problem of chronic over-supply in residential construction cuts house prices – down 3.9% y-o-y in May from -3.1% in April. The Government’s focus on fostering high-tech industries fails to provide most Chinese households with reason to spend more rather than try and save more to guard against a bleak future.
In Europe, economic reports released in June show weak growth but combined with still tight labour market conditions and high wage growth (up 5.3% y-o-y in Q1 2024 compared with 3.2% in Q4 2023). Progress reducing inflation faltered in May with CPI inflation lifting to 2.6% y-o-y from 2.4% y-o-y in April. Notwithstanding the inflation setback the ECB at its June policy meeting cut its official interest rates by 25bps (deposit rate down to 3.75% from 4.00%) responding more to signs of weak growth rather than evidence of still sticky inflation. The ECB also warned that the path ahead for future rate cuts was uncertain because of the difficulty getting inflation down to target 2%. In the UK, even though inflation is lower than in the EU at 2% in May, the Bank of England chose at its June policy meeting to leave the Base Rate unchanged at 5.25%. It wants more certainty that inflation will stay down before deciding to cut and at present the tight British labour market, high wage growth and loose government fiscal position all militate towards inflation starting to lift again rather than stay at 2% or push lower.
In Australia, inflation is showing signs of holding up higher for longer. The monthly CPI showed annual inflation falling to a low point of 3.4% y-o-y back in February. Since then, inflation has lifted to 3.5% in March, 3.6% in April and the May CPI report due this week is expected to show another small increase. Although demand in the Australian economy has softened, evident in the Q1 GDP increase of 0.1% q-o-q and 1.1% y-o-y, it has not softened enough to weaken the labour market to the point of starting to contain wage growth or to the point of reducing inflationary housing demand. Looking ahead, there are factors such as the approaching income tax cuts and the Federal Government’s expansionary budget position that may add to demand growth and limit how much labour market conditions may soften.
The RBA continues to forecast that inflation will return inside 2-3% band by late- 2025/early-2026, but that progress has become less certain since that inflation forecast was made in early-May. The labour market remains tighter than the RBA would like, with another 39,700 jobs added in May and with the unemployment rate edging down to 4.0%, low enough to herald a long stay for wage growth above 4% y-o-y. House prices and rents continued to rise in May, adding to the likelihood of inflation getting stuck above 3% for a protracted period.
The RBA was noticeably less comfortable with the inflation outlook at its mid-June policy meeting than it was at its previous meeting in early-May, and noted that the committee discussed whether it should hike the cash rate. It settled for leaving the cash rate on hold at 4.35% but what is evident is that the RBA will be torn between whether to leave the cash rate on hold or hike for at least the next meeting (in early-August).
While there are pressures keeping inflation higher than the RBA would like and that will need to be recognised in the August Monetary Policy Statement, we feel that the hurdle is set high for a rate hike given soft GDP growth and in a world where some of the RBA’s central bank peers are starting to cut rates. Nevertheless, Australia’s relatively poorer progress reducing inflation does mean that the RBA will have little opportunity to cut the cash rate for many months. At this stage we do not see the RBA being in a position to be comfortable with the inflation outlook until mid-2025 and even when it does start to cut it is likely to be limited how far it can cut rates without the risk of inflation rekindling.