Economic data released in April again showed most major economies close to recession or experiencing slow growth. Inflation remained sticky and above the targets of most central banks. The difficulty reducing inflation towards target became more pronounced in the US and Australia promoting a reassessment that it might take longer before official interest rates can be cut and in Australia resurrecting the possibility that the cash rate might need to be lifted further to bring inflation down to target range. Government bond yields rose in the US and Australia in April to reflect that official interest rates cannot be reduced this year.
In the United States, while GDP growth was softer than expected in Q1 at 1.6% annualised, down from 3.4% in Q4 2023, annual CPI inflation at 3.5% y-o-y in March and up from 3.2% in February, was above expectations for a third consecutive month. Rising cost of shelter and service prices continue to underpin inflation above the Federal Reserve’s 2% target. The US labour market also remains too tight to provide hope of inflation pressure subsiding in the near term. In March, nonfarm payrolls rose strongly by 303,00, the annual growth in average hourly earnings was above 4% at 4.1% y-o-y and the unemployment rate stayed low at 3.8%.
Despite the soft Q1 GDP growth reading, retail sales were strong in both February, +0.9% m-o-m, and March, +0.7%, signaling that US households continue to spend freely, buoyed by rising income and wealth. During April, the Federal Reserve seemed to tweak its guidance on the rate outlook from possible rate cuts starting mid-2024 towards no rate cuts before end-2024 at earliest. If US inflation continues to drift higher there is a small risk that the Federal Reserve may need to consider hiking the 5.50% funds rate. In a sign that the US bond market has all but lost hope of rate cuts over the next year or so, the 2-year US bond yield has risen 40bps over the past month and is sitting just below 5% yield.
In China, Q1 GDP was stronger than expected, up 5.3% y-o-y from 5.2% in Q4 2023. The strength in the Q1 GDP reading appears illusory, however, given mostly softer than expected March month economic reports consistent with growth below 5%. March fixed asset investment spending rose 4.5% y-o-y, industrial production was up 4.5% y-o-y while retail sales rose only 3.1% y-o-y. Export growth weakened sharply in March, -7.5% y-o-y from +7.1% in February. Weak inflation (deflation) reports in March also speak of continuing excess capacity with the CPI -0.1% m-o-m, +0.1% y-o-y and producer prices -2.8% y-o-y. Essentially, China needs to find a way to bolster growth in household spending, a tall order given the destruction of wealth from falling residential property prices (-2.2% y-o-y in March) combined with income growth constrained by high unemployment (5.2% in March). The authorities are resisting the type of policy program that might bolster general household spending such as large-scale government spending to provide a better income safety net combined with much easier monetary conditions.
In Europe, economic reports released in April continue to show almost no growth in the euro-area. Q1 GDP will be released later this week and is expected to show growth around 0.2% q-o-q, +0.1% y-o-y, a touch firmer than in Q4 2023, 0.0% q-o-q, +0.1% y-o-y. Weak growth running near recession is allowing inflation to moderate more in Europe than elsewhere with headline CPI inflation down to 2.4% y-o-y in March with underlying inflation 2.9% y-o-y. Pushing inflation down the last few yards to the European Central Bank’s 2% target is proving hard although there are signs that one of the sticking points for inflation , the tight European labour market generating high wage claims, may be starting to turn softer. Europe’s unemployment rate at 6.5% in February is showing signs of starting to increase. The European Central Bank (ECB) at its April policy meeting indicated growing concern about soft growth and if inflation pushes down nearer to 2% target that may still allow the ECB to start cutting the 4.00% deposit rate in the second half of 2024.
In Australia, the last hope was dashed of any RBA rate cut later this year by evidence of a still tight labour market in March and inflation in March and Q1 running higher than would be consistent with the RBA’s February Monetary Policy Statement economic forecasts. The RBA in the approaching May Monetary Policy Statement is likely to revise higher forecasts of CPI inflation which were 3.2% y-o-y for December 2024 and 2.8% for December 2025. It is likely that the RBA’s CPI forecasts will be above the top of its 2-3% target range through the remainder of this year and through 2025.
The Q1 CPI was up 1.0% q-o-q, 3.6% y-o-y (market and probably RBA expectations 0.8% q-o-q, 3.4% y-o-y) with higher-than-expected underlying readings too, trimmed mean 1.0% q-o-q, 4.0% y-o-y and weighted median 1.1% q-o-q, 4.4% y-o-y. Australia’s sticky inflation rate is home grown with non-tradables inflation at 5.0% y-o-y in Q1. It is also driven mostly by service price inflation, 4.3% y-o-y. Also, there are signs in the monthly CPI report that inflation may be starting to turn higher with the March CPI up 3.5% y-o-y after sitting at 3.4% y-o-y in both January and February.
Apart from evidence of higher-than-expected inflation the RBA also received news through April that the labour market is still tight (employment fell only 6,600 in March after rising an upwardly revised 117,600 in February), that retail sales are lifting from their low point late last year with increases of 1.1% m-o-m in January and 0.3% in February and that house prices and rents (a big contributor to sticky inflation) are still rising briskly. Looking ahead, the approaching income tax cuts on July 1 may add to spending and inflation. It also seems unlikely that the Federal Government’s 2024-25 Budget to be released May 12 will work actively to suppress demand and assist the RBA’s task containing inflation.
The Australian bond market has seen a sharp lift in yields over the past month taking the 2-year bond yield up 39bps to 4.13% and the 10-year yield up 50bps to 4.46% and is indicating that the market has adjusted to almost no chance of the RBA’s current 4.35% cash rate being any less over the remainder of 2024 and much of 2025. We are now penciling in a delay in the first RBA rate cut to the second half of next year. We are not yet at the point of forecasting more rate hikes this year, but if the Budget is too loose and there is any further evidence of too high inflation, unacceptably high (4.3%+ y-o-y) wage growth or too firm demand indicators that will tip the balance towards two more rate hikes in this cycle.
Author’s note: I will be away on leave through May returning in early June. The next economic report will be on Monday 10 June.