Fears of a financial meltdown in the US and Europe have faded and instead we have returned to regular broadcasting with slowing inflation and slowing economies. The UK with its stubborn inflation remains the odd country out. China is still benefiting from its reopening while Australia is benefitting from this and the mending of trade relations with China.
What is happening in Australia?
After ten consecutive rate rises, the RBA finally paused in April.
These ten rate rises were the most since the six rate rises from October 2009 to May 2010. Those rises were in response to a resilient Australian economy and a stronger than expected rebound in the domestic and international economies, coming out of the GFC. Sound familiar?
Technically, the RBA did pause in the middle of the 2009-2010 increases, in February 2010. The pause was partly in response to growing concerns over the European debt crisis. Similarly, the US and Swiss banking crises in recent months were important factors in April’s pause.
With the 25 bps increase in May, the question becomes will we see another run of increases like we did in 2010 or was May a one-off increase?
The RBA minutes from the April meeting shows a board willing to wait and see the quarterly inflation data for Q1 2023 and developments in the Australia and international economies, before deciding on further interest rate increases.
The quarterly inflation figures for Q1 2023 were released at the end of April. It confirmed the RBA’s earlier prediction that inflation had peaked in December (see chart below). The new monthly inflation indicators had already shown this, but the RBA and analysts were keen to see it confirmed by the more accurate quarterly inflation indicator.
Despite inflation now trending down, inflation remains too high and well above the RBA’s target range so expect a further run of rate increases with a few pauses mixed in for good measure.
The chart below shows that the market has tempered some of its optimism since the April pause with the yield curve shifting up over the last month. This also reflects the fact that many in the market were surprised by the RBA's 25 bps increase in May.
The yield curve has also become more inverted, which shows that the market is more convinced than ever that we are heading for a recession followed by some interest rate cuts.
Economic data released in April and early May confirms the slowdown of the Australian economy. Retail turnover only grew 0.2 and 0.4 percent on a monthly basis for February and March. Monthly growth in business turnover continues its downward trend since August. Household spending slowed in February, with discretionary spending slowing further than the headline figure from 13.3 percent in January to 5.8 percent in February on an annual basis.
A big reason for slowing consumer spending is unsurprisingly rising mortgage payments. The Living Cost Index for Employees is now at its highest levels since it began in December 1999. The category that has had the highest increase over the last year was mortgage interest at 78.9 percent. Consumers are feeling the squeeze.
However, despite slowing down, the economy is still in positive territory and any potential recession is still months away. Unemployment remains stuck at 3.5 percent.
The Government’s review into the RBA was released on 20 April. It is hard to know if this would have garnered much attention if the RBA governor had not infamously said back in 2020 that he didn’t expect any interest rate rises until 2024! Of course the big theme from the review was to increase RBA accountability! Two new boards will be created, including an “expert” Monetary Policy Board, which will take over monetary policy decisions from the RBA Board and will meet 8 times a year compared to the RBA Board’s current 11 times a year. The review also recommended that the Government and RBA Monetary Policy Board do a formal review of the monetary policy framework and tools every 5 years.
What is happening around the world
The US increased interest rates by 25 bps on 3 May, which was the tenth consecutive increase. Similar to Australia, US economic growth has slowed and a very inverted yield curve promises a recession, but the labour market remains tight, and inflation remains high.
Real GDP growth has slowed from 2.6 percent in Q4 2022 to 1.1 percent in Q1 2023 on an annual basis. This was mainly driven by businesses with a decrease in private inventory investment and a slowdown in nonresidential fixed investment. Consumer spending and saving actually increased in Q1.
The Federal Reserve’s preferred inflation measure, Personal Consumption Expenditure minus food and energy, slowed slightly in March to 4.6 percent but remains historically high (see chart below).
Despite the demise of another bank during the month (First Republic), financial conditions have improved slightly. The Federal Reserve seems less concerned than it did last month over the banking sector, but is still closely watching the impact of tighter financial conditions on the US economy.
“Inflation has moderated somewhat since the middle of last year. Nonetheless, inflation pressures continue to run high and the process of getting inflation back down to 2 percent has a long way to go.” Jerome Powell, FOMC Press Conference, 3 May, 2023.
China’s economy grew 4.5 percent on an annual basis in Q1 2023, which was much faster than expected. Retail sales increased 10.6 percent while services increased 5.4 percent.
However, manufacturing PMI decreased for the second month in a row in April and is now slightly contractionary. The result was attributed to slower demand.
In contrast, non-manufacturing PMI, led by services, saw its fourth consecutive increase. Domestic tourism has rebounded strongly with a return to pre-pandemic levels during the Chinese New Year and a similar rebound expected for Golden Week in May.
Chinese exports also increased by 14.8 percent in March, which was the first increase in 6 months. Commentators attributed this to Chinese factories catching up with back-orders.
Australian goods exports to China increased by 31 percent on an annual basis in March helping Australia record its second-highest trade surplus ever. With China and Australia agreeing to mend trade relations after the threat of a WTO hearing, China ended the unofficial ban on Australian coal in January. In March, Australian thermal coal exports to China increased by 125% by volume compared to February.
As expected the ECB raised interest rates by 25 bps on 4 May. Euro Area inflation fell from 8.5 percent in February to 6.9 percent in March, but increased slightly in April to 7 percent.
EU GDP increased by 0.3 percent in Q1 2023 up from a -0.1 decrease in Q4. EU unemployment fell slightly to 6 percent in February and was steady in March. With the economy holding up and the labour market still tight, the ECB remains wary of wage pressures.
Kazuo Ueda held his first meeting as BOJ Governor on 27 April. As expected, he indicated a dovish stance, with markets nervous over any signal of future monetary policy tightening. He did however announce a review of monetary policy going back two decades. Could this provide the arguments for a future move towards tightening?
Inflation slowed to 3.2 percent in March, but recent estimates from Tokyo suggest that prices may be increasing again. There is also pressure on wages from a tight labour market.
After the shock increase in inflation in February, inflation decreased slightly in March to 8.9 percent but remains above January’s rate (see chart below). Growth in average weekly earnings also remains high, increasing 6.6 percent (excluding bonuses) between December 2022 and February 2023. The Monetary Policy Committee meets next on 11 May.
What this means for Australian Private Debt
The global economy is steady as it goes with some signs of slowing in the US and EU and some positive signs in China. Inflation has turned the corner, except in the UK and possibly Japan. Such a gradual and predictable slowdown in the US and EU along with the potential upside in China, should stand the Australian economy and the private debt market in good stead.