Interest rates will still need to rise higher and for longer, but there are signs in Australia and the major economies that a slowdown is coming. How fast that slowdown occurs will determine the actions of central banks over the next year.
What is happening in Australia?
Could the RBA be right about inflation peaking in December? Monthly inflation in January did fall: from 8.4 percent in December to 7.4 percent in January on an annual basis. Inflation for food (8.2 percent), housing (9.8 percent), and travel (17.8 percent) are still high, but have decreased slightly from their November and December levels.
Further, the Australian economy is showing some signs of slowing down.
After 0.9 and 0.7 percent in the June and September quarters, GDP growth fell to 0.5 percent in the December quarter. Household consumption has fallen from 2.2 in June to 0.3 percent in the December quarter. We are not in recession territory yet, but there is a downward trend.
Consumers are starting to feel the bite of higher interest rates with interest payments increasing 23 percent in the December quarter after a 36.1 percent increase in the September quarter. The consumer savings rate has also fallen to pre-pandemic levels.
Unsurprisingly, loans by first home buyers continue to fall and are now at their lowest level in five-years (see chart below). Similarly building approvals for private houses hit a 10-year low in January.
However, the labour market remains tight. Unemployment increased slightly in December and the number of vacancies fell 11.2 percent, but the Wage Price Index increased to 3.3 percent on an annual basis for the December quarter. This needs to come down before the RBA can start bringing interest rates down.
What is happening around the world
An upward revision in past inflation results showed that inflation rose in December by 0.1 percent instead of falling 0.1 percent as originally indicated. This small change sent the market into a spin as people began to question their assumption of rate cuts in the first quarter of 2023. On top of this, the change in nonfarm payrolls for January was larger than expected.
The bad news was compounded further when January’s inflation was released along with the Federal Reserve’s preferred measure: the PCE index. Both the CPI and PCE rose in January. CPI rose 0.5 percent compared to December, while the PCE rose 0.57 percent (see chart below).
The labour market remains tight with only some small signs that consumers may be starting to feel the pinch from the increases in interest rates.
In early March, the Federal Reserve Chairman Jerome Powell confirmed the market’s fears when he told congress that, “The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated,”.
Chinese consumption and production has rebounded with the economy’s re-opening. For example, in January, the Caixin services PMI expanded for the first time since last August.
However at the recent annual meeting of parliament, Premier Li Keqiang surprised markets by setting a lower than expected GDP growth target of 5 percent. The IMF is predicting 5.2 percent while the World Bank is predicting 4.3 percent. However, this is probably more about China missing its growth target in 2022, 5.5 percent vs 3 percent actual, than actual pessimism from the Communist party.
The property market remains a concern and key downside risk. In its annual report for China, the IMF praised China’s efforts in addressing problems in the housing market but argued that more needs to be done to help property companies already in trouble and to reduce the possibility of downside scenarios.
“Accumulating pressures from the unresolved property crisis could trigger a sharp retrenchment in aggregate demand, with adverse macro-financial feedback loops and potentially large external spillovers”. IMF.
Euro area inflation continued its downward trend in January falling from 9.2 percent in December to 8.6 percent in January. The economy is slowing with GDP flat for the December quarter and unemployment increasing slightly by 0.4 percent. Industrial production was down 1.1 percent in December for the Euro area, while retail spending was down 2.7 percent.
The ECB is not taking any chances and has already indicated that it will raise the official interest rate by 50 bps in March. It is also finally putting its Asset Purchase Program into Quantitative Tightening mode: a €15 billion per month on average wind-down until the end of June 2023.
Inflation rose to 4.2 percent in January, which like December, was the highest level since 1981.
Prime Minister Fumio Kishida surprised everyone and nominated an academic economist, Kazuo Ueda, to take over at the BOJ rather than choosing the current BOJ Deputy Masayoshi Amamiya as was expected.
Watchers believe that the Prime Minister wanted a governor who was not only a monetary policy expert but who is also in touch with markets and the real economy.
Markets will feel a little nervous when the BOJ eventually starts to tighten given Japan’s high level of debt and a bond market dominated by the BOJ. The Nikkei says Ueda will be taking the hardest central bank job in the world!
So far, Ueda has kept to the party line and has told the Diet that he is not intending to tighten monetary policy just yet, “I believe it is appropriate to continue monetary easing measures while being creative in line with the situation,”. Creativity will definitely be needed over the next year!
Inflation continued its fall in January after peaking in October (see chart below). Both goods (-0.3 percent) and services (-0.5) fell over the month. However, 8.8 percent is still too high and the economy is just starting to slow. Unemployment is still historically low and GDP was only flat in Q4 2022. Worryingly, growth in average total pay remained high in the December quarter (5.9 percent excluding bonuses) and strikes are still sweeping the country. More pressure needs to come out of the labour market before the BOE can relax.
What this means for Australian Private Debt
Australia’s economy is in sync with the world’s major economies. A slowing world economy should reinforce Australia’s slowing economy and hopefully inflation will start to significantly decrease in Australia and elsewhere. However, central banks will need to keep raising interest rates until that happens. These are good times for those looking for higher returns in private debt.
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