Economic Update - February 2025

The White House hasn’t been this exciting since Martin Sheen was president! From Ukraine to USAID, Gaza to Guantanamo, there has been non-stop drama. Tariffs have been the main focus for Wall Street and economists. Just as inflation was coming under control and recession avoided, the Federal Reserve and central banks everywhere are watching closely to see what happens next.     

What happened in Australia?

As expected, the RBA cut the cash rate by 25 bps in February. Slowing inflation and some signs of slowing growth pointed to a cut but don’t expect another one anytime soon.

“The Board judges its time to reduce a little of the restrictiveness but we cannot declare victory over inflation just yet.” Michele Bullock, RBA, governor.

Curiously, Bullock admitted that the Board does not know what to make of a tight and tightening labour market (see decades-low unemployment in the chart below) but slowing wage growth (see second chart below). Has a structural change happened in the labour market? Maybe, but the RBA will want to be sure that there will be no sudden increase in wages before it makes too many further cuts.

“The strength of the labour market has been surprising,” Michele Bullock.

Annual trimmed mean inflation ticked up in January from 2.7% to 2.8% but January is one of the months where 38% of the data is carried over from the previous month so not too much notice should be taken. The RBA is really waiting to see the March-quarter inflation when it is released in April. Thankfully, the economy is holding up well and does not need to be encouraged with further cuts until then. 

What happened around the world?

USA

After a hotter-than-expected core CPI result for January earlier in the month, markets feared the worst. However, the Fed Reserve’s preferred inflation measure PCE came in as expected for January with a small decrease to 2.5% - the first decrease in four months (see chart below).

But it is clear that policy uncertainty around tariffs and geopolitics is taking a toll on the psyche of the American consumer with two bad results from the University of Michigan. US consumer sentiment fell to its lowest level since December 2023 and 1-yr inflation expectations shot up to its highest level since December 2023 (see chart below).

Further, the S&P 500 has also slowly been retreating from record highs in the middle of the month.

Pessimism may also be seeping into the real economy with the Atlanta’s Fed GDPNow Forecast and the S&P’s US PMI index indicating slowing US economic growth in the March quarter (see chart below).

China

The Lunar New Year holiday has come and gone with economists mixed over its impact. While total spending was up, spending per capita was down (see chart below).

On the policy front, sources indicate that the People’s Bank of China is looking to inject USD 55 billion into the top-six state banks and that the government and PBoC are looking at countermeasures in response to Trump’s tariffs, which will come into effect in March.

EU

The flash estimate for December-quarter GDP shows the euro area growing 0.1% for the quarter and 0.9% on an annual basis. Germany slipped back into negative territory on a quarterly basis and was joined by France and Ireland.

 Inflation increased from 2.4% in December to 2.5% in January.

As has been the case for the last several months, the ECB will be paying more attention to the GDP numbers than the inflation numbers as they believe that inflation is on its way down. 

Japan

Last month’s rate rise looks even better with core inflation rising from 3% to 3.2% in January and nominal wages increasing at their fastest rate in nearly 30 years (see chart below).

However, the Nikkei index has trended down since the middle of the month with increased uncertainty over US economic and geopolitical policies.

UK

The Monetary Policy Committee voted 7-2 to cut interest rates by 25 bps to 4.25% in February. The two dissenters wanted to cut rates by 50 bps! While inflation remains high, and actually increased in January from 2.5% to 3%, the BoE believes that it is on its way down.

“There has been substantial progress on disinflation over the past two years, as previous external shocks have receded, and as the restrictive stance of monetary policy has curbed second-round effects and stabilised longer-term inflation expectations. That progress has allowed the MPC to withdraw gradually some degree of policy restraint,” Monetary Policy Summary, February 2025.

New Zealand

The Reserve Bank of New Zealand cut the cash rate by 50 bps in February, that’s 175 bps in cuts since August last year. With the slowdown in economic growth, the RBNZ believes that aggregate demand is now less than aggregate supply, which will continue to see inflation fall.

 “Economic activity in New Zealand remains subdued. With spare productive capacity, domestic inflation pressures continue to ease. Price and wage setting behaviours are adapting to a low-inflation environment.” RBNZ, media release, 19 February, 2025.

 What this means for Australian Private Debt

The RBA’s 25 bps interest rate cut largely reflects an improvement in inflation pressures rather than a deterioration in economic activity. The Australian economy thus remains in a sweet spot for private debt investors.