The median Fed forecast is now indicating that six more rate hikes should be expected this year, with those to be followed by another three hikes in 2023. The policy move comes against the backdrop of a global economy that continues to be shaken by the impact of the war in Ukraine and which has more recently been buffeted by the prospect of yet more supply chain disruption following Beijing’s decision to lock down multiple cities including a planned six-day shutdown of Shenzhen as China struggles to maintain its zero-COVID strategy.
I recently gave a presentation on the series of shocks hitting the world economy and some of the implications for Australia. You can find the slide pack here.
In Australia, the ABS announced this week that the unemployment rate fell to just four per cent in February 2022. In the entire history of the monthly series – which dates back to February 1978 – the rate has only been this low twice before: in February and August 2008. Australia is now on the verge of an historic sub-four per cent unemployment rate for the first time since the early 1970s. The strength of the labour market revealed in this week’s report increases the likelihood that the RBA will see the kind of wage growth that it has been seeking, which in turn will allow for the start of the normalisation process for Australian monetary policy.
Less welcome news was that higher petrol prices and the Ukraine war have pulled down consumer confidence and pushed up inflationary expectations. The ANZ-Roy Morgan consumer confidence index fell 4.3 per cent last week, dropping to its lowest level since October 2020. At the same time, weekly inflation expectations jumped to 5.6 per cent, the highest reading in the history of the weekly series (which dates back to October 2014) and the highest overall since November 2012.
Other releases this week included international arrivals and departures, business turnover, population data and the latest quarterly ABS house price numbers. You can find an updated housing market chart pack here. The RBA also published the minutes from the March 2022 monetary policy meeting.
This week’s collection of links includes the latest RBA bulletin and the most recent edition of the IMF’s Finance & Development magazine; six ways that COVID has changed Australia’s housing market; global housing risks in the wake of the pandemic; how war in the Ukraine could reshape the world, boost global inflation, lift global food prices and accelerate Russia’s brain drain; visualising military budgets; the Lowy Institute on China’s long-term growth prospects; tracking crony capitalism; and a podcast with Fiona Hill on deindustrialisation, despair and demagoguery.
Finally, a reminder that you can register for the upcoming Budget 2022 webinar here.
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A new global monetary policy cycle is now underway
This week saw the US Federal Reserve raise the target range for the federal funds rate by 25 bp to 0.25-0.5 per cent. The accompanying announcement also noted that the Federal Open Market Committee (FOMC) ‘anticipates that ongoing increases in the target range will be appropriate.’ The FOMC voted 8-1 in favour of the decision, with the one dissenter preferring a 50bp increase.
Given the central and dominant role that the Fed plays in the global financial system, this was a landmark moment for the world economy. What was the first increase in the Fed Funds rate since 2018 both signals an end to the extreme monetary policy settings the US central bank had adopted to fight the pandemic and marks the start of only the third Fed tightening cycle this century.
The Fed was responding to a headline consumer inflation rate that hit a 40-year high of 7.9 per cent in annual terms in February this year as well as an annual rise of 6.1 per cent in January in its targeted measure of inflation (the PCE or personal consumption expenditures price index) along with a 5.2 per cent year-on-year increase in the core PCE, its’ preferred gauge of underlying inflationary pressures. The latter result was the strongest reading for the core series since April 1983.
The beginning of a monetary policy tightening cycle immediately prompts two questions: where will the policy rate end up, and how quickly will it get there? The FOMC provided its own best guesses as to the answers to both of those questions in its Summary of Economic Projections (SEP). These show that the median expectation of FOMC members is for the midpoint of the Fed’s target range to end this year at 1.9 per cent and to end next year at 2.8 per cent.
Assuming that all future rate increases come in the Fed’s standard 25bp doses, that would imply rate hikes at each of the six remaining Fed meetings this year plus another three rate hikes next year for a total of ten 25bp rate hikes including this one (although note that financial markets think a super-sized 50bp move is quite likely at some stage). The same numbers also indicate a significant shift in the Fed’s thinking since the December 2021 SEP, with the new forecasts depicting a much more aggressive profile for the policy rate, including the assumption that it will have to be taken above the estimated long-run or neutral rate of 2.4 per cent in order to bring inflation under control.
If the median forecast turns out to be correct, that implies a quite aggressive tightening schedule relative to recent history. As noted above, we’ve only seen two tightening cycles this century, and the most recent of those was a very gradual process: between December 2015 and December 2018, the FOMC delivered a total of 200bp of policy tightening in the form of eight 25bp rate hikes that took the target range for the Fed Funds rate from 0-0.25 per cent to 2.25-2.5 per cent.
The second and earlier tightening cycle was rather more brutal, however. Between June 2004 and June 2006, the FOMC imposed 425bp of tightening via 17 25bp rate hikes, taking the target Fed Funds rate up from one per cent to 5.25 per cent.
Australia’s unemployment rate is now at its lowest since August 2008
Turning to domestic developments, this week saw the ABS report that Australia’s unemployment rate had fallen to just four per cent (seasonally adjusted) in February 2022. That’s the lowest the unemployment rate has been since August and February 2008, and in the history of the monthly series (which dates back to February 1978) the unemployment rate has never been lower. According to the ABS, a sub-four per cent rate was last achieved before November 1974, when the labour force survey was quarterly.
February’s 0.2 percentage point drop in the unemployment rate was also accompanied by an 18,500 fall in the number of unemployed people, a 0.1 percentage point fall in the underemployment rate to 6.6 per cent, and a 0.3 percentage point drop in the underutilisation rate.
In a very strong labour market report, there was also good news on employment. Total employment rose by 77,400 people last month, with a 121,900 rise in full-time employment more than enough to offset a 44,500 drop in part-time work. Total employment is now just shy of 13.4 million people, which is approaching 400,000 more than the level of employment in March 2020, pre-pandemic. And after having dropped by in January in response to the impact of the Omicron variant, hours worked jumped by 8.9 per cent (148.7 million hours) in February.
Other signs of a rapidly tightening labour market included a rise in the employment to population ratio to a new record high of 63.8 per cent – 1.4 percentage points higher than its pre-pandemic level – and a record high participation rate of 66.4 per cent, which is 0.6 percentage points higher than the corresponding pre-pandemic rate.
All of which should increase the chances that the RBA will start to see the kind of increase in wage growth that will signal that it is time to start hiking the cash rate.
There will be more detail on this week’s labour force report, plus updates on the labour account, job vacancies and job ads in the next update of our labour market chart pack, which should be on our website early next week.
The Ukraine war has sent petrol prices up and confidence down
On a less positive note on the Australian data front, the ANZ-Roy Morgan Consumer Confidence index fell 4.3 per cent last week, taking that index further into negative territory. Confidence fell in all states except Western Australia and all five of the subindices dropped over the week, with declines in excess of five per cent for ‘current financial conditions’ and ‘future economic conditions.’ Confidence is now back down at its lowest reading since October 2020.
At the same time, weekly inflation expectations jumped 0.4 percentage points to 5.6 per cent last week, the highest reading in the history of the weekly series (which dates back to October 2014) and the highest rate in the monthly series since November 2012.
A common factor in both increased concerns over prices and softer confidence is likely to have been higher petrol prices as the war in Ukraine has pushed up global energy prices (although note that the immediate impact of the China lockdowns noted earlier has been to take some of the steam out of the oil price rally).
The latest (December 2021) reweighting of the CPI saw the transport group’s share increase from 10.2 per cent in 2020 to 10.6 per cent last year, the third largest share of the CPI basket by expenditure group and behind only housing and food and non-alcoholic beverages. Within that overall grouping, automotive fuel now has a weight of 3.3 per cent.
Rising automotive fuel prices have already played a significant role in driving the headline rate of inflation in recent quarters. In particular, in the most recent data release for the December quarter of last year, a 6.6 per cent quarterly rise in automotive fuel represented a sixth consecutive increase in petrol prices, taking the series up by 32.3 per cent over the year and to a new record level. Fuel prices on their own contributed 0.2 percentage points of the 1.3 per cent quarterly rise in the CPI in Q4:2021.
The prospect of higher petrol prices feeding mechanically into higher headline inflation rates and from there into higher household inflation expectations (and lower confidence) gives force to the story told in the previous Weekly note, which reported on a speech by RBA Governor Lowe that emphasised the importance of inflation expectations and his concern that high inflation rates could lead to shift in ‘inflation psychology,’ and which noted in that context that the conflict in Europe was complicating the central bank’s job via more adding more price pressures (also, see below for a discussion of this week’s RBA minutes).
What else happened on the Australian data front this week?
The RBA published the minutes from the 1 March 2022 Monetary Policy Meeting of the Reserve Bank Board. As would be expected, the reported discussion spent some time on the potential implications of war in Ukraine with members noting that it ‘would pose a significant setback for the recovery in Europe’ and that for the world economy overall ‘the surge in prices for energy and other commodities…was a substantial relative price shock…the net effect would be lower global output than otherwise…[and] further disruptions to global supply chains would lead to higher global inflation’.
On domestic conditions, the minutes record that ‘members observed that the Australian economy had been resilient in the face of the Omicron outbreak’, that disruptions to labour supply ‘had been short-lived’, and that now ‘labour market conditions were the tightest since 2008 and the outlook remained positive’ and the unemployment rate was at its lowest in 14 years. (And as we now know after this week’s labour market report, the unemployment rate is lower again, and conditions are even tighter.)
Even so, although wage growth had picked up, it was ‘only to around its pre-pandemic rate’ and that across ‘industries and states, wages growth outcomes had been unusually tightly clustered in the low-to-mid two per cent range.’ The discussion did, however, go on to note that members ‘agreed that the risks to the outlook for wages growth were skewed to the upside, reflecting the low rate of labour underutilisation.’ Moreover, ‘non-labour input cost pressures remained widespread across industries… firms were increasingly prepared to pass these higher costs onto their customers, particularly in the construction, manufacturing and retail industries, where upstream cost pressures had been most acute…[and]…high international shipping rates…remained a source of cost pressure for firms.’
In terms of the implications for monetary policy, the minutes note that, in year-ended terms, ‘underlying inflation was expected to increase further over coming quarters before moderating as supply problems are resolved’ but that ‘the war in Ukraine and the associated increase in energy prices had created additional uncertainty about the inflation outlook…headline inflation would increase by more than underlying inflation in the near term because of the effect of global developments on petrol prices.’ And the bottom line(s) remained familiar:
‘While inflation had picked up, members agreed it was too early to conclude that it was sustainably within the target band. There were uncertainties about how persistent the pick-up in inflation would be given recent developments in global energy markets and ongoing supply-side problems. Wages growth also remained modest and it was likely to be some time before aggregate wages growth would be at a rate consistent with inflation being sustainably at target. The Board is prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve.’
Meanwhile, market pricing continues to predict at least five hikes in the cash rate by the December 2022 RBA meeting.
ABS House Price Index
According to the ABS Residential Property Price Index, capital city prices rose 4.7 per cent over the December 2021 quarter to be up 23.7 per cent over the year. That marked the strongest annual growth since the series began in the September quarter of 2003. House price growth (at 27.5 per cent over the year) continued to run ahead of price growth for attached dwellings (up 14 per cent).
The ABS also said that the total value of Australia’s 10.8 million residential dwellings rose $512.6 billion to $9,901.6 billion in Q4:2021 while the mean price of residential dwellings rose to $920,100.
While the ABS numbers show the housing market ending the year strongly, more timely data from CoreLogic suggests that the pace of growth has continued to ease into the first quarter of 2022. Earlier this month, CoreLogic reported that its National Home Value Index (HVI) had risen 0.6 per cent over the month in February 2022 to be up 20.6 per cent over the year. While that was the 17th consecutive monthly rise, it was also the lowest monthly growth reading since October 2020. Likewise, the CoreLogic combined capitals index also rose at a softer 0.3 per cent monthly rate in February (also the weakest gain since October 2020) and was up 19.2 per cent in annual terms.
Notably, prices fell 0.1 per cent in Sydney, in the first drop in housing values in that city since September 2020, while home values in Melbourne were flat. Rising interest rate expectations, higher fixed-term mortgage rates, and declining housing affordability have all combined to take some of the heat out of the housing market. You can find more analysis and background in our updated housing market chart pack.
Monthly business turnover
The ABS’s new experimental indicator of business turnover showed turnover in January 2022 falling in ten out of the 13 industries covered by the data (on a seasonally adjusted basis). The Omicron variant and the resultant rise in household caution along with the impact of official restrictions saw a 10.6 per cent fall in monthly turnover for the arts and recreation industry while accommodation and food services saw turnover drop 6.6 per cent.
Overseas arrivals and departures
According to the ABS, in January 2022 total arrivals increased by more than 69,000 trips over December to 265,190. Total departures over the same period fell by more than 39,000 to 188,200 trips.
National, state and territory population
Australia’s population rose to 25,750,198 as of 30 September 2021. The ABS said that population growth was just 0.05 per cent (12,100 people) over the quarter and a modest 0.3 per cent (68,900 people) over the year. Natural increase contributed 136,200 to that annual growth while net overseas migration subtracted 67,300.
Four states saw positive population growth over the year to 30 September 2021, with the fastest growth in Queensland (up 1.1 per cent in annual terms) followed by Western Australia (up 0.7 per cent). Three states and territories saw falls, led by Victoria (down 0.5 per cent) and the Northern Territory (down 0.1 per cent). Tasmania’s population was largely unchanged relative to September 2020.
Other things to note . . .
- The March 2022 RBA Bulletin has lots of interesting-looking content, including pieces on tracking consumption during the pandemic, COVID risk and labour supply, and the significant shift in Australia’s balance of payments as the economy has moved from current account deficits to more than two years’ worth of surpluses.
- Isaac Gross looks at the recent resignation of the RBA’s Depuy Governor in the context of pressures to reconsider what would otherwise have been another internal appointment to Governor and to improve gender diversity, while the AFR’s John Kehoe reviews some of the candidates to replace him.
- The ABS released the results of its first Household Impacts of COVID-19 survey since June 2021. According to the findings, in February this year 47 per cent of Australians reported that a household member had completed a COVID-19 test in the previous four weeks. Of that group, 17 per cent reported that someone in their household had tested positive. The results also showed that reaction to the Omicron wave saw more than twice as many Australians (98 per cent) report wearing a face mask in February 2022 compared to June 2021 (44 per cent). And 26 per cent of respondents said that the job situation of someone in their household had changed in one or more ways due to the pandemic (including working from home, unable to work, increased/reduced hours, different responsibilities and different pattern of hours worked).
- Two years on, CoreLogic sets out six ways that COVID-19 has shaped the Australian housing market: (1) home values rose almost 25 per cent between the end of March 2020 to February 2022; (2) First homebuyer activity spiked during the first year of the pandemic, peaking in January 2021; (3) Rents rose to record highs even as gross yields fell to record lows as rising house prices outpaced rental growth; (4) Housing debt levels set new records of their own; (5) the premium of house prices over units hit record highs; and (6) growth in regional prices outpaced rises in capital cities.
- Related, the BIS on housing market risks in the wake of the pandemic.
- In the FT, Martin Wolf thinks Russia’s war will remake the world. AFR version.
- In the WSJ, Grep Ip reckons that the war in Ukraine will fan the flames of global inflation.
- An FAO information note on the importance of Ukraine and Russia to global food markets (pdf) and the risks associated with the current crisis.
- Russia’s accelerating brain drain.
- A visual guide to the world’s military budgets.
- A new Lowy Institute analysis looks at China’s long-term growth prospects, predicting that the annual pace of real economic growth will slow to about three per cent by 2030 and two per cent by 2040.
- The March 2022 Issue of the IMF’s Finance & Development magazine focuses on rethinking fiscal, with pieces on how to decide when public debt becomes unsafe, uncovering hidden liabilities, new criteria for debt sustainability, and understanding the growth of the social state.
- A VOX essay reviewing the long, strange history of anti-vaccination movements.
- The Economist magazine’s crony-capitalism index. Russia is in first place, with Malaysia, Singapore, the Philippines and Ukraine rounding out the top five.
- A Rhodes Centre Podcast with Fiona Hill on deindustrialisation, despair and demagoguery.