Australia - RBA Governor gives green light to economic rebound, but dismisses rate hikes next year

Australia - RBA Governor gives green light to economic rebound, but dismisses rate hikes next year

• AUD: RBA Governor Lowe in a speech earlier this week says the Delta outbreak has delayed but not stopped the recovery in the Australian economy. This comment though is already in the August SMP and not new information. The Governor believes Australian output will decline by at least 2% in Q3 as a result of lockdowns with the risk that the decline could be larger. But with rising vaccination rates, economic activity should recover thereafter, with pre-COVID output returning by H2’2022 and rising house prices and equity values likely helping to support household spending when restrictions are eased. However, downside risks remain from the possibility of new Delta outbreaks, new Covid variants or decline in potency of vaccines.      

• AUD: The Governor pours cold water on suggestions the RBA should lean against high house prices through increasing interest rates and curbs on lending. That said, the RBA believes monetary policy remains extremely accommodative despite beginning its tapering in September. Indeed, the Governor confirms this view by stating that - “the RBA's purchase program started later than that of most other central banks but recently has been expanding faster relative to the stock of bonds outstanding. This represents a substantial and ongoing degree of support to the economic recovery”. But the Governor pushes back against market pricing for earlier rate hikes that what’s implied by the Bank’s forward guidance. Australian short rates currently prices a cash rate of 60bps by the end of 2023 and around 100bps by the end of 2024. This is significantly at odds with the Bank’s view that conditions—wages at around 3% and underlying inflation at the mid-point of its 2%-3% target— are unlikely to be met to lift the cash rate until early 2024. Indeed, the Governor notes that “I find it difficult to understand why rate rises are being priced in next year or early 2023”…and believes supply-side inflation is transitory. Governor Lowe expects price pressures to dissipate but would become more concerned if the price increases experienced from the supply shortages leads to fundamentally higher wages growth. He does not view this as likely.    

• AUD: Citi analysts’ base case remains unchanged for the RBA Board to finish its asset purchase (LSAP) program by Q4 next year. On inflation however, Citi analysts remain more hawkish, noting that the RBA continues to focus on demand-pull inflation while recent supply side issues have led to higher producer costs which could feed into higher wages. Citi analysts believe that supply side issues could persist into 2022, so upside risks to inflation should also persist even though the RBA believes that it’s unlikely. Therefore, the team maintains that the first RBA rate hike could occur in H2 2023, earlier than what Governor Lowe foreshadows but still later than what  current rates pricing implies. 

Chinese growth to slow further, but broad-based stimulus unlikely for now

• CNH: China’s FAI growth slows from 10.3%YoY Ytd in July to 8.9%YoY Ytd in August, slightly below market expectations (Citi/Mkt: 9.1%/8.9%YoY Ytd) and FAI’s 2yr average growth at 4.2% in Jan-Aug is flat from the previous print as an industrial capex upcycle still seems to be playing out. Meanwhile, real estate investment (REI) cools further with REI up 10.9%YoY Ytd and 2yr-average up 7.7% in Jan-Aug, but visibly lower than 8% in Jan-Jul. Retail sales also disappoint materially due to the Delta outbreak, tumbling from 8.5%YoY in July to 2.5%YoY in August and lower than Citi’s below-consensus (7%YoY) forecast at 4%YoY with the 2yr average growth dropping from 3.6% to 1.5%. Headline industrial production also falls sizably from 6.4%YoY in July to 5.3%YoY in August, lower than expected (Citi/Mkt: 5.8%YoY). The corresponding 2yr average at 5.5% is a moderation from 5.6% in July, attributable to disruptions from the pandemic and flooding in some parts of China.   

• CNH: Citi analysts trim their annual growth forecast for China by half percent and now expect China’s GDP growth to slow to 4.9%YoY (vs 6% anticipated previously) in Q3 and 4.5%YoY (vs 5.1%YoY) in Q4, cutting full-year projections from 8.7%YoY to 8.2%YoY. However, this downward pressure may not trigger another round of broad-based stimulus any time soon as the full-year growth target (6%) should be met and the labor market is not seen under major pressure for now. The team however sees another 50bp RRR cut by year-end.   

Other data releases overnight         

• USD: US industrial production still rising despite hurricane and supply issues - US industrial production rises 0.4%MoM in August, matching Citi analyst expectations and in line with consensus at 0.5%. The largest subset of manufacturing production rises a more moderate 0.2% but is revised higher to 1.6% in July from 1.4%. Demand for industrial goods remains strong and would imply even higher production levels if supply was not an issue. This strong demand should further support strong production into next year as supply issues are eventually resolved.           

• GBP: UK CPI - a notable overshoot, supply chain disruption coming to the fore – UK CPI Inflation up at 3.2% Y/Y and targeted by the Bank of England, overshoots Citi,  consensus and BoE expectations (Citi and Consensus 2.9%, BoE 3.0%). This marks a sharp acceleration compared to July, when headline CPI moderated to 2.0%YY. However, broader measures of domestic inflationary pressure remain subdued. Transitory, but a 12 rather a 6-month story – the inflationary pick-up is caused by external disruption, rotations in demand and low inventories across the consumer goods complex. These effects are likely to accelerate into 2022. With domestically driven inflation still somewhat subdued, the bigger issue from the policy side may be inflation expectations as UK inflation is likely to accelerate sharply in H2’2021 with CPI likely peaking at 4.3%YY in December and remaining more resilient through Q2 and Q3 2022 than Citi analysts had previously thought.    

• CAD: Stronger Canada CPI to keep BoC cautious, even if transitory - Canada’s headline CPI surprises on the upside again in August, rising to 4.1%YoY, more than twice the BoC’s target rate of 2%. Core inflation measures also continue to rise across the board, with the CPI-common measure rising to 1.8%, CPI-median rising to 2.6% from a downwardly revised 2.5%, and CPI-trim rising to 3.3%. While the BoC will likely continue to dismiss the rise in prices as largely due to “transitory” factors, Citi analysts expect them to become increasingly concerned with the persistence of elevated inflation. Core measures now average 2.6% compared to 2.4% in July and various indications of businesses’ price plans and difficulty meeting demand suggest further increases in prices are still to come. This makes it very likely that the BoC will end QE purchases either by the end of this year or very-early 2022 while erring on the more hawkish side over the medium term.   

This is an extract from the Daily Currency Update, dated September 16, 2021. Please approach a Citigold Relationship Manager if you would like more information. For the latest updated CitiFX house views and strategy (updated every Monday) please click here - 

 https://asia.citi.com/wealthinsights/citifx-house-views-and-strategy