Investment markets and key developments

Australian economic events and implications

Reserve Bank of Australia board minutes for the August meeting contained a very detailed discussion about the two decisions presented to the Board: keep the cash rate steady or increase the cash rate by 0.25% from 4.35% to 4.6%. The main argument for a hike was that there are still too many upside inflation risks at a  time when inflation has been above target over a long period. And perhaps it is better to mitigate these risks by tightening monetary policy pre-emptively. The case to leave rates on hold was because there had already been earlier increases to interest rates and that the economy was already moving towards more optimal levels of inflation and full employment (and home prices had declined more than expected and the unemployment rate was a little higher). But overall the Board seemed willing to raise rates if  “upside [inflation] risks materialise”. The flow of data this week, particularly on inflation, suggests that these upside risks may already be playing out.

The July monthly inflation figures showed a 1% rise, or 3.5% over the year – down from 3.8% last month. The bigger issue was trimmed mean at 3.6% which was the same as last month and above expectations. Importantly, the trimmed mean measure is now running above the RBA’s forecast for the September quarter of 3.5%. This will be problematic for the Board who is so laser-focused on upside inflation risks.

The next RBA Board meeting is in late September, but there is no other inflation data before then. As a result, some economists have shifted to expecting a September rate hike. We had been expecting a November increase and remain of that view for now because it is possible that the relatively new monthly CPI figures have overshot for July. But, a September rate hike which would take the cash rate from 4.35% to 4.6% is clearly risk. I would say there’s a 50% change of a hike in September.

Financial market pricing for the possibility of rate hikes bounces around faster than my kid on a trampoline but its also now assigning at 50% change to a September hike (a big rise from ~10% just a few weeks ago). And it now suggests >100% chance of a hike before the end of the year.

Other data this week was mixed. Construction project work fell by 2.1% in the June quarter with engineering down but building up (good news for residential construction). Capital expenditure also fell after a huge rise last quarter in data centre spending so its more like a normalisation in usual business investment, rather than underlying weakness in business investment. And buildings capital spending rose in the June quarter. Taken together, construction activity looks like it will add to June quarter GDP growth but there will be some weakness in engineering and plant and equipment.

Australian reporting season is 90% complete. Profit growth has finally rebounded after three financial years of falls which is good news. The consensus estimate is for FY26 growth of 11.6% (which is ~0.5% lower than at the beginning of reporting season). The negative is that the improvement is narrowly based. Take out mining and energy and its more like 5.3%. FY27 earnings is around 10% - which is also solid. However, these numbers just pale in comparison to the blockbuster tech earnings from the US. There have been some encouraging results, like in healthcare (companies like CSL and Cochlear) as well as Super Retail Group, Universal Store, Mirvac and REA but these were all basically “less bad than feared” rather than signs of outright strength. Around 36% of earnings have been above expectations (lower than the usual 40%) with more results being “in line” with expectations.

Dividend announcements have been positive with 59% announcing an increase in dividends from a year ago. And it’s good to see that 67% of earnings are up from a year ago. But the message is still that while profits are improving, the rebound is narrow and lacks the scale of what is occurring in countries like the US or Asia that have large tech exposures.

• So far, 67% of results surprised expectations on the upside while only 13% underwhelmed, much better than the historical average of around 40% each. But remember that it’s still early days!

• 67% of companies have increased their dividends this earnings season, the highest since 2021, which is a good sign as it shows that companies have confidence in their cash flows to do so! But it’s lower than the percentage of reported companies which have seen historical earnings rise at 80%.

What to watch over the next week?

Fed Chair Kevin Warsh’s first Jackson Hole testimony is keenly anticipated. Markets are looking for more clues about forward guidance from the Fed given that inflation is still well above 2%.

US economic data includes the August ISM manufacturing and services figures (expected to remain consistent with ongoing strength in activity), July job openings/quits data and the August payrolls to finish the week (should show moderate growth of ~55K, after a fall last month).

In Australia, the key is the June quarter gross domestic production (GDP) figures which show the pace of growth in the economy. We expected growth of 0.4% or 1.9% over the year which is close to the RBA’s forecast.

The monthly Cotality home price data indicates that the pace of price falls accelerated a little in August, with the daily data showing a monthly fall of 1% across the capital cities over the month with the largest decline in Sydney and Melbourne, but with falls also broadening out to Brisbane, Adelaide and Perth. We expect that price declines will continue due to the impacts of higher interest rates, the tax changes and general affordability pressures.

Other data of interest in Australia is July credit growth (softer in housing but stronger in business and other personal), a decline in building approvals in July after a large rise in the prior month) and the July trade balance (expected to be a $2.7bn surplus).

In other parts of the world watch for China PMI figures and the Bank of Canada decision (expected to be a hold).

Outlook for investment markets

Global and Australian share markets are likely to remain volatile with the lack of any long-term resolution to the Iran War and hit to global oil supplies, stretched valuations, sticky inflation, political uncertainty associated with Trump & the midterm elections and worries about the impact of AI and whether there is an AI bubble. However, returns should still be okay for the next 12 months as a whole thanks to continuing economic growth with recession avoided and strong global profit growth and likely rate cuts next year.

Bonds are likely to see returns around running yield or a bit less.

Unlisted commercial property returns are likely to be solid helped by strong demand for industrial property associated with data centres.

Australian home prices are expected to fall around 7% top to bottom, of which they have already done around 2%, out to the June quarter next year as a result of poor affordability, RBA rate hikes, reduced investor demand flowing from the winding back of negative gearing and the capital gains tax discount and poor confidence.

Cash and bank deposits are expected to provide returns around 4-5%.

The $A is likely to rise reflecting the wider interest rate differential to the US, although a move to Fed hikes may limit this. Fair value for the $A is around $US0.72.

ANZ-Indeed job advertisements have been steadily rising since April (blue line below). Job ads rose another 0.8% in July and are now 1.9% higher over the year, pushing back against concerns that a slightly higher unemployment rate signals a rapid weakening in the labour market. High-frequency jobs indicators are now mixed, but the stabilisation in the ANZ-Indeed index lines up with Michelle Bullock’s recent comments that some firms have resumed hiring after the initial concerns around the Middle East war.

Household spending in Australia was remarkably strong – so much for the cost-of-living crisis!? Nominal spending rose 0.8% in June and 6.0% over the year, partly fuelled by households buying EVs, which were, in turn, fuelled by fuel shortage concerns! But even in volume terms, the spending indicator was up by a strong 0.7% through the June quarter (or 2.4%yoy), concentrated in discretionary spending including electronic equipment, recreation and cultural events, hotels and restaurants, and clothing. Clearly the three rate hikes haven’t yet materially dampened aggregate demand, which makes it easier for businesses to pass through any input price hikes in the next quarter.

The Melbourne Institute trimmed mean inflation gauge remained high at 3.4%yoy in July. It’s not too different from the official monthly trimmed mean figure in the second quarter, where inflation came in below forecasts but hasn’t decisively trended down either. In other words, it is too high versus the 2.5% target.

Australian trade balance tipped back into surplus of $1.9bn in June (from -$1bn prior), thanks to large jumps in commodity revenues. Imports dipped slightly by 0.2% over the month, while exports rose 9.6%mom thanks to non-monetary gold (+60%), gas (+23%), and coal (+15%). Nominal trade data has been volatile, but large imports of cars and data processing equipment this quarter points to a flat to slightly negative contribution from net exports volume to GDP.

Australia’s home price downturn deepened in July, with prices now around 2% below their peak while Sydney and Melbourne have seen larger falls around 5–6%. National prices fell 0.7% in this month, and we expect further weakness given the double whammy of rate hikes and investor tax changes. Home sales volumes have unsurprisingly trended lower, similar to levels seen during the 2022-23 downturn. By next year, national prices are expected to fall around 7% before rebounding as monetary policy eases in the second half of 2027 and the structural supply shortage remains.

My Bui,
Economist, AMP