Cliff Notes: Consumers Wonder What’s Next

Consumer Confidence Edges Up, But Pessimism Lingers

This past week in Australia, the Westpac-MI Consumer Sentiment Index registered a modest gain of 3.5%, reaching 83.0. However, this recovery only clawed back about a quarter of the significant drop experienced in April. The current sentiment level remains deeply pessimistic, echoing the lingering effects of the cost-of-living shock that followed the pandemic era. While the government's decision to halve the fuel excise in May provided some welcome breathing room, particularly improving outlooks for family finances over the past 12 months and the next 12 months (up 9.0% and 10.7% respectively), broader economic anxieties persist.

The central bank's decision to implement a third consecutive interest rate hike has amplified concerns, with a staggering 85% of consumers anticipating further increases in mortgage rates within the coming year. This financial pressure, coupled with the geopolitical uncertainty stemming from the Middle East conflict and apprehension over proposed budget tax changes, has driven views on the one-year and five-year economic outlook to their lowest combined point in three and a half years. The full picture of economic momentum may also be weakening, as indicated by the latest labour force survey.

Labor Market Shows Signs of Easing

April's employment figures revealed a surprising contraction, with a decrease of 18.6k jobs, abruptly halting the upward trend observed earlier in the year. Although the participation rate saw a slight dip to 66.7%, the unemployment rate climbed by 0.2 percentage points to 4.5%, reaching its highest level since the COVID-19 Delta outbreak in late 2021. While some of this fluctuation can be attributed to seasonal factors around the Easter period and irregularities in youth employment data, underlying weakness is becoming apparent.

This softening in the labor market emerges precisely as the economic repercussions of the Middle East conflict and earlier interest rate hikes begin to filter through the broader economy. Recognizing the inherent volatility in monthly labor statistics, the Reserve Bank of Australia (RBA) will likely anticipate a rebound in the upcoming month. Nevertheless, the data released this week provides the RBA with sufficient grounds to consider a pause in policy adjustments during June. Despite this, our forecast remains for further cash rate increases in August and September, driven by the pass-through of energy costs and the RBA's commitment to anchoring inflation expectations. We project the cash rate will then hold steady until 2028, at which point a return to near-target inflation should permit a reversal of the current year's rate hikes.

Global Economic Snapshots: US, Europe, and Asia

Across the Atlantic, minutes from the US Federal Open Market Committee's April meeting spotlighted discussions on inflation's trajectory. A significant portion of the dialogue centered on potential upside risks to inflation, including the ripple effects of the Middle East conflict on prices, the impact of US tariffs, and the robust investment in AI infrastructure. Conversely, participants expressed confidence in the labor market, perceiving a balance between demand and supply with minimal downside risks. Solid GDP growth for the year was also anticipated, with staff projections indicating a trend-rate performance.

Regarding monetary policy, committee members suggested that a pivot towards easing could be contemplated if evidence emerges of disinflation resuming its course or if the labor market shows signs of weakening. However, a notable sentiment among a majority was that further policy tightening might be necessary should inflation persist above the 2 percent target. In the Euro Area, April's Consumer Price Index (CPI) inflation met expectations, rising 1.0% month-on-month to reach 3.0% annually, an increase from March's 2.6%. Core inflation remained elevated monthly but stayed close to the 2.0% medium-term target on an annual basis, with broad-based price increases across various categories, notably in transport.

Meanwhile, the United Kingdom saw its annual CPI inflation moderate to 2.8% in April from 3.3% in March, with prices rising 0.7% for the month. This deceleration was largely influenced by discretionary goods sectors such as clothing and furniture. Core CPI inflation also eased to 2.5% year-on-year, down from 3.1% in the prior month. Bank of England Governor Bailey indicated that the monetary policy committee has the flexibility to evaluate the war's impacts, having effectively tightened policy by removing earlier expectations of a rate cut. UK employment figures for the three months to March showed a rise of 148k, and the unemployment rate eased to 5.0%. However, subtle signs of labor market cooling are emerging. The unemployment rate edged up to 5.5% in March, and the number of employees on payrolls declined by 100k in April. Wage growth, excluding bonuses, moderated to 3.4% year-on-year, with underlying wage growth in the private sector being a more subdued 3.0%.

Turning to Asia, China's April data indicated a continued need for economic stimulus. Retail sales growth decelerated sharply to 0.2% year-on-year from 1.7% in March, marking a post-pandemic low, largely due to reduced government subsidies affecting sales of automobiles and home appliances. Fixed asset investment declined by 1.6% year-to-date, primarily driven by the private sector. Property investment, which had shown recent improvement, saw its decline accelerate again in April to -13.7% year-to-date. Industrial production growth also slowed from 5.7% year-on-year to 4.1% in April, suggesting that supply chain disruptions linked to the Middle East conflict may be starting to impact the region. This presents a risk to both economic activity and inflation across Asia, particularly challenging for policymakers given the concurrent surge in tech-related production and investment.

Market Ripple Effects

The geopolitical tensions in the Middle East remain a critical factor, with Iran indicating that the latest US proposal offers partial common ground. However, statements from Supreme Leader Khamenei regarding retaining Tehran's uranium stockpile and ongoing disputes over passage tolls in the Strait of Hormuz suggest a resolution is still distant. President Trump voiced opposition to any toll system for the Strait of Hormuz, emphasizing a desire for free and open passage.