The Australian dollar continued to strengthen for much of the week,looking past relatively solid US data as even stronger domestic data took precedence. Inflation came in hotter than the market and our ownf orecast had anticipated, while household spending data pointed to resilient consumer demand, together lifting the case for the RBA to consider tightening further. However, the Aussie gave back the bulk of these gains late on, as Fed Chair Kevin Warsh struck a hawkish tone at the Jackson Hole Symposium, driving broad based US dollar strength that overwhelmed the earlier domestic-driven rally.
July CPI was the highlight of the week, with headline inflation rising 1.0%MoM (0.6% in SA terms). The annual rate eased to 3.5% from 3.8% inJune, but this was above both the 3.3% Bloomberg consensus and our own 3.2% forecast. Trimmed mean inflation rose 0.5% MoM (SA), with the annual rate holding at 3.6%. The data complicates the RBA's thinking, with the data coming a day after the RBA board's minutes flagged that risks tothe inflation outlook remain skewed to the upside, even as the bank held the cash rate steady at 4.35% earlier this month.
For the RBA, measures of underlying inflation firmed a bit stronger than what they would of life. Trimmed mean inflation, while holding stable at3.6%, is now annual ising at 4.7% on a 3-month basis. Adding to this,services inflation rose 0.6% MoM (SA) and is annual rising at 4.6%, its highest level since October 2025. Core services rose 0.9% MoM, following a 1% rise in June, pointing to growing stickiness in price pressures, which would be a growing concern for the RBA.
Household spending added to the case, rising 1.1% MoM and 7% YoY, the third consecutive monthly increase. Discretionary spending rose 1% MoM and 7.8% YoY, its fastest annual pace since mid-2023, with recreation and culture spending up 1.5% MoM on higher gambling activity, major sporting events, and entertainment. The data suggests the RBA may be able to put aside concerns around wealth effects and their flow-through to spending.
Combined with the inflation surprise, the case for a further rate rise has firmed, and markets are now fully pricing a hike by end 2026. That said,we continue to see pockets of weakness elsewhere in the economy,which supports our view that rates stay on hold for now, though there are growing risks to this view given the recent stronger data.
Looking ahead, Q2 GDP will be released on Wednesday. We expect growth to rise 0.4% through the quarter, which will see the annual rate ease to 2% YoY. While the data is largely backwards looking, it does provide a good gauge of how well the Australian economy has responded to the beginning of the RBA's rate hike cycle coinciding with the impacts from the Middle East conflict. That said, higher frequency measures of activity, in particular household spending, has suggested the Australian economy has fared relatively well.
Globally, the focus was on US PCE data, which came in a touch stronger than expected. Nominal spending rose 0.2% MoM in July, though this was flat once adjusted for inflation. More importantly for the Fed was the inflation measures, with the headline PCE deflator rising 0.2% MoM(above the 0.1% expected) and up 3.7% YoY, while core also rose 0.2%MoM and 3.3% YoY, in line with expectations. Overall, the data continued to show little sign of inflation creep from oil or elevated semi conductor prices, though annual inflation does remain elevated. Indeed, with inflation still sitting well above the Fed's target and the Middle East conflict posing a continued upside risk, we think the markets case for a tightening bias remains intact. However, we don't share this view, as we believe there are pockets of softness in the US economy (particularly in the labour market), and as a result, don't believe the Fed will move ratesthis year.
Attention then turned to Fed Chair Kevin Warsh's speech at Jackson Hole,where he struck a notably hawkish tone, warning that inflation was not slowing meaningfully and that policymakers still had work to do if that failed to change soon. Warsh pointed to the Fed's preferred inflation gauge running at 3.7% annually and annual lising at 4.1% over six months in uly, well above target, while suggesting current policy settings weren't clearly restrictive enough to weigh on growth. He also described the labour market as broadly sound, framing price stability as the Fed's dominant concern.
The remarks were widely read as a deliberate clarification after his noncommittal July press conference, prompting markets to quickly reprice the odds of a September hike to 50/50, alongside a jump in short term yields and broad based US dollar strength. Given the clear emphasis on inflation risk over growth concerns, we read this as a genuine hawkish shift in the Fed's reaction function for now. That said, we maintain our view that the Fed will likely look through this given pockets of underlying softness in the US economy, and don't expect a move this year.
Turning to the Middle East, Brent crude stabilised somewhat this week,settling near $88/bbl after touching around $95/bbl earlier on. Prices did edge back up late in the week as hopes for a reopening of the Strait ofHormuz faded. Iran and Oman had reached a revenue-sharing agreement on the waterway earlier in the week, before President Trump reportedly stated he had no interest in reverting to the terms of the prior memorandum of understanding. The White House further confirmed itisn't negotiating with Iran and that the naval blockade on Iranian ports remains in place.
The stalled progress on Hormuz has also spilled into gas markets. The stalled progress on Hormuz has also spilled into gas markets, with European benchmark futures reversing recent declines as concerns mount over restocking depleted storage amid growing competition from Asian buyers. LNG cargoes have become increasingly sought after in the region, pushing prices sharply higher versus the start of the year.
