As it turned out, last week proved to be chocked full of important economic data and events.
The week began with the release of the Japanese GDP data for the December quarter preliminary estimates. These showed GDP growth at 0.1% in the December quarter and the GDP price index easing slightly to 3.4% from 3.5% in the September quarter.
We are closely monitoring Japanese economic data and the policy response following the snap government election, given the implications for the Yen carry trade. Australian 5- and 10-year bond yields are currently trading at a 70–75 basis point premium to the US benchmark curve — a historically generous spread. Even if the US 10-year yield holds trend support, this Australian premium could still compress, potentially reverting toward the 15 basis points seen last year. However, understanding the persistence of this spread requires examining the impact of the AUD/JPY carry trade on Australian bond yields. On that front, the outlook is less constructive. AUD/JPY is trading near record highs, which is likely to sustain selling pressure from Japanese investors on the Australian benchmark curve.
The UK employment and average earnings data, together with the inflation data showed that the BOE is in a difficult position when making monetary policy decisions.
- Core inflation 3.1% is way too high to justify a rate cut and should, in fact, be requiring a rate increase.
- Retail Price Index is at 3.8% and a real danger.
- Unemployment at 5.2% is well above full employment, even in the UK where the welfare state punishes those that choose to work.
- Average earnings at 4.2% are producing a real wage increase but are too high without a labour productivity gain of at least 1.1%. It will feed it into higher inflation over the next year.
The risk of stagflation in the UK is now very high.
On Wednesday, Australia’s December quarter Wage Price Index received significant media attention, with much of the commentary suggesting that wage growth remains insufficient relative to inflation. The data showed wages rising 0.8% for the quarter and 3.4% year-on-year, broadly in line with market expectations. Importantly, wage gains were broadly based across sectors. However, public sector wage growth has now accelerated to 4%, surpassing the private sector’s 3.4%. This marks a shift from the post-pandemic period, when private sector wages were leading the acceleration. As Australia emerged from lockdowns, private sector wage growth coincided with a sharp lift in labour productivity. That productivity surge was largely driven by small and medium-sized enterprises reinvesting pandemic-related fiscal support and accumulated savings into expanding production capacity.
In Australia, public sector wage growth is now catching up to that of the private sector — a development we have previously flagged as likely. When inflation surged above 4% in the wake of global supply chain disruptions, public sector wages were rising by only 2–2.5% per annum. It was therefore unsurprising that many households felt increasing budget pressure during that period. Private sector wage growth only just kept pace with CPI inflation (to the extent that a representative household basket reflects lived experience), while public sector wages lagged materially behind. That gap is now closing. Looking ahead, there is a genuine risk that wage growth could re-accelerate in 2026 if the unemployment rate remains below 4.75% — broadly consistent with full employment. Ongoing constraints in skilled labour supply, combined with the uptick in inflation observed in the December quarter, could add further upward pressure on wages.
The FOMC minutes received an unusual amount of attention. The overall tone of the minutes is one of a divided, cautious committee — willing to hold rates steady for now, watching inflation carefully, and not ruling out hikes if price pressures prove stubborn.
Inflation Outlook — Cautious
Participants generally expected inflation to come down through the year, though the pace and timing remained uncertain. Most participants cautioned that progress toward the 2% objective might be slower and more uneven than generally expected and judged that the risk of inflation running persistently above target was meaningful. They noted the impact of tariffs on prices but expected that impact to wane as the year progresses.
Divided Views on the Path Ahead
Several participants indicated they would have preferred a two-sided description of the Committee’s future interest rate decisions, reflecting the possibility that upward adjustments could also be on the table. The minutes conveyed a committee that is genuinely uncertain about whether the next move will be a cut or a hike.
Economic Conditions — Resilient
Consumer spending had been resilient, importantly supported by gains in household wealth, though several participants noted a disparity between strong sales to higher-income consumers and soft sales to lower-income consumers. Business fixed investment remained robust, particularly in the technology sector.
Market Expectations
Market-based measures of policy rate expectations indicated one to two 25 basis point cuts this year, with the median modal path in the Desk survey also pointing to two cuts.
AI and Financial Stability
The minutes highlighted divided views on AI’s economic impact — some members projected productivity gains that could ease inflationary pressures, while others warned that substantial investment in the sector could heighten financial risks through surging asset valuations and opaque market activity.
Markets and the Dollar
Longer-term Treasury yields rose slightly, steepening the curve. The largest technology companies continued to underperform the broader market. The dollar depreciated markedly in the days leading up to the meeting following reports that the New York Fed’s Desk had made rate checks on the dollar–yen exchange rate — the manager clarified these were conducted solely on behalf of the U.S. Treasury in its fiscal agent capacity.
Friday then proved to be eventful. Firstly, the Japanese inflation data showed a fall from 2.1- to 1.5% (MOM decline to 0.2%). It must be noted that the fall of inflation was due to falling food and energy prices. Secondly, we then had the December quarterly and January monthly US PCE data. This was not good news. The monthly number arrived at core PCE +0.4% up from 0.2% in December. This increase may be due to the cold weather event that hit the east coast in January. The FOMC uses the core PCE quarterly figure as its preferred measure of inflation as the monthly data can be volatile. There the news was better with a 2.7% p.a. increase in the December quarter down from 2.9% in the September quarter.
Thirdly there was the US GDP data. In the December quarter the economy expanded at a modest 1.4% per annum due to the government shutdown and the GDP price index arrived higher than expected at 3.7% but in line with the September quarter.
Lastly, the US Supreme Court ruled unlawful the Trump administration’s country-level tariffs imposed under the International Emergency Economic Powers Act. Broad, country-based tariffs have always been economically questionable in design, although sector-specific tariffs remain in place. From an economic perspective, sector-based tariffs can be more defensible — provided the factors of production within the domestic economy are sufficiently flexible to shift quickly into import-substitution industries. Without that mobility, the efficiency costs can still outweigh the intended benefits. In the Australian context, the 10% tariff applied to our beef exports was a targeted sector measure, reflecting the Trump administration’s view that the US beef market was in surplus (wrong) while the broader US trade balance remained in deficit. Given the relatively narrow scope of the measure, it was unlikely to have a material macroeconomic impact.
