ECB calls emergency Governing Council meeting

Chris Scicluna

Emergency ECB meeting likely to repeat there are “no limits” to prevent fragmentation; but discussions reportedly to focus on PEPP reinvestments rather than a substantive new tool
BTPs have rallied hard (yields currently down 25-35bps across the curve between 2Y and 10Y maturities), while other euro area govvies (except Bunds) have also made substantive gains, on the announcement that the ECB Governing Council is set to hold an ‘emergency’ meeting to discuss market developments from 11am CET. The ECB has clearly been spooked by recent market shifts and wants to try to calm investors before financial conditions tighten to such an extent that monetary policy normalisation becomes impossible to deliver or indeed provokes a new debt crisis in the periphery.

By yesterday’s close, 10Y BTP yields had risen to above 4.15% for the first time since 2013, up more than 80bps since last week’s monetary policy meeting when the Governing Council offered no detail on how it would be prepared to address fragmentation risks as it normalises monetary policy. 2Y BTP yields were also up about 100bps since the ECB meeting to above 2.15%, while OIS markets were also pricing 175bps or more of rate hikes by year-end. Currently, 2Y yields are back down to about 1.92% with 10Y yields down to 4.00%.

To give a flavour as to what to expect from the Governing Council today, yesterday evening the Executive Board’s key hawk Isabel Schnabel echoed recent comments by Christine Lagarde that the ECB has “no limits” to tackle bond market fragmentation risks. She also insisted that the ECB “will not tolerate changes in financing conditions that go beyond fundamental factors”, and “monetary policy can and should respond to a disorderly repricing of risk premia that impairs the transmission of monetary policy”. But she added “How we ultimately react… will firmly depend on the situation we are facing”, suggesting no willingness to give any information about its reaction function in advance.

So, expect a similar message to Schnabel’s to be endorsed by the whole Governing Council today. That might provide a modicum of reassurance to markets. But no new policy tool will be unveiled. Indeed, the Governing Council will reportedly focus discussions on the mechanics of how PEPP reinvestments – a relatively modest instrument – can be deployed to support strained markets, while leaving the door open to the possibility that new tools can be developed flexibly in future if necessary. So, the markets will be left in the dark as to whether, for example, any substantive conditionality would be attached to any new ECB support – additional to reinvestments – for strained sovereigns. And markets should also assume that any support forthcoming would be concentrated largely at the shorter end of the yield curve, which is most relevant for the monetary transmssion mechanism, rather than at the longer end. (Christine Lagarde is also currently scheduled to talk publicly this evening, but it remains to be seen whether that appointment will be fulfilled.)

The ECB will certainly not adjust its commitment to raise rates by 25bps in July and probably more in September. However, it could try to push back somewhat against expectations that aggressive tightening is likely in Q4 and beyond, which a lower trajectory for rates seeming appropriate if the ECB now sees a greater risk that Fed tightening will push the US (and perhaps the world economy) into recession next year.

Fed to hike 75bps today, Powell likely to signal possibility of another 75bps in July and more to come too
All eyes on the Fed this evening, with a 75bps hike in the Fed Funds Rate now widely expected and fully priced after Monday’s WSJ article stated it was being considered. A signal from Jay Powell that another hike of that magnitude could possibly come in July is also likely to be forthcoming today, as are suggestions that further tightening – albeit not quite so aggressive – will likely come thereafter. The Fed’s updated macroeconomic projections, also due today, will be somewhat less informative than usual if they were finalised before last week’s shocking CPI data.

PBoC eschews rate cut, yuan appreciates
Contrary to some speculation of a possible Chinese rate hike, the PBoC today kept its key 1Y medium-term lending facility rate unchanged at 2.85%, its level since the 10bps hike in January. Expectations of a big Fed hike this evening and wariness of the impact on the yuan, as well as the global inflation environment more generally, are likely to have been considerations. Our economics team in Daiwa Hong Kong expects just a couple of cuts in the RRR in the second half of the year and no rate cuts. The yuan firmed on the rate news.

Chinese IP returns to positive growth but retail sales remain in the doldrums
China’s economic activity figures for May were a mixed bag, although at the margin they were not quite as awful as had been feared, reflecting the easing of some pandemic restrictions last month. Industrial production was certainly firmer than expected, up 0.7%Y/Y following the fall of 2.9%Y/Y the prior month, contrary to the consensus expectation of a drop of almost 1%Y/Y. Retail sales were still very weak, although the decline of 6.7%Y/Y was similarly less marked than in April (-11.1%Y/Y) and was a little less abrupt than anticipated. Urban fixed asset investment slowed just 0.6ppt to 6.2%YTD/Y, but property investment slowed more than 1ppt to 4.0%YTD/Y. Surprisingly perhaps. Finally, the jobless rate dropped 0.2ppt to 5.9%, but was still 0.8ppt above the level at the end of last year.

Japan’s services data signal firm GDP growth in Q2 with machine orders up sharply too
In Japan, the latest data for tertiary activity – which accounts for roughly ¾ of all GDP – came in close to expectations. Growth of 0.7%M/M in April following the rise of 1.7%M/M in March took the level of output in the services sector 1.2% above the Q1 average, a clear sign of the likelihood of decent growth in GDP this quarter. Among others, activity was firmer in ICT services, transport, and finance and insurance. Meanwhile, Japanese machine orders – a useful guide to capital spending three to six months ahead – comfortably beat expectations, with the value of core private sector orders (which exclude volatile items) leaping 10.8%M/M, contrary to expectations of a modest decline, to be almost 12% above the Q1 average. Growth was broad-based, with orders from manufacturers up 10.3%M/M and those from the non-manufacturing sector up 8.9%M/M. Orders from overseas rose more than 50%M/M. Demand was particularly strong from producers of oil and coal – which more than doubled in April to suggest the strong likelihood of payback in May – while orders from auto producers (21.6%M/M), ICT manufacturers (49.2%M/M) and electrical machinery producers (13.4%M/M) were also firm. Despite the likelihood of a drop in May, machine orders now look set for growth over Q2 as a whole, pointing to firmer business capex in Q3.

Euro area IP likely grew moderately at start of Q2, trade deficit likely narrowed from record high in March
The euro area data focus is on the manufacturing sector, with industrial production and goods trade numbers for April due. Country data published over the past couple of days now point to a return to growth at the start of Q2 following a decline of 1.8%M/M in March. In particular, an extreme drop in Ireland (-9.6%M/M) and some modest weakness in France (-0.1%M/M) will be more than offset by positive data elsewhere, including in Germany (1.3%M/M, excluding construction), Spain (2.1%M/M), and Netherlands (where manufacturing output rose 5.3%M/M). Meanwhile, euro area goods trade data are expected to reveal a narrowing in the trade deficit in April (to €14.5bn), albeit remaining large by historical standards and relatively close to the record deficit of €17.6bn recorded in March. Separately, France’s final consumer price inflation figures for May confirmed the flash release, whereby the headline HICP measure rose 0.4ppts to 5.8%Y/Y while the national CPI measure rose 0.4ppt to 5.2%Y/Y. While higher petrol prices played a role in driving inflation to a multi-decades high, the core CPI measure rose 0.5ppt to 3.7%/Y, with services inflation up 0.2ppt to 3.2%Y/Y.

US retail sales likely softer in May as inflation erodes purchasing power
The US dataflow will include retail sales, import prices and business inventories. Most notably, the retail sales figures for May are expected to be softer than in April, restrained not least by a drop in new vehicle sales. However, while they are likely to erode the volume of sales of many items, sharply higher prices will boost the value of sales at gasoline services stations. Our colleagues at Daiwa America expect total retail sales to be unchanged on the month but sales ex autos to be up 1.0%M/M.

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