A busy week ahead for monetary policy

Emily Nicol

Monetary Policy

Fed set to resume tightening cycle this week
The conclusion of this week’s Fed’s FOMC policy meeting on Wednesday is widely expected to see the tightening cycle resume, with a further 25bps hike in the target range for the Fed Funds Rate to 5.25-5.50%. But, with the outlook for policy less clear, of greater significance at this week’s meeting will be Chair Powell’s post meeting press conference for further insight. Admittedly, a more favourable inflation outturn in June will have provided support to the more dovish Committee members. But recent labour market data have surprised to the upside and suggest ongoing resilience, with wage growth still above rates considered to be consistent with achieving the inflation target over the medium term. Economic growth appears to have held up remarkably well (see below). Meanwhile, the closely watched National Financial Conditions Index compiled by the Federal Reserve Bank of Chicago suggests that conditions are touch looser than the long-run average despite the aggressive monetary policy tightening over the past eighteen months. As such, Daiwa America’s Chief Economist Lawrence Werther still expects the Fed to signal the likelihood of additional tightening ahead, in line with the dot plot charts published last month.

ECB expected to raise rates by a further 25bps and likely signal more tightening to come
The ECB’s Governing Council decision on Thursday also appears clear cut. Indeed, at the June meeting, President Lagarde was unambiguous in her press conference that a “material change” to the ECB’s baseline outlook would be required to prevent it hiking again in July. As such, we expect interest rates to be increased by a further 25bps this week, taking the deposit rate to 3.75% and the cumulative tightening so far this cycle to 425bps. Of more interest, therefore, will be signals for forthcoming policy decisions. While surveys have pointed to a marked softening in economic activity towards the end of Q2 and bank lending figures continue to illustrate the negative impact of higher borrowing costs on the supply and demand for credit, what matters most for the ECB is the inflation outlook. While the latest inflation figures aligned with the ECB’s projections published last month, the uptick in the core rate (up 0.2ppt to 5.5%Y/Y), although related to base effects associated with last year’s discounted travel pass in Germany, will likely remain a concern for the majority on the Governing Council. Moreover, the Governing Council will be wary of a potential loss of credibility should it face significant upside surprises to inflation over the near term. So, like in her speech at the ECB forum in Sintra, President Lagarde is likely to maintain a hawkish tone in her post-meeting press conference and leave the door open for a further rate hike in September.

BoJ to maintain policykey policy parameters of its Yield Curve Control framework
The outcome of the BoJ’s Policy Board meeting on Friday is arguably the least certain of the monetary policy meetings this week. At the BoJ’s previous meeting in June, Governor Ueda acknowledged in his press conference that like other major central banks the BoJ might ultimately misjudge the strength of underlying inflation. But he also maintained the view that inflation was expected to decelerate towards the middle of FY23 as cost-push pressures moderated. And Ueda subsequently cautioned at the ECB’s forum in Sintra at the end of last month that a policy shift would require confidence that inflation would accelerate to 2% in 2024, something that the BoJ was less sure about. Our BoJ watcher in Daiwa Tokyo Mari Iwashita thinks that the Policy Board’s updated economic forecasts will see core inflation nudged slightly lower in FY24 to be just shy of the 2% target, with the forecast for FY25 to be left unchanged at 1.6%, giving the BoJ justification to keep policy on hold. As such, Iwashita expects the BoJ to maintain its key policy parameters this week, including the negative policy rate (-0.1%) and +/-0.50% Yield Curve Control target range for the 10Y JGB. This notwithstanding, we do not rule out a slight tweak to the 10Y yield target should we see a notable upwards revision to the BoJ economic assessment and outlook.

Economic data

The main economic focus today will be on the release of the flash July PMIs. The Japanese survey published overnight saw the composite PMI move sideways at the start of Q3, at 52.1, suggesting ongoing modest expansion. The recovery continues to be driven by the services sector, with the activity index at a still-elevated 53.9 despite easing to a six-month low. But conditions in the manufacturing sector remain challenging, with the output index (48.4) marking the twelfth sub-50 reading out of the past thirteen months. And new orders slowed sharply in both sectors in July, with the respective composite PMI (50.9) the weakest since February. In terms of the surveys price indices, the composite input price PMI ticked slightly higher as services firms reported higher labour, fuel and raw material costs. But firms continue to pass on some of these extra operating costs to consumers – indeed, the composite output price PMI rose 1.4pts in July to 54.6, admittedly almost 2pts below April’s peak but nevertheless still almost 6pts above the pre-pandemic average.

Inflationary developments will be closely watched in the euro area and UK surveys too for further evidence of sticky services prices. In terms of activity, the euro area composite output PMI is expected to fall further below the key-50 level in July. Indeed, the flash German composite output PMI, just released, fell more than 2pts to an eight-month low of 48.3, while the French composite index declined 0.6pts to 46.6, a 32-month low. Meanwhile, the equivalent UK index is expected to have declined to a four-month low, albeit remaining in expansionary territory.

The outcome of Spain’s general election of the weekend points to an extended period of political uncertainty. As predicted, the centre-right Popular Party won the most votes (136 seats, 33%) but with the far-right Vox losing seats this time around (33 seats, 12%), together they fell short of the 176 seats needed for a majority. The Socialists performed better than had been polled (122 seats, 31%). But while current Prime Minister Sánchez together with Sumar (31 seats, 12%) might be able to form a minority coalition with the support of other smaller parties, the most likely outcome will be another snap election.

A key release ahead of the Governing Council meeting will be the ECB’s bank lending survey, which is likely to highlight some of the effects of the central bank’s aggressive policy tightening since last summer, with a further tightening of credit standards and decline in demand for loans. Sentiment surveys will continue to dominate the data flow too, with the German ifo business survey to provide more insight into conditions, including the construction and retail sectors, in July. The CBI’s industrial trends survey will also offer an update on manufacturing sector conditions in the UK. And the Conference Board consumer confidence survey is likely to report a notable improvement in July, supported by resilience in the labour market and easing in inflation.

Euro area bank lending figures for June will further illustrate the impact of higher borrowing costs on lending and deposits, with M1 money supply growth expected to have remained firmly in negative territory. Meanwhile, US new home sales figures might well report some payback in June following a surge of 22% over the previous three months, with Lawrence Werther forecast a drop of 1.7%M/M.

The key data focus on Thursday will be the first estimate of US Q2 GDP. While household consumption growth is anticipated to have slowed sharply, a stronger performance in the business sector, including construction activity and capex, and public sector spending should support another solid GDP growth reading last quarter. Indeed, Lawrence Werther forecasts annualised growth of 1.8%Q/Q, bang in line with the consensus, but a touch softer than the Atlanta Fed NowCast projection, and only slightly softer than growth in Q1 (2.0%Q/Q ann.). German consumer confidence, Italian ISTAT business and consumer confidence and UK distributive trades surveys for July are also due.

Tokyo CPI figures for July are due on Friday. The headline rate is expected to have edged slightly lower, by 0.3ppt to an eleven-month low of 2.9%Y/Y due principally to softer energy inflation. Indeed, when excluding fresh foods and energy, core inflation is forecast to have dropped just 0.1ppt to a still-elevated 3.7%Y/Y. Flash July inflation estimates from Germany, France and Spain are also due for release. The German and French headline HICP rates are expected to have eased slightly this month, by 0.2ppt to 6.6%Y/Y and 0.3ppt to 5.0%Y/Y respectively. The equivalent Spanish figure, meanwhile, is expected to have edged higher, albeit still likely remaining below 2%Y/Y. Q2 GDP estimates are also due from France and Spain. Growth is expected to have moderated from Q1 in both countries, with our expectation for French GDP to have risen a modest 0.1%Q/Q from 0.2%Q/Q previously, while Spanish GDP is expected to rise 0.3%Q/Q from 0.6%Q/Q previously. Finally, attention will also be on the US Employment Cost Index – arguably the best guide to wage growth – which is expected to report that growth in Q2 remained close to the brisk pace recorded through H222 of 1.2%Y/Y. The monthly personal income and consumption numbers for June are also expected to confirm relatively firm wage growth, with spending also expected to have risen around ½%M/M supported by solid auto sales and services consumption.

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