ECB highly likely to keep interest rates unchanged

Chris Scicluna
Emily Nicol

ECB highly likely to keep interest rates, and other policy instruments, unchanged
The main event in the euro area this week will be the outcome of the latest ECB monetary policy meeting on Thursday. However, we, like the consensus, fully expect rates to be left unchanged. The statement issued following the September Governing Council meeting gave a strong indication that the terminal rate for the tightening cycle has probably now been reached. The account of the meeting subsequently revealed that the decision for some about whether to hike or pause had been a close-run thing. And while the account also stated that a “solid majority” backed the decision, we suspect that many Governing Council members did so without enthusiasm and only in order to avoid the impression of division.

Events since the last meeting have largely been unconducive to a further rate hike too. Data and surveys have reinforced the likelihood that euro area GDP contracted in Q3 and that economic activity will be at best subdued in Q4. Moreover, inflation fell in September by the most in six months to the lowest level in almost two years, with a broad-based easing of pressures pointing to the likelihood of further significant declines to come. Recent increases in bond yields will have strengthened further the transmission of the ECB’s recent policy tightening. And events in Israel and Gaza have increased geopolitical tensions and uncertainties. So, if any members of the Governing Council are tempted to argue for a further hike, we suspect they will wait to make the case at the following meeting in December, when data for GDP in Q3, as well as two further months of figures for inflation and economic surveys and additional information on the potency of the transmission mechanism will be available, and the economic consequences of events in the Middle East, including on oil prices, are likely to be clearer too.

We suspect that the ECB Governing Council will also have discussions this week on its other policy instruments, including the future of its asset purchase programme and reserve remuneration. With respect to quantitative tightening, we doubt that the current elevated level of uncertainty and recent upwards shift in yields will encourage a majority to support yet an end to reinvestments of maturing PEPP securities before the end of 2024 as is currently envisaged. We also suspect that the Governing Council will not be ready this month to announce details on its plans for active greening of its corporate bond (CSPP) portfolio now that it has ceased reinvestments. And while the Governing Council agreed in July to reduce from September the remuneration of minimum reserves held by credit institutions at the ECB to 0%, an announcement of other possible related adjustments, such as an increase in the size of minimum required reserves – e.g. from 1% to 2% of deposits and certain other sources of funding – or a system of reverse tiering to reduce interest payments from the ECB to banks would seem more likely to come in December.

Flash euro area PMIs, ECB’s Bank Lending Survey and monetary figures in focus too
The Governing Council will also have plenty of data to digest this week, including the October flash PMIs (tomorrow), ECB quarterly Bank Lending Survey (also tomorrow) and monthly monetary figures for September (Wednesday). With demand lacklustre and uncertainties regarding the economic outlook arguably having increased due to geopolitical events, we might expect the headline composite PMI index to do no better than move sideways at the start of Q4. Meanwhile, with the input cost PMI having ticked up in the previous two months due to the higher oil price, the survey’s inflation measures will also be watched closely. The preliminary Commission euro area consumer confidence indicator is also due later today – while the equivalent bellwether Belgian figure moved sideways, we expect a third successive deterioration to a 7-month low, still however well above last year’s range following the Russian invasion of Ukraine. Given the deterioration in the economic outlook over the summer, higher borrowing costs and falling house prices, the Bank Lending Survey is likely to highlight a further tightening in credit standards, while monetary figures will also illustrate ongoing weakness in demand for both secured and unsecured lending. Finally, Friday will also bring the first estimate of Q3 GDP from Spain, which is expected to show that growth slowed from Q2, by around 0.3ppt to 0.2%Q/Q.

US Q3 GDP estimate expected to report solid expansion boosted by strong consumer spending
In the US, the key economic release will be the first estimate of Q3 GDP on Thursday. Close to the Bloomberg survey consensus, Daiwa America’s Lawrence Werther expects another solid quarter of expansion over the summer, forecasting GDP growth of 4.5%Q/Q annualised, which would be the strongest increase since Q421. Growth is expected to be broad-based across expenditure components, albeit led by a solid contribution from consumer spending. The subsequent release of the monthly personal spending and income figures for September (due Friday), will offer further insight into spending patterns towards the end of the third quarter. Lawrence forecasts real consumption growth of 3.5% annualised in Q3, which will boost GDP growth by around 2.4ppts. Meanwhile, net exports are also expected to provide a non-negligible contribution, while updated monthly trade figures (also due Thursday) will offer more insight into external demand in September. Flash October PMIs (tomorrow), September durable goods orders data (Thursday), new home sales (Wednesday) and pending home sales figures (Thursday) are also scheduled. And the September personal consumption deflators (Friday) should be a touch softer than the equivalent figures for CPI but – with the headline and core measures up about 0.3%M/M and 0.2%M/M respectively – still a touch firmer than rates that would be consistent with the Fed’s inflation target if sustained over coming months.

Flash UK PMIs likely to remain consistent with contraction, while employment figures are likely to signal further cuts in headcount
A key economic focus in the UK this week will be the release of the flash October PMIs (tomorrow). Having fallen below the key-50 ‘no change’ level in August, and slipped to an eight-month low of 48.5 in September, the headline composite PMI is expected to move broadly sideways in October, consistent with ongoing modest contraction at the start of Q4. The survey’s price measures will be watched for evidence of an easing in price pressures in the services sector, while manufacturing cost burdens will continue to fall in line with the supply-demand rebalancing in the sector. And having dropped to the lowest level since the start of 2021, the employment component is likely to signal further cuts in headcount. Meanwhile, the postponed official Labour Force Survey results (also tomorrow) are likely to report that employment remained well down on a three-month basis in August, probably close to the prior month’s fall of 207k – a magnitude always previously associated with recession. We also expect the unemployment rate to remain unchanged at July’s rate 4.3%, up 0.3ppt from the three months to May. But commentators will raise question-marks about the quality of these data given the low survey response rate, and we don’t rule out meaningful revisions to past data too. Other releases include the CBI industrial trends (tomorrow) and distributive trades surveys (Thursday), with the latter likely to suggest ongoing challenges in the retail sector at the start of Q4 after the drop in sales in Q3.

Flash PMIs and Tokyo CPI in focus in Japan in the week ahead
Finally, like elsewhere, Japan’s data calendar kicks off with the flash October PMIs (tomorrow). But in contrast to the other major economies, the services activity index is expected to remain firmly in expansionary territory at the start of Q4. As such, despite the manufacturing survey likely to remain consistent with contraction, the composite PMI will point to ongoing modest GDP growth. Another highlight will be the Tokyo CPI report for October (Friday). The headline rate is expected to have moderated slightly at the start of Q4, by 0.1ppt to 2.7%Y/Y, due in part to lower food inflation. Indeed, when excluding fresh foods, core inflation is forecast to move sideways at 2.5%Y/Y. Admittedly, when also excluding energy, the BoJ’s preferred measure of core inflation is expected to have eased 0.2ppt to 3.7%Y/Y, a seven-month low, albeit still well above the BoJ’s 2% target.

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