Asia | China | Europe | Global | Monetary Policy & Inflation | US
Will the ECB Hike 75bp?
- By Dominique Dwor-Frecaut, Ben Ford and Henry Occleston
- 12 min read
US – Europe – $-Bloc – China/Japan – Covid-19 Monitoring
US
Monday 5 September is the Labor Day holiday in the US.
Summary
- Beige Book could surprise with more upbeat tone.
- Services PMI to remain strong.
Fed
There was a lot of tough Churchillian talk at Jackson Hole, from Chair Powell and other panelists. Yet markets continue to price cuts in 2023 (see Jackson Hole: The Mountain That Will Bring Forth a Mouse?). This could reflect that the Fed macro scenario remains highly unrealistic.
The Fed releases its Beige Book this week. Our Beige book sentiment score has tended to correlate well with consumer confidence, that has recently recovered. As a result, the Beige Book could turn out more upbeat this time around.
Fed speakers this week did not express a preference on 50 vs 75bp this month. The next key data point for the FOMC is the CPI that will be released on September 13 during the pre-meeting blackout period.
I continue to expect 75bp because the data is not consistent with the FOMC expectations of growth slowing below trend in H2. In addition, a 50bp hike (less than the market expect) would risk an easing of financial conditions and would be inconsistent with JH’s tough talk.
This is the last week before the pre-meeting blackout and as of this writing speakers include Barkin, Mester, Brainard, Barr, Powell, Evans, Waller, George.
Data
This was a good week for hard and soft data with strong labor market, manufacturing PMI and a recovery in consumer expectations. House prices and the PMI prices paid increased by less than expected. Covid related hospitalizations continued to fall (Charts 5 and 7).
This is a data light week. Key data include the services PMI, the trade balance, jobless claims, consumer credits and inventories where I agree with the consensus that is consistent with continued sustained activity.
The Fed will be releasing its flow of funds accounts for Q2 and I will be looking for a decrease in household net worth and an increase in businesses leverage.
Events/Political Developments
Most pollsters agree that the Democrats mid-term prospects have improved mainly due to a combination of reaction to the Supreme Court Roe vs Wade ruling, negative reactions to candidates backed by former president Trump, and lower gas prices.
For now the Democrats appear likely to keep control of the Senate while the House has become more of a tossup. That said, the elections are on November 8, and 2 months is a very long time in politics.
This matters for fiscal policy as a split Congress would likely see additional fiscal consolidation.
Links to New York Fed POMOs/TOMOs: Repos, Treasury, MBS, CMBS
Europe
Key Points
- The ECB will be the week’s main event in Europe:
- This week, we expect that they will be able to deliver an additional 75bp hike.
- Furthermore, we believe the time has come for President Lagarde to drop ‘roughly neutral’ as an end goal, and instead open the doors to hiking into restrictive territory.
- However, given how high yields have become in the European periphery, we do not believe the time has come for serious talk of QT.
- Elsewhere, the new UK PM will be announced. At the time of writing, this is likely to be Liz Truss. An immediate requirement will be for her to set out her plan to resolve the growing cost-of-living crisis.
- The implications of her policy for the BoE will be important. We will be watching the testimony to Parliament, for signs that they will follow the Fed and ECB more hawkish.
Will the ECB Hike 75bp?
At this Thursday’s ECB meeting, several compounding factors lead us to lean marginally in favour of a 75bp hike. There are several clear reasons why we expected this hawkishness:
- With the gas situation in Russia so uncertain, the medium-term inflation outlook has lost its potency. Current inflation is taking greater weight.
- Recent inflation has strongly overshot expectations. Updated inflation forecasts will need to reflect this (Chart 2).
- There is growing evidence that the medium-term inflation outlook has shifted structurally higher. It would not take much to greatly overshoot the ECB’s target.
- The euro has weakened substantially, both trade-weighted and versus the USD since the last meeting. This means a need to raise real rates.
- TPI should have the power to keep BTP spreads capped (although QT talks are premature).
The market is beginning to agree with us, pricing just shy of 70bp for the meeting. However, despite this it continues to price only a modest move beyond the estimated neutral rate (1-2%), in line with Lagarde’s previous comments that the rate would be left ‘broadly neutral’. We do not think this is credible given the outlook. Even if Lagarde was to repeat the line (likely to temper market moves feeding into credit spreads) we would look to fade any reaction from it.
Ultimately, we see her, and the majority of the GC members, coming around to Board Member Isabel Schnabel’s perspective. She believes that the recent changes are structural, and will ultimately mean higher underlying inflation into the medium term.
On this basis, more drastic action than even the 50bp from July will be required, with even a conservative Taylor Rule suggesting a hike out to 6% (Chart 3). Right now 75bp does not explicitly appear to hold a majority (Chart 4). But with doves like Villeroy sounding more supportive of a big move, the chance is that the ‘more now, less later’ argument will win out.
However, there will need to be a careful balancing act to prevent spreads from blowing out. 10Y BTP yield is fast approaching 4%. This is a level that will almost certainly be tested soon, even while BTP/Bund spreads are relatively capped. Conscious of this, we would expect that Lagarde may attempt to temper the hawkishness of the move at the press conference. It would probably also be wise for her to avoid speaking too much on the prospect for QT, which would probably spook the market. However, she has been known to misstep before.
New UK PM to Face Growing Cost of Living Crisis
In the UK, the Conservative party leadership contest will (finally) come to an end on Monday. The probability still points towards Liz Truss taking the reins. Her most pressing requirement will be to organise her Cabinet and set out a clear path for how to resolve the growing cost-of-living crisis. Something large must be delivered on that front. However, what form it takes remains to be seen. She has previously been averse to simply capping energy price rises as well as imposing wind-fall taxes on energy profit.
Can the BoE Resist the Call of the Hawks?
The important question will be where Truss’ chosen solution leaves the BoE. They will likely continue to bear the brunt of the blame from her and her party for the inflation situation. However, we find that simply hiking rates will likely only exacerbate the situation. Governor Bailey’s testimony to Parliament on Wednesday will be important to watch. If he stands strong and continues to toe the line that there was nothing more they could have done, then it will add to our conviction that BoE hikes will ultimately disappoint market pricing. On this front it will be important to also hear from the (newly crowned, after Saunders’ departure) most hawkish MPC member, Catherine Mann, on Monday. She has been a proponent of front-loading hikes for some time. Whether the new, higher expected path for household energy prices adds or detracts from her conviction will be important to see.
$-Bloc
Central Bank Watch
Reserve Bank of Australia
We have long expected the RBA to deliver a fourth 50bp hike on 6 September (Tuesday, 05:30 GMT +1:00), taking the cash rate to 2.35%. It is also the opinion of most economists (21 of 23 economists surveyed).
The move itself, while important, will grab little attention. Instead, the focus will be two-fold. First, what is Governor Lowe looking for? He wants to keep the economy on an ‘even keel’ while returning inflation back to target (2-3%), yet he has kept his cards close to his chest. The second, and more important point of the two, is the RBA’s outlook on the economy. It is unclear how sensitive the economy is to raising interest rates. Indeed, we have already seen consumer confidence head towards rock bottom (as it has globally), but retail sales (July: +1.3% MoM) and unemployment (3.4%) would suggest, alongside somewhat resolute business confidence, that the economy is resilient.
So, while some analysts favor the RBA to slow down the pace of rate hikes in October, we believe it is unclear. Instead, we will wait to see if Governor Lowe is holding any aces up his sleeve, he talks on 8 September (Thursday, 04:05 GMT+1:00).
Bank of Canada
Following a surprise 100bp rate hike in July, we expect the BoC to hike the policy rate to 3.25% (+75bp) on 7 September (Wednesday, 15:00 GMT+1:00). This would be a continuation of their plan to ‘front load the path to higher interest rates’ as they move rates above the 3% neutral rate.
Reserve Bank of New Zealand
Inflation expectations moved one-tenth lower in the ANZ Business Survey to 6.13% YoY while pricing intentions remained elevated. So, while the RBNZ is in a ‘comfortable position’, so are we. We continue to expect the RBNZ to take the OCR to 4% through two 50bp hikes in October and November, and then re-assess the situation. It may mean another 25bp further down the line.
Calendar Preview
Australia
- Melbourne Institute Inflation (Monday, 02:00 GMT +1:00): With inflation expected to peak over the next two quarters, according to RBA forecasts, it will be imperative to watch the Melbourne Institute’s measure.
- ANZ Job Advertisements (Monday, 02:30 GMT +1:00): Job adverts appear to have peaked. We are looking for any signs that the slowdown is accelerating.
- RBA Rate Decision (Tuesday, 05:30 GMT +1:00): We see the RBA raising the cash rate to 2.35% (+50bp).
Canada
- BoC Rate Decision (Wednesday, 15:00 GMT +1:00): We see the BoC raising the cash rate to 3.25% (+75bp).
- Unemployment (Friday, 13:30 GMT +1:00): Employment has declined for two consecutive months, though this is largely due to a lack of workers. Job vacancies here have remained above pre-pandemic levels, so any immaterial increase in the employment rate is unlikely to spook the central bank.
New Zealand
- Card Spending (Thursday, 23:45 GMT +1:00): We are looking for any continuation of the slowdown that Governor Orr is comfortable with.
Links to BOJ Rinban , BOE OMO
China/Japan
Key data releases this week include China’s credit, CPI, PPI and trade balance.
COVID-19 Monitoring
