The week ahead: ECB to signal successive rate rises

Chris Scicluna

ECB on Thursday to signal successive rate rises from July, but likely to leave open size of first hike; net purchases should end this month, but new instrument to address fragmentation risks likely to be endorsed too
With euro area inflation continuing to surprise on the upside – more than four times the ECB’s target at 8.1%YY in May, and on track to be more than 2ppts above the ECB’s forecast for Q2 published just three months ago – following this week’s Governing Council meeting on Thursday, the ECB will set out its plan for monetary policy normalisation.

  • According to its current forward guidance, the Governing Council expects to conduct a further €20bn of net asset purchases this month before ending them in the third quarter and raise rates sometime after that. But given the extreme leap in inflation, an early end to those purchases this month might now seem appropriate.
  • A clear signal of rate lift-off at the 21 July policy meeting and further hike at the following meeting on 8 September, allowing it to exit negative rates by end-Q3, would now appear all but inevitable. The Governing Council will also highly likely signal that, subject to the incoming data, it expects to keep increasing rates thereafter until they are eventually back into (unspecified) neutral territory, likely in practice to be somewhere between 1-2%.
  • In due course, we expect rates to be hiked in increments of 25bps. Indeed, one member of the Governing Council noted last week that, in the absence of surprises in the ECB’s projections, there would be no “general support for a 50bps hike”. But in her press conference on Thursday, ECB President Lagarde would seem likely to leave the door open to hikes of 50bps apiece if the incoming data demand them.
  • While the regular asset purchase programme is set to come to an end, with the spread of 10Y BTPs over Bunds now firmly above 200bps the FT reports this morning that most Governing Council members will support the establishment of a new programme that would be ready to step in to support certain stressed sovereign bond markets if and when fragmentation risks emerge. Whether that simply brings forwards maturing proceeds of PEPP bonds to stressed markets ahead of schedule, or goes beyond that, remains to be seen, as does the nature of any conditionality attached.
  • The Governing Council’s decisions on policy this week will be guided by its updated projections, which will revise up sharply its expected profile of inflation from its previous baseline projection published in March. The new forecast will more closely resemble its previous “severe” scenario of an average of 7.1% this year and 2.7% in 2023 than its baseline of 5.1% and 2.1%. The projections will still, however, likely suggest that inflation is expected to return back to the 2% target over the medium term. And the risks will be two-sided. But the skew is likely to be very much to the upside given the possibility of disruption to energy supply as well as an apparent recent shift in firms’ pricing behaviour.

Johnson’s demise could come this evening, with confidence vote due 6pm BST
With Tory MPs likely to have been repeatedly reminded over the long holiday weekend of the significant unpopularity of PM Boris Johnson, this morning brought confirmation that at least 54 of them have submitted letters to trigger an emergency no-confidence vote in his leadership. The vote will take place for two hours from 6pm (BST) this evening, with the result out shortly thereafter. Judging from the public mood, and the recent poor showing of the Conservatives in the opinion polls, we see a probability close to 50% that Johnson will be removed from Downing Street today, meaning that his term of office would fall short even of his hapless predecessor Theresa May. If he is kicked out by his MPs, with lack of clarity as to who in the Conservative party might possibly succeed Johnson – whether from the populist right (e.g. Truss, Mordaunt, Barclay or Baker) or a more traditional Tory (Hunt, Wallace, Tugenhadt, Javid but probably not the damaged Chancellor Sunak) – markets might be unlikely to respond significantly either way to the result this evening. If, on the other hand, Johnson wins this evening – if only perhaps as there is no obvious successor – party rules would mean that he should avoid another such vote over the coming year.

More prosaically, a relatively quiet week ahead for UK economic data starts today with just May new car registration figures, continues tomorrow with the BRC retail sales survey for the same month (which is highly likely to be weak), and also includes the RICS residential market survey on Thursday (which will remain consistent with ongoing house price growth).

Caixin PMIs weaker than official surveys; Chinese trade to show moderate rebound in shipments; China’s inflation data to show price pressures remain more subdued than in Europe and the US

A relatively quiet start to the week for Asian economic news today brought China’s Caixin services PMIs for May, which were significantly weaker than the government’s official PMIs suggesting a somewhat more marked pace of contraction in the middle of Q2. In particular, the Caixin services PMI rose 5.2pts to 41.4, still merely the second-lowest reading since the initial Covid lockdowns in February 2020. And with the manufacturing output index having risen last week a little less than 5pts to just 43.2 – likewise a level only lower once since February 2020 – the Caixin composite PMI rose 5pts to 41.4, some 7pts below the official government index, which is skewed more heavily towards larger SOEs.

Looking ahead, the week in China will bring the goods trade report for May (Wednesday), which seems likely to show a rebound in growth in shipments after the marked slowdown in April, when import growth in USD terms dropped to 0.0%Y/Y despite strong import price inflation. Nevertheless, domestic price pressures are expected to have remained subdued in May – the headline CPI inflation rate (due Friday) is forecast to have risen just 0.2ppt to 2.3%Y/Y, with core inflation likely remained close to 1%Y/Y. And the headline PPI rate is forecast to have dropped a further 1½ppts in May from 8.0%Y/Y previously, which would mark its lowest reading since March 2021.

Consumption and wage data the focus in Japan this week
In Japan, Wednesday’s updated GDP data might well suggest a slightly steeper drop in economic output in Q1, although the annualised Q/Q rate of decline is expected to be revised a mere 0.1ppt to -1.1%. More importantly perhaps, tomorrow’s household spending data, as well as the BoJ’s consumption activity index, should add to evidence of a pickup in private spending in April, while Wednesday’s economy watchers survey results for May are expected to suggest the most favourable conditions since December. Separately, labour cash earnings data due tomorrow are expected to report a moderation in the pace of growth in April from March’s near-four-year high of 2.0%Y/Y, which was flattered by special payments. The expected nominal growth rate of 1.5%Y/Y would be consistent with a drop in earnings in real terms. Finally, Friday’s producer goods price data are expected show the headline inflation rate still close to April’s four-decade high of 9.5%Y/Y.

German factory orders and IP due this week along with euro area Q1 GDP breakdown
While the ECB policy meeting will obviously be the principal focus in the euro area this week, the dataflow will likely report a third successive monthly decline in German factory orders in April (tomorrow), but a partial rebound in German industrial production (Wednesday). Euro area GDP data for Q1 (also Wednesday) will likely confirm a second successive quarterly pace of growth of 0.3%Q/Q, with a decline in household consumption offset by growth in fixed investment and inventories. Growth in employment is likely to have been firm at 0.5%Q/Q. Survey-wise, tomorrow will bring the May construction PMIs, which are expected to signal a softening of activity in the sector on heightened uncertainty about supply chains, cost pressures and interest rates.

CPI and consumer confidence the main US data focus before next week’s FOMC
Ahead of the Fed’s policy meeting next week, all eyes in the US this week will be on Friday’s CPI inflation report for May. While our colleagues in Daiwa America think that core prices might have slowed 0.2ppts to 0.4%M/M due to an easing of some pandemic-related pressures (e.g. vehicles, clothing and hotels), higher energy and food prices are expected to push the headline CPI up 0.6%M/M, twice the rise in April. And that could leave the annual rate unchanged at 8.3%Y/Y. The preliminary University of Michigan consumer confidence survey for June, due the same day, could report a slight improvement from the prior month’s recession-level reading thanks to slightly firmer equity markets. And before that, the full April trade report (tomorrow) should confirm a notable narrowing of the trade deficit at the start of Q2 thanks to weaker imports.

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