Monetary Policy

Another hike of 75bps expected from the ECB on Thursday
This week’s main event in the euro area will be Thursday’s conclusion of the ECB’s monetary policy meeting, when we expect the ECB to raise each of its three main policy rates by 75bps, most notably taking the deposit rate to 1.50%. With euro area inflation in September having again exceeded the ECB’s forecast, and the euro having depreciated significantly below parity against the dollar since the last monetary policy meeting, all members of the Governing Council will agree that real short-term rates are still far from the neutral stance that they hope to achieve by year-end. So, while a dovish minority will be mindful of rising recession risks, another hike of 75bps this month is likely to be uncontroversial. While the post-meeting policy statement will likely repeat that future policy decisions will continue to be data-dependent and made on a meeting-by-meeting basis, it will also likely make clear that rates will likely rise again before year-end. And Lagarde might make clear that the ECB will consider reducing its bond holdings (i.e. quantitative tightening) once interest rate normalisation has been completed.

ECB could also announce adjustments to address issues relating to excess liquidity
Technical adjustments are also likely in order to address issues related to the huge amount of excess liquidity in an environment of positive an interest rates, which offers banks significant risk-free income while also representing a big cost to the ECB. Several policy options appear to have been under consideration. In particular, to sharpen banks’ incentives to repay their TLTRO loans without undue delay, it is possible that the Governing Council might decide retrospectively to amend the terms of that long-term liquidity. That, however, might have a reputational cost for the ECB. Alternatively, the ECB might simply introduce a ‘reverse-tiering’ system to reduce interest paid on deposits above a certain threshold. Whatever precise measure is agreed upon, it will likely reduce total net income for euro area banks by tens of billions of euros in the coming year.

BoJ to leave its key policy parameters unchanged on Friday despite yen weakness
While the yen remains under pressure, one focus in Japan this week will be the BoJ’s Policy Board announcement on Friday. Despite the 10Y JGB yield having breached the upper limit (0.25%) of its YCC framework last week, and the yen continuing to move lower despite repeated bouts of MoF forex intervention, the BoJ is widely expected to leave its key policy parameters unchanged, leaving it still as the only central bank to maintain a negative policy rate. This week’s decision will be accompanied by updated economic forecasts, which might well see its near-term inflation forecasts revised a touch higher – the average forecast for FY22 in July was 2.3%. However, not least reflecting increased downside risks to economic growth from an uncertain global outlook, the BoJ will continue to forecast sub-target inflation in FY23 and FY24, justifying the continuation of its ultra-accommodative policy stance. And while a draft of the latest stimulus plan reportedly suggests that the government will expect the BoJ to be mindful of market moves and manage policy appropriately, for as long as the central bank maintains its current policy stance while the Fed and other major central banks continue to push rates higher, the yen will remain under pressure to depreciate.

UK politics in focus as new PM possibly to be announced by the end of the day
Politics will remain the key focus in the UK this week, with the nomination process for a new Conservative Party leader to close at 14.00BST today. With former disgraced Prime Minister Boris Johnson not standing, former Chancellor Rishi Sunak – who argued strongly against Liz Truss’s fiscal agenda in the summer – can only now be stopped by Penny Mordaunt. But, unlike Sunak, she looks still to be well short of the 100 nominations from Conservative MPs required to force a vote among party members. So, we assume that Sunak will be appointed as new leader and Prime Minister later today. But in the unlikely event that both pass the threshold, an unbinding vote among Conservative MPs will be held this afternoon ahead of an online ballot of party members, with the result then due to be announced on Friday.

Data

Japanese PMIs boosted by relaxation of Covid restrictions and discounted travel scheme
Japan’s flash PMIs signalled a further improvement in sentiment at the start of Q4 as the relaxation of Covid-related restrictions and the government’s discounted travel programme gave a boost to activity. Indeed, the composite output index rose 0.7pt to a four-month high of 51.7, with the headline services PMI (53.0) the joint highest reading since just before the consumption tax hike in August 2019, while the new export orders index (51.3) increased for the fourth consecutive month to its highest for three years. However, today’s survey suggested that despite an improvement from September, conditions in the manufacturing sector remained challenging, with the output (48.7) and new orders (48.2) components still firmly in contractionary territory. In terms of inflation, the composite output price PMI rose to its joint highest since the series began in 2007. The BoJ’s estimates of underlying inflation (due tomorrow) are likely to report a further broadening of price pressures last month, while the Tokyo CPI figures for October (Friday) are expected to see the headline inflation rate jump to the highest since the early 1990s.

Chinese Q3 GDP beats expectations on infrastructure but still lags well behind 2022 target
China’s delayed Q3 data were eventually published today and beat expectations, reporting growth of 3.9%Y/Y, 0.6ppt above the Bloomberg consensus. That marked an improvement from just 0.4%Y/Y in Q2, when pandemic lockdowns were most damaging. But it was still well down on the rate of 4.8%Y/Y in Q1 and left the government’s target of 5.5%Y/Y for 2022 as a whole all-but-unattainable. On a seasonally adjusted basis, GDP is estimated to have risen 3.9%Q/Q annualised in Q3 following the contraction of 2.7%Q/Q ann. in Q2. Perhaps surprisingly, growth in construction activity was particularly strong in Q3, up 7.8%Y/Y (from 3.6%Y/Y in Q2) thanks to increasing government support for infrastructure, even as real estate activity dropped 4.2%Y/Y (after -7.0%Y/Y in in Q2) as adjustments in the sector continued. Overall, industrial sector output rose 4.6%Y/Y in Q3, up from just 0.4%Y/Y in Q2. And services rebounded 3.2%Y/Y in Q3, following the dip of 0.4%Y/Y in Q2.

Chinese manufacturing accelerates in September, but retail sales slow & real estate investment tanks
In September, manufacturing and mining continued to find support from easing of supply-chain strains, including power outages. Manufacturing accelerated 6.4%Y/Y last month from 3.1%Y/Y previously. Mining accelerated 7.2%Y/Y in September, up from 5.3%Y/Y in August, benefiting also from demand related to infrastructure investment. But retail sales slowed to 2.5%Y/Y from 5.4%Y/Y in August, likely reflecting the impact of new outbreaks of Covid-19. Growth in car sales remained vigorous, however, at 19.2%Y/Y in September, benefiting from subsidies as well as supply-chain improvements. In marked contrast, real estate fixed asset investment plunged 12.6%Y/Y last month, following the drop of 11.0%Y/Y in August.

Flash PMIs disappoint pointing to steeper pace of contraction; Q3 GDP and October HICP estimates due from euro area member states later in the week
A busy week for euro area top-tier releases, kicked off this morning with the flash PMIs for October, with the headline composite output PMI down a steeper than expected 1pt to 47.1, its lowest reading for two years, and the weakest since April 2013 outside of pandemic lockdown periods. The drop in activity was evident in services (down 0.6pt to 48.2) and manufacturing (down 2.1pts to 44.2), with new business slowing sharply too. Among the member states, Germany reported the steepest pace of contraction (composite PMI fell 1.6pts to 44.1), while growth in France stalled (composite PMI declined 1.2pts to 50.0) and growth elsewhere in the region declined at the fastest pace since January 2021.

A raft of other sentiment indicators this week concludes with the Commission survey indices on Friday, along with the flash Q3 GDP estimates from Germany, France and Spain. Germany might report a contraction in Q3 (our forecast is for a slight drop of 0.1%Q/Q), following only a modest increase (0.1%Q/Q) in Q2. Growth is also expected to have slowed in France and Spain, albeit remaining in positive territory at 0.2%Q/Q and 0.3%Q/Q respectively. In terms of inflation, Friday’s HICP data from the four largest euro area economies to reveal underlying price pressures remained elevated, albeit perhaps hinting that the euro area headline rate of inflation (due for release a week today) is close to its peak. Other releases this week include the ECB’s latest quarterly Bank Lending Survey (tomorrow) and monthly bank lending numbers for September (Wednesday).

UK flash PMIs report a marked drop in activity at the start of Q4 as demand slumps
The flash UK PMIs fell well short of expectations, with the composite PMI down 1.9pts to 47.2 in October, the lowest since January 2021 and firmly in contractionary territory. There was a sizeable weakening in services, with the headline activity index down 2.5pts to 47.5, similarly the lowest for 21 months, while the manufacturing output PMI (45.6) ticked slightly higher, albeit still signalling marked contraction. And the survey signalled a further significant slump in demand, with the composite new orders down almost 4pts to 44.7, the lowest since the onset of the pandemic. The CBI industrial trends and distributive trades survey will follow tomorrow and Thursday respectively.

US Q3 GDP to be boosted by stronger net trade
In the US, Thursday will bring the first estimate of Q3 GDP. Despite weak construction and only moderate growth in consumer spending and business investment, our colleagues in Daiwa America expect GDP to have been boosted by a strong contribution from net trade, with overall GDP growth likely to be around 2%Q/Q annualised, after two negative quarters in the first half of the year. The advance goods trade report (Wednesday) will give further guidance to the trade performance at the end of Q3. Ahead of this kicks off today with the flash October PMIs and Chicago Fed National Activity index for September, followed by the Richmond Fed manufacturing index and Conference Board consumer confidence survey (tomorrow). The end of the week will bring the monthly personal income and consumption numbers for September, alongside the quarterly Employment Cost Index for Q3.