All eyes on the ECB and BoE

Chris Scicluna
Emily Nicol

Fed tightens by 50bps and signals further hikes and no pivot to easier policy in 2023
As was widely expected, the Fed raised the target range for the Fed Funds Rate by 50bps to 4.25-4.50%. However, the FOMC’s dot plot was more hawkish than many market participants had anticipated, signalling that it expects the Fed Funds Rate to end 2023 above 5.0%. Indeed, 17 out of 19 members of the Committee foresee the rate above that level at year end, two expect it to reach 5.625%, and no member expects to pivot to easier policy next year, while Jay Powell was broadly hawkish in his press conference, suggesting that it will take “substantially” more evidence to convince the Fed that inflation is now on a path to 2%. Nevertheless, he did not rule out a further downwards shift in the pace of tightening in the New Year to 25bps. Please read the comment of Daiwa America economists here.

ECB expected to slow the pace of tightening to 50bps, but decision won’t be unanimous and Governing Council will signal further tightening and possible start to QT in Q1
The outcome of the ECB’s Governing Council decision on Thursday is arguably the most difficult of this week’s major monetary policy meetings to predict with confidence, with policymakers likely to be split between those favouring a third successive increase of 75bps and those preferring a moderation in the pace of tightening to 50bps. With 200bps of tightening already implemented, banks on track to reduce their total TLTRO-iii borrowing by almost €800bn in November and December, and today’s hike likely to return rates to a broadly neutral setting, we expect the majority of Governing Council members to back a slowing in the pace of ECB rate hikes to 50bps. But the hawks are likely to want to extract something from the doves in return. So, the ECB will reiterate that it “expects to raise interest rates further”.

Today we also expect an agreement – implied or explicit – that, in the absence of new shocks, ECB quantitative tightening (QT) will get underway by end-Q1. The principles for QT, certain to be agreed today, will be like those guiding the Fed’s programme. In particular, the run-off of APP bonds will be passive and predictable, running in the background to allow rates to remain the main policy tool. And there is likely to be a cap to the pace of reduction in the ECB’s bond holdings (perhaps about €20bn per month). Finally, the ECB’s updated economic projections will revise down the expected rate of GDP growth next year from 0.9%, probably close to 0.5%. But President Lagarde might insist that recession is not certain. And she will justify further tightening on the basis of an upwards revision to the inflation outlook in 2023 (probably to above 6.0%Y/Y) and 2024 (probably to 2.5% or more). However, the inflation projection for 2025, to be published for the first time, will likely be only just above the 2.0% target.

BoE likely to revert to hike of 50bps, but with MPC split three or four ways
Not least thanks to the restoration of confidence in UK economic management following the autumn Gilt crisis, as well as the downside surprise to yesterday’s inflation data for November, and the cumulative tightening of 290bps over the past year, the MPC is expected today to revert back to an increase of 50bps – as in August and September – taking Bank Rate to 3.50%. However, the vote on the Committee is highly likely to be split again, perhaps three or four ways. With inflation expected to moderate next year somewhat more gradually than in the US and euro area, and the Committee still mindful of second-round effects not least given the tight labour market and survey evidence of elevated business price expectations, the hawks (in particular external members Catherine Mann and Jonathan Haskel) might vote for another hike of 75bps. In contrast, with the UK economy probably now in recession, the doves will likely call for a more marked slowing in the pace of tightening this month – in November when the MPC hiked by 75bps, the newest external member Swati Dhingra voted for a more moderate hike of 50bps hike, while long-standing dove Silvana Tenreyro voted for just 25bps.

Chinese economic activity weakened further than expected in November before the authorities started to reverse the zero-Covid policy
Chinese economic activity weakened significantly further than expected in November before the authorities belatedly started to ease its zero-Covid policy. In particular, retail sales dropped 5.9%Y/Y, the sharpest decline since May and well in excess of the median forecast on the Bloomberg survey (-4.0%Y/Y). In addition, industrial production slowed a larger-than-expected 2.8ppts to just 2.2%Y/Y, also the weakest in six months. Growth in fixed-asset investment slowed to 5.3%YTD/Y with property investment down 9.8%Y/Y, residential property sales falling 31.1%Y/Y and new home prices down for a fifteenth successive month (-0.25%M/M). The surveyed jobless rate rose 0.2ppt to a six-month high of 5.7%. The evidence current surge in new Covid cases seems bound to weigh on activity over the near term despite the easing of government restrictions.

Japan’s trade deficit exceeds expectations again, but narrows somewhat as imports fall back amid lower commodity prices; net trade unlikely to support GDP growth in Q4
Japan’s goods trade deficit once again exceeded expectations in November. Indeed, on an unadjusted basis the deficit remained above ¥2.0trn for a fourth successive month to be on track for a record nominal high this year. However, on an adjusted basis, the deficit narrowed in November for just the second month in the past eight, by ¥475bn to ¥1.73trn, as the value of imports fell back (-5.3%M/M) amid lower commodity prices. Indeed, the annual pace of import growth fell more than 23ppts to 30.3%Y/Y, with the value of mineral fuel imports down 47ppts to 60.8%Y/Y. When also adjusting for prices, the BoJ’s measure of import volumes fell more than 3½%M/M in November. But coming on the back of the surge in demand at the start of Q4 (4.9%M/M), import volumes were still trending almost 2½% above the Q3 average. Given waning external demand and persisting supply constraints, shipments of Japanese goods to China declined for the ninth consecutive month (-16.4%Y/Y) and growth in export volumes to the US slowed to a four-month low of 1.0%Y/Y. Admittedly, when adjusting for seasonal and price effects, exports were trending a little more than 2% above the Q3 average. Given the stronger pace of growth of import volumes on the same basis, that nevertheless suggests that net trade will offer little support GDP growth in Q4.

Japanese tertiary activity posts modest rise at the start of Q4; but final manufacturing confirms slump in output that month
Japan’s services sector at least appeared to provide modest support to GDP at the start of Q4. In particular, tertiary activity rose 0.2%M/M in October, boosted by a rise in hospitality as the remaining Covid restrictions were relaxed, with the level of such activity roughly 3½% above the Q3 average. But the improvement in services was limited by declines in utilities, transport, medical care and retail trade. And growth was well below rates required to offset manufacturing weakness, with today’s final output data for October confirming a sizeable drop of 3.2%M/M, reflecting steep declines in autos (-6.5%M/M), semi-conductors (-21%M/M) and chemicals (-21%M/M).

Faster euro area new car sales driven by pent-up demand and easing supply strains
Today’s euro area new car registration figures suggested that pent-up demand and the recent easing of supply strains drove car sales notably higher in November. In particular, euro area car registrations jumped 18.2%Y/Y, with the strongest growth in Germany (31.4%Y/Y), and solid increases in France (9.8%Y/Y), Italy (14.7%Y/Y) and Spain (10.3), suggesting a welcome boost to spending and overall GDP growth in the final quarter of the year. But the level of registrations was still almost 6½% below the pre-pandemic level in November 2019, with the year-to-date sales down almost a third compared with the equivalent period that year. And with consumer confidence still historical low and households purchasing power continuing to decline, we might well see demand for new cars moderate over coming quarters.

French business sentiment resilient in December according to INSEE survey
Ahead of tomorrow’s flash PMIs, the French INSEE business survey suggested that conditions were broadly stable and confidence resilient at the end of year despite ongoing concerns of disruption to energy supply. In particular, the headline sentiment index stood at an above-average 102 for the fourth consecutive month in December. Having underperformed in recent months, there was an improvement in retail sentiment back to the long-run average (100), while the respective indices were unchanged in manufacturing (101), and services (104). But these figures remain well down on levels seen earlier in the year, with the average indices for manufacturing and services in the fourth quarter some 2pts below the Q3 average too, suggesting perhaps unsurprisingly that the French economy slowed (if not contracted) in the final quarter of the year.

November retail sales and IP data the US focus today, with growth in both likely subdued
Today’s data from the US will give insights into growth in the middle of Q4 with November retail sales and IP data the highlights. Retail sales are expected to have slowed significantly following surprisingly strong growth of 1.3%M/M in October. Our colleagues at Daiwa America expect overall sales to rise just 0.1%M/M, suppressed by a drop in new vehicles. Excluding autos, they expect sales to rise 0.4%M/M, exceeding the Bloomberg consensus (0.1%M/M). Industrial production is expected to be subdued again, restrained by the manufacturing component. Our colleagues predict IP growth of just 0.1%M/M, supported by mining and a weather-related boost to utilities. Other US data due today include the latest Empire manufacturing and Philly Fed surveys.

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