Monetary policy in the spotlight this week

Chris Scicluna
Emily Nicol

Monetary policy
The Fed’s FOMC policy announcement on Wednesday looks relatively straightforward, with Chair Powell among other Committee members having strongly hinted at a slowing in the pace of tightening this month to 50bps, which will take the Fed Funds Rate target range to 4.25-4.50%. But the Fed will continue to signal more tightening to come, and so there will be great interest in the FOMC’s updated economic forecasts and dot-plot charts. The median expectation for the FFR for next year will be revised higher from 4.50-4.75% in the previous projections published in September, possibly as high as 5.00-5.25%. That, nevertheless, would still be below the forecast of the terminal rate of our Daiwa America colleagues (5.50-5.75%). The dispersion of the dots in 2023 will also be closely watched, with a wide dispersion suggesting a high degree of uncertainty and therefore perhaps a lower probability of aggressive monetary policy action next year.

With market confidence in UK economic management now broadly restored following the autumn Gilt crisis, the BoE is under less pressure to deliver another jumbo rate hike on Thursday. So, having tightened by 75bps last month, the MPC is expected to revert back to an increase of 50bps – as in August and September – taking Bank Rate to 3.50% and the cumulative tightening over the past year to 340bps. 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 more gradually than in the US and euro area, and the Committee mindful of second-round effects, the hawks (including external members Catherine Mann and Jonathan Haskel) might vote for another hike of 75bps. In contrast, with the UK economy now in recession, the doves will likely call for a more marked slowing in the pace of tightening this month – in November, the newest external member Swati Dhingra voted for a hike of 50bps hike, while long-standing dove Silvana Tenreyro voted for 25bps.

The outcome of the ECB’s Governing Council decision on Thursday is arguably the most difficult to predict with any 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 set to repay early a larger-than-expected €447.5bn of TLTRO-iii loans this month, and this week’s hike likely to return rates to a broadly neutral setting, as for the Fed and BoE 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 signal an expectation of further hikes in Q1. And we also expect an agreement – implied or explicit – that, in the absence of new shocks, quantitative tightening (QT) will get underway by end-Q1. The principles for QT, certain to be agreed this week, 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).

Today’s data

Rebound in UK GDP in October a touch firmer than expected, but downwards trend remains
While the rebound in UK GDP at the start of the fourth quarter was a touch firmer than had been expected, it nevertheless maintained a downwards trend and reaffirmed that the economy is now probably in recession. GDP growth of 0.5%M/M in October was principally supported by expansion in the services sector (0.6%M/M), with wholesale trade, retail and auto repair reporting a firm rebound, while healthcare was supported by the autumn vaccination booster campaign. But while output from consumer-facing services grew 1.2%M/M in October, this followed two consecutive declines of more than 1½%M/M. Construction also rose for the fourth consecutive quarter (0.8%M/M), while a pickup in manufacturing (0.7%M/M) was offset by a negative contribution from energy supply to leave total industrial production broadly flat on the month.

Overall, the level of GDP in October was a touch higher than the Q3 average (0.2%). But it was still 0.1% below the pre-pandemic peak in January 2020. And smoothing out monthly volatility, GDP reported the third consecutive decline on a three-month basis and the steepest in this sequence at -0.3%3M/3M. Given the weakness in various surveys, the increasing squeeze on household budgets from high inflation and rising borrowing costs, and deteriorating housing market (today’s Rightmove survey reported the steepest decline in asking prices in four years), we see little improvement in GDP on the horizon. The current cold snap and rail strikes will certainly add further challenges to services activity in the run up to Christmas.

Japanese services firms more upbeat in Q4, but manufacturers remain challenged
Ahead of the BoJ’s Tankan survey this week, the Japanese government’s latest business survey suggested a very modest improvement in conditions heading into the end of the year, supported by a pickup in services. In particular, the headline diffusion index for large firms rose 0.3pt to 0.7 in Q4, its highest for four quarters and above the long-run average (-1.1), despite a deterioration in the manufacturing sector (down more than 5pts to -3.8). The magnitude of improvement was more striking among medium-sized firms (up 6.9pts to 4.7), although on balance small firms considered conditions to be worse than in Q3. SMEs were also more downbeat about expectations for Q1, with manufacturers on balance also expecting domestic economic conditions to worsen over the coming quarter. Separately, today’s goods PPI figures suggested that, despite an easing in import price pressures, inflation at the factory gate remained significant in November. Indeed, while imported prices fell more than 5%M/M (down 14ppts to 28.2%YY), total goods prices rose 0.6%M/M to leave the annual rate down just 0.1ppt at 9.3%Y/Y, nevertheless still 1ppt below September’s peak.

Looking ahead to the week’s key data release

US CPI figures are expected to show a more modest pace of increase in November amid a dip in gasoline prices. In line with the consensus, our colleagues in Daiwa America forecast an increase of 0.3%M/M, 0.1ppt less than in October, to leave the annual rate down 0.4ppt to 7.2%Y/Y. But they are more downbeat than the consensus about core inflation, expecting a rise of 0.4%M/M (up 0.1ppt from the prior month), so that the annual rate moderates only slightly from 6.3%Y/Y in October. Before the US data are released, UK labour market figures are expected to report a second successive decline in employment in the three months to October, although elevated inactivity and a lack of skilled workers will ensure continued upwards pressure on private sector wages. Regular pay growth is forecast to rise to a new series high (5.9%3M/Y) in October outside of the height of the pandemic distortion.

The BoJ Tankan survey will likely signal a mixed performance among Japanese businesses in Q4, with manufacturers continuing to struggle amid ongoing supply constraints, higher input costs and softer global demand. But services firms are expected to report a modest improvement in conditions as Covid restrictions have been relaxed and the government introduced a discounted travel programme. UK CPI figures are expected to show that headline inflation edged slightly lower in November due principally to an easing in energy inflation. But, in line with the Bloomberg consensus, we forecast inflation to fall only marginally below 11%Y/Y, with core inflation likely to remain sticky at 6.5%Y/Y.

US retail sales are expected to report only modest growth in November despite boosts from Black Friday discounting and gasoline sales as prices fell. Daiwa America economists forecast an increase of just 0.1%M/M (0.4%M/M when excluding autos). Japan’s goods trade report is likely to show that exports fell back in November as supply bottlenecks continue to restrain production, while subdued domestic demand and moderation in commodity prices will weigh on the value of imports. Chineseretail sales and IP numbers are expected to report a further slowing in economic activity last month amid weakening demand and persisting disruption from the government’s zero-Covid policies.

Main focus will be December’s flash PMIs from the major economies. While the euro area composite PMI ticked up in November, at 47.8 it remained firmly consistent with contraction, with the services index the weakest since mid-2013 outside of Covid lockdown periods. Likewise, the UK composite PMI will remain consistent with ongoing contraction after it was unchanged last month at the 22-month low of 48.2. Final euro area inflation figures for November are likely to confirm that the headline rate fell sharply last month by 0.6ppt to 10%Y/Y. While the core rate remained sticky at a series high 5.0%Y/Y, there are risks of a modest downside surprise. UK retail sales figures are likely to suggest only modest growth despite Black Friday discounting, while the GfK consumer confidence index is likely to remain near historical lows. 

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