ECB likely to signal further “significant” tightening ahead after 50bps hike on Thursday
When its Governing Council meeting concludes on Thursday, there is no doubt that the ECB will announce a further 50bps hike in all of its main policy rates. That decision, which was all but pre-agreed last month, will take its deposit rate to 3.00%, and the cumulative tightening since July to 350bps. The outcome of this meeting will not be without interest, with the ECB’s updated forward guidance on the next steps for rates is far from certain. The doves on the Governing Council will want to leave flexibility to respond to incoming economic and financial data, which will provide greater evidence of the effects of recent rate hikes and, in due course, the impact of quantitative tightening, which only got underway this month. Certainly, the doves will insist on maintaining the text in the monetary policy statement that “future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach”. Recent public remarks suggest that the Governing Council’s hawks will be keen at the coming meeting to signal further “significant” rate hikes (i.e. of at least 50bps) to come. And given the unwelcome rise in core inflation in February to a new series high of 5.6%Y/Y, we suspect that the hawks will again be in the majority. So, we expect a signal that a further 50bps of monetary tightening in May is likely (if not yet a done deal).
ECB projections to revise down profile for headline inflation despite persistence in core pressures
The ECB’s updated macroeconomic projections are, however, highly likely to revise down the profile of headline inflation over the horizon. The annual rate of HICP inflation in the first two months of the year was already 0.5ppt below the ECB’s December baseline forecast (9.1%Y/Y). Moreover, gas and oil futures point to a markedly lower path for energy prices over the remainder of the year than was assumed in December. Short-term interest rates are about 100bps higher and 10-year bond yields are around 50bps higher than when the ECB’s last projections were finalised, with the euro exchange rate stronger too. But while the new forecasts could well suggest that the 2.0% inflation target will be met by the end of 2024, they will also likely suggest that core inflation will on average remain above 2.0% in 2025, justifying additional monetary tightening.
Final euro area inflation to confirm a 4th drop in the headline rate but a record high in core CPI
With respect to euro area economic data, Friday’s release of final February CPI and Q4 labour costs numbers will be of most note. In the absence of significant revisions to the equivalent releases from Spain (tomorrow), France (Wednesday) and Italy (Thursday), the aggregate euro area inflation figures should align with the flash estimates. They saw the headline HICP rate edge slightly lower for the fourth consecutive month, by 0.1ppt to 8.5%Y/Y in February, but core inflation leap to a new record high of 5.6%Y/Y. The labour cost figures will be watched for any evidence of second-round effects from recent elevated inflation, although we do not expect a marked acceleration.
Budget to target energy bills, business capex, labour supply and public sector pay
Ahead of the BoE’s next monetary policy announcement on 23 March, the main event in the UK this week will be the Government’s new fiscal policy plans laid out in the Budget on Wednesday. With public sector net borrowing in the first ten months of the current fiscal year running about £30bn below the OBR’s forecast profile, the Chancellor would appear to have significant scope for fiscal loosening. Indeed, not least given the sharp drop in wholesale gas prices since the autumn, the near-term economic growth outlook – while still downbeat – looks somewhat improved, while the fiscal cost of the Government’s energy bill support has fallen significantly. The scope for fiscal giveaways, however, will be constrained if – as would be appropriate – the OBR revised down its estimate of potential GDP growth (1¾%Y/Y by the forecast horizon) closer to that of the BoE (0.7%Y/Y). Nevertheless, we expect the Chancellor to confirm that he will not go ahead with the further increase in the average household energy bill to £3000 from April – a measure that will ensure a faster decline in inflation from Q2 onwards. He is also likely to scrap plans to increase fuel duty. Moreover, he will announce new corporation tax incentives to encourage business investment once the current super-deduction ends at the end of this month, as well as measures to encourage labour force participation among older workers. And he is also likely to announce funds for increased public sector pay, in an attempt to bring an end to strike action affecting key public services.
UK labour market likely to have remained tight, with wage growth still too high for BoE comfort
In terms of the UK’s economic data flow, the week’s labour market numbers will be noteworthy. Despite an anticipated further increase in employment in the three months to January, the unemployment rate is expected to have ticked slightly higher, by 0.1ppt to 3.8%, the highest for seven months but nevertheless still consistent with a tight labour market. Moreover, with average regular wage growth expected to have remained close to December’s series high (outside of the height of the pandemic period) of 6.7%3M/Y, this release will likely further support the case for further modest tightening this month. Also of relevance for the monetary policy decision will be the results from the BoE’s latest inflation attitudes survey on Friday.
US inflation one key focus for the Fed this week
Ahead of the Fed’s latest monetary policy announcement on 22 March, this week will bring a number of top-tier releases that will factor heavily in the decision-making process. First up, and of most importance, will be February’s consumer price inflation figures on Tuesday. While pressure on food prices has eased recently, energy prices could well rise for the second consecutive month, while a moderation in core goods prices will be offset by broad pressure in service prices. Indeed, our colleagues at Daiwa America forecast core prices to have risen 0.4%M/M, in line with the Bloomberg consensus survey, to leave the annual core rate down just 0.1ppt to 5.4%Y/Y. Meanwhile, the annual headline inflation rate is forecast to have eased 0.4ppt to 6.0%Y/Y. The latest PPI data will follow on Wednesday, along with retail sales figures for the same month. Higher prices are likely to boost the nominal value of sales at gasoline service stations, but overall retail activity is likely to see some payback for the strength in January, with auto dealers, general merchandise stores, and restaurants especially vulnerable to downside risks. IP data and the University of Michigan consumer survey are due Friday, with the measure of household inflation expectations of note in the latter.
Japanese business sentiment deteriorates in Q1, goods trade numbers likely to remain subdued
The overnight release of the Japanese government’s latest quarterly business outlook survey signalled a deterioration in sentiment at the start of the year. In particular, the net balance of firms reporting a decline in business conditions fell in Q1 to its most negative for a year (-3.0) amid a marked deterioration in manufacturing conditions. This should, however, mark the trough, with firms forecasting a modest improvement over the coming two quarters. Looking ahead, the back end of the week will bring goods trade figures for February on Thursday, which are likely to report still subdued export growth amid ongoing supply constraints and softer global demand. Certainly, the revised January IP numbers (also due Thursday) are likely confirm the sharp decline reported in the preliminary estimate (-4.6%M/M). January machine orders data (Thursday) will also likely point to a subdued outlook for private capex over the coming three months amid ongoing global uncertainties. But the latest territory activity numbers (Friday) might reported a further boost to the demand for services, not least due to the ongoing return of overseas visitors.