ECB set to hike interest rates by 25bps today and will also likely signal further tightening ahead
The main event today will be the ECB’s policy announcements. Recent public comments from President Lagarde and other key policymakers have made clear that interest rates will be hiked further. So, having slowed the pace of rate hikes to 25bps in May, another increase of that magnitude in all main interest rates – taking the deposit rate to 3.50% – seems inevitable. This will take the cumulative tightening since last July to 400bps. And while it will continue to insist that policy will be data-dependent, the Governing Council’s forward policy guidance is likely to signal that a further hike of 25bps is expected to come in July, but that the path for rates thereafter will be guided by the following set of macroeconomic projections due in September. In terms of the ECB’s balance sheet, the Governing Council will confirm that reinvestments of the proceeds of maturing APP securities will cease from the start of July, but reiterate that it will continue full reinvestments of proceeds of maturing PEPP bonds through to end-2024. And while a huge repayment of TLTRO-iii loans is due later this month, we don’t expect the Governing Council to take any offsetting action to support liquidity.
The ECB will also publish updated macroeconomic projections today. Given the downward revision last week to the estimate of Q1 GDP to suggest a mild recession at the turn of the year, we expect the ECB to revise down its full-year growth forecast for 2023 (currently 1.0%), perhaps by about 0.3ppt, and its forecast for 2024 (currently 1.6%) more marginally. The downside surprise to the flash May estimate of inflation means that the ECB’s forecast of 6.0%Y/Y for Q2 looks broadly on track. And given the steeper than expected drop in wholesale energy prices, signs of a softening in food inflation, stronger euro exchange rate and slightly weaker GDP outlook, the ECB’s headline inflation projection of 5.1%Y/Y over 2023 as a whole could well be nudged lower. However, despite evidence of a further cooling in global goods prices, the Governing Council’s hawks will remain concerned about stickiness in core prices, particularly in services where price momentum still appears strong, justifying (in their view) the further monetary tightening.
PBoC cuts 1-year loan rate as Chinese recovery momentum ebbs
As expected, the PBoC cut the rate on its 1-year medium-term lending facility by 10bps to 2.65%, in its first such reduction in ten months. The move followed Tuesday’s reduction in the 7-day reverse repo rate. And it preceded the release of May’s economic data, which – consistent with the PMIs – suggested that recovery momentum faltered last month. In particular, retail sales grew 12.7%Y/Y, a full 1ppt below the median forecast on the Bloomberg survey and down 5.7ppts from the prior month, to suggest that private consumption is sagging amid subdued confidence. While spending on eating out remained strong (35.1%Y/Y), spending on consumer goods slowed (down more than 5ppts to 10.5%Y/Y). In line with expectations, industrial production rose a lacklustre 3.5%Y/Y, despite continued strong growth in the autos subsector (23.8%Y/Y). Urban fixed investment slowed to 4.0%YTD/Y, 0.4ppt below the median on the BBG survey, with private capex down 0.1%YTD/Y and investment growth entirely reliant on government and SOEs. But the pace of decline in property development investment accelerated by 1ppt to 7.2%YTD/Y. Finally, while the unemployment rate was unchanged at 5.2%, matching the lowest rate since the start of last year, the youth unemployment rate rose 0.4ppt to a new series high of 20.8%.
Retail sales and IP reports due on a busy day for US data after the Fed’s hawkish pause
So, unsurprisingly, the Fed left the target range for the fed funds rate unchanged at 5.00-5.25% yesterday evening, but also signalled further tightening to come. Indeed, the upwards revisions to the FOMC’s projections and dot-plot were more substantive than many had anticipated. The median forecast of GDP growth this year was revised up, the unemployment rate for year-end was nudged down, and core inflation at year-end was revised up. Most notably, the median fed funds rate for end-‘23 in the new dot-plot was 50 bps higher 5.625%, with 12 of 18 dots at or above that level. And the median FFR forecast for end-‘24 was raised by 375bps to 4.625%. Please read the commentary from Daiwa America’s Lawrence Werther here.
Data-wise, the US focus today will be on the May reports for retail sales and industrial production, although the usual weekly jobless claims figures are also due along with import prices, the Philly Fed and Empire manufacturing surveys among other releases. Following relatively firm growth in April, Lawrence expect both retail sales and industrial production to be unchanged on the month and hence to come in a touch softer than the consensus on the BBG survey. In retail, the flat reading will in part reflect a drop in the auto component, while lower fuel prices will restrain nominal sales at gasoline service stations. Ex autos and gasoline, Lawrence expects retail sales to rise 0.2%M/M. Meanwhile, industrial production is expected to be weighed by both manufacturing and mining, but utility output is expected to rebound following sharp declines in three of the past four months.
Net trade on track to provide a boost to Japan’s GDP growth in Q2 as easing supply bottlenecks drive acceleration in car exports
At face value, Japan’s goods trade report for May was less encouraging. Admittedly, the adjusted trade deficit narrowed to its smallest (¥778bn) since December 2021, while the unadjusted deficit (¥432bn) was the smallest since October 2021. But this reflected a much steeper drop in import values – the seventh consecutive monthly decline and by a sizeable 5.6%M/M – than export values (-3.1%M/M). And when adjusting for price effects, the BoJ’s measure of export volumes fell 3.5%M/M, the most in fourteen months. This is likely in part reflecting some payback for the strength seen in April, with the level so far in Q2 still some 1½% above the Q1 average. And with import volumes down a whopping 6.2%M/M in May and trending almost 1% below the Q1 average, overall today’s data suggest net trade is on track to provide a non-negligible positive contribution to Japanese GDP growth in Q2.
Subdued exports and imports are consistent with the picture of goods trade worldwide. But within the detail, the slowdown in export growth in May (0.6%Y/Y) reflected persisting weakness in shipments to elsewhere in Asia, with the decline (-8.1%Y/Y) the steepest for almost three years, reflecting double-digit drops in semiconductors, semi-conductor machinery, iron and steel and chemical products. In contrast, export values remained strong to the US (9.4%Y/Y) and EU (16.6%Y/Y), reflecting an acceleration in autos shipments – which in total jumped 78%Y/Y – on the back of easing supply bottlenecks.
Japanese machine orders post stronger-than-expected growth in April
Encouragingly, the rebound in Japan’s machinery orders data was firmer than expected at the start of Q2, with core orders up 5.5%M/M in April more than reversing the decline in March (-3.9%M/M). But orders were still down almost 6%Y/Y and three-month growth slowed 2ppts to 0.6%3M/3M, perhaps suggesting a softer pace of private sector investment growth over the coming quarter. This in part reflects ongoing weakness in orders placed by manufacturers, which fell for the second-successive month in April (-3.0%M/M), to be trending some 1½% below the Q1 average, with sizeable declines in ICT and ship building (albeit the latter was payback for a surge in the previous month). Meanwhile, orders placed by non-manufacturers jumped 11%M/M, underpinned by a jump in orders in the finance subsector to the highest level since May 2013. Surveys still, however, point to a firm pickup in business investment as the year goes on.
Rebound in Japanese tertiary activity firmer than expected at the start of Q2
While manufacturing production started the second quarter on the back foot, consistent with recent upbeat surveys, today’s Japanese tertiary activity figures were more upbeat. In particular, activity rose a stronger-than-expected 1.2%M/M in April, with the decline in March revised slightly softer too (-1.5%M/M). Overall, tertiary activity was more than ½% above the Q1 average. The improvement principally reflected a jump in transport activities (13.4%M/M), with ICT services, wholesale trade and real estate also providing a positive contribution too. In contrast, retail and healthcare services activities fell back.