Monetary policy

FOMC set to maintain a restrictive policy stance, but dot-plots to be revised lower
The main focus in the US this week will be the Fed’s monetary policy announcement on Wednesday. With the FFR target range widely expected to be kept unchanged at 5.25-5.50%, the Fed’s forward guidance, including the publication of updated economic projections and dot-plot charts will be of most interest. While recent data point to a moderation in economic momentum in Q4, this followed stronger than expected GDP growth in Q3, while last week’s payrolls report was largely consistent with still strong employment growth. And while inflation continues to ease, the Fed’s preferred price measure – the core PCE deflator (3.5%Y/Y) – will still be considered to be elevated. Indeed, while the Fed is likely to revise lower its full-year growth forecast for 2024 from 1.5% in the September projections, it might well leave its PCE deflator forecast unrevised (2.6%). The FOMC will also be mindful of the recent easing in financial conditions, with 10Y UST yields down almost 70bps since the Fed’s early November meeting.

As such, Daiwa America’s Lawrence Werther expects the FOMC to maintain the language in the policy statement leaving the door open to a further hike if required, and Powell to reiterate that policy will remain restrictive for some time. This notwithstanding, the updated dot-plots will suggest that the peak in rates has been reached, having previously forecast one additional hike this year. As a result, the end-2024 projection should also be revised lower, with a non-negligible risk that a third rate cut of 25bps could be added to next year’s profile, which would push the year-end median projection to 4.50-4.75%.

ECB to revise down profile of GDP and inflation but Lagarde could try to push against dovish market pricing
Like the Fed the day before, the ECB on Thursday will leave policy unchanged, with the Deposit Rate to be left at a record high 4.00%. And while the statement will reiterate that policy will be data dependent and that rates will be set at sufficiently restrictive levels for as long as necessary, we suspect that President Lagarde will echo the recent comments of Executive Board member Schnabel – who has typically been the most eloquent advocate of the hawks – that a further rate hike is now “unlikely”. Certainly, the ECB looks set to revise down its projections for GDP and inflation from three months ago, with full-year GDP growth in 2023 likely to be nudged down by 0.2ppt to 0.5%Y/Y, and its GDP projection for 2024 to be below 1.0%Y/Y. More importantly for monetary policy, the revised projections should suggest that headline inflation will average less than 3.0%Y/Y in 2024 and return to the 2.0% target by mid-2025.

Nevertheless, with core inflation still well above the 2.0% target at 3.6%Y/Y in November and likely to remain above 3.0%Y/Y until February at the earliest, and unit labour costs having risen at a record rate in Q3, Lagarde will be reluctant to suggest that a rate cut could come as soon as the first quarter of 2024. Indeed, given the likely discomfort of many Governing Council members to recent market moves, she might well try to push back somewhat against the marked downward shift in expectations of future rates, which has priced in five cuts of 25bps apiece over the course of next year. Moreover, in her press conference, Lagarde might remind that the Governing Council will soon discuss the possibility of an early end to PEPP reinvestments, which would tighten financial conditions somewhat even as the ECB pivots towards lower policy rates.

BoE to maintain a tightening bias despite recent drop in inflation
The BoE’s policy announcement on Thursday will also keep policy unchanged, leaving Bank Rate at 5.25% for a fourth successive meeting. But given the recent market shifts and fiscal policy easing, the MPC might well judge that economic growth over coming quarters is likely to be somewhat firmer than it anticipated in its projections published last month. And although the MPC will have welcomed the big drop in inflation in October of 2.1ppts to 4.6%Y/Y, 0.2ppt below the MPC’s projection, with core inflation also the softest since March 2022, given that services inflation (6.6%Y/Y) remains highly elevated, the BoE’s policy statement will surely repeat its concerns that the risks to the inflation outlook remain skewed to the upside. The MPC will therefore also again underscore that “monetary policy is likely to need to be restrictive for an extended period of time”. And so, pushing back against market pricing, which is now consistent with a first rate cut next June, it will maintain a tightening bias, restating that “Further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures.” Indeed, as in November, we suspect that three MPC members will again vote for a hike this month.

Key economic data

The coming week will also be a busy one for top-tier economic data. Most significant in the US will be the release tomorrow of the November CPI estimates. Not least given the decline in gasoline prices last month, Daiwa America’s Lawrence Werther expects only a modest increase in consumer prices (0.1%M/M) following no increase in October. This would take the annual headline CPI rate down 0.1ppt to 3.2%Y/Y. But given ongoing increases in rents and owner-occupied housing costs as well as a moderation in discounting in used vehicle prices, core consumer prices are expected to have risen 0.3%M/M, to leave the annual unchanged at 4.0%Y/Y. November figures for retail sales (Thursday) and industrial production (Friday) are also due.

Tomorrow will also bring the latest UK labour market figures. The suspension of the ONS’s Labour Force Survey, due to the marked decline in the response rate, means that the information provided by the labour market report will be less comprehensive than normal. But those figures to be published – including payroll jobs, the claimant count and vacancies – will be watched for evidence of a further softening of the balance between supply and demand, as suggested by survey results such as last week’s REC report. And although the annual rates of average earnings growth will remain very elevated, they are likely to imply a notable slowing of momentum. This will be followed by UK GDP figures for October (Wednesday). We expect these to report a third successive very modest monthly increase in growth, which would suggest that a contraction should be avoided in Q4.

Ahead of the BoJ’s forthcoming policy-setting announcement on 19 December, the key Japanese release this week will be the BoJ’s comprehensive quarterly Tankan Report on Wednesday. This is expected to report a modest improvement in business sentiment among large manufacturers in Q4, while the headline non-manufacturing DI is forecast to move sideways at 27, which was the highest since 1991. The survey’s inflation expectations measures will also be closely watched. In September, firms’ expectations for CPI in five years’ time moved sideways at just above the 2% target. But expectations for the cumulative increase in their own output prices over the coming five years was revised lower to just 4.4%Y/Y.

Friday’s highlights include the flash PMI surveys for December from the euro area, UK, US and Japan, which are likely to be consistent with mild contraction (euro area) and broad stagnation elsewhere at the end of the year. Friday will also bring the latest Chinese monthly activity figures for November.