Monetary policy

Fed to pause tightening cycle this week, but possibly leave the door open to future hikes
While the ECB pressed ahead with a likely final rate hike last week, the Fed is widely expected to pause its tightening cycle on Wednesday, maintaining the FFR target range at 5.25-5.50%. But it certainly won’t signal that the terminal rate has been reached. Since the July meeting, various officials have suggested that the rate hike cycle is nearing the end. But while jobs market data suggest that labour supply and demand is becoming better aligned, last week’s core CPI data were a touch firmer than expected. And with economic growth continuing to exceed expectations, Daiwa America’s Lawrence Werther expects the FOMC to leave the door open to one further rate hike this year. The FOMC’s updated economic forecasts and dot-plot will be closely watched for signals on the likely near-term policy path. Lawrence Werther expects an upwards revision to the median expectation for GDP growth in 2023 and possibly 2024, but possibly an upwards revision to the unemployment rate forecasts too. Overall, he thinks the dot-plot will continue to suggest one further rate hike this year, with a possible upwards tilt to the median projection at end-24 from 4.50-4.75% in July. The forecasts will also include projections for 2026.

BoE expected to hike rates by a further 25bps on Thursday, and accelerate the pace of QT
The BoE’s monetary policy announcement on Thursday is more uncertain to predict with confidence. On balance, we expect the MPC to hike Bank Rate by a further 25bps to 5.50%. However, we do not reject entirely the possibility that rates will be left unchanged. Since the August meeting, the macroeconomic data have been mixed. Two of the most important variables in the BoE’s current reaction function – services inflation and private sector wages – have so far exceeded the MPC’s forecasts. But another key variable – tightness in the labour market – has moderated much further than anticipated. And that softening of the labour market tallies with GDP data and recent surveys which suggest that the BoE’s growth forecast for the current quarter (0.4%Q/Q) is too strong. How the MPC responds to the data is unclear. The most hawkish MPC member (Mann) has already signalled her willingness to vote for another hike, while the most dovish (Dhingra) will vote for no change. Importantly, Governor Bailey and Chief Economist Pill have sounded much more dovish of late. Nevertheless, given the persistent strength in private sector pay and services inflation, and in the absence of a significant downside surprise in the August CPI data due Wednesday, we expect the majority to back one last hike in Bank Rate this cycle to 5.50%.

As well as deciding whether to raise rates again, the MPC will also discuss quantitative tightening (QT). In line with the preference expressed by Deputy Governor Ramsden, we expect the MPC to agree to increase the pace of balance sheet reduction over the twelve months from October. With the Gilt market having been untroubled by QT since the BoE started active sales last November, we would not be surprised to see the intended annual rate of reduction increased from about £80bn in the year to September to £100bn. With automatic run-off of the BoE’s bond-holdings set to rise from £35bn in the current period to £50bn over the twelve months from this October, active Gilt sales would still increase only modestly in the new period, by £5bn also to £50bn. If the Committee was keen to keep yields higher across the curve, the risks to that forecast could be skewed to the upside.

BoJ set to leave policy unchanged, with focus on Ueda’s post-meeting press conference
Having tweaked its yield curve control framework at the end of July to raise the upper limit on its 10Y yield target to allow greater flexibility, the BoJ’s latest Policy Board announcement on Friday is widely expected to see policy left unchanged, including the short-term interest rate at -0.1%. The Bank will continue to state its intentions to maintain QQE with Yield Curve Control for as long as it is necessary to achieve the 2% inflation target in a stable manner. And while inflation remains above the 2% target, the BoJ will again highlight extremely high uncertainties for the outlook for GDP growth and inflation. Likely of most interest at this week’s meeting will be Governor Ueda’s post-meeting press conference, where he will be pressed for greater clarity on his comments in a newspaper interview nine days ago of the possibility of ending the negative interest rate policy, possibly as soon as year-end. The role of the weak yen in the BoJ’s reaction function will also be watched.

Key economic data
Tuesday
Tomorrow will bring final euro area HICP figures for August. These will provide more granular detail and allow for calculation of measures of underlying inflation watched by the ECB. The flash figures suggested that headline inflation moved sideways at 5.3%Y/Y amid a pickup in energy prices related not least to the jump in petrol prices. But core inflation moderated a further 0.2ppt to 5.3%Y/Y. In the US, housing starts figures for August are expected to have remained very weak amid still elevated inventories of new homes and challenging affordability conditions.

Wednesday
A key focus will be UK CPI figures for August. Given the recent rise in the price of Brent crude oil and associated pick up in petrol prices, headline inflation is likely to have edged slightly higher last month, with our expectation for an increase of 0.3ppt to 7.1%Y/Y. While we think that services inflation merely moved sideways, a further moderation in non-energy industrial goods inflation should see the core CPI rate ease back slightly, by 0.2ppt to 6.7%Y/Y, a five-month low. Euro area construction output figures are expected to show that activity dropped at the start of Q3. Meanwhile, Japanese goods trade figures are to report a modest narrowing in the trade deficit in August. Despite an anticipated drop in the value of exports amid weaker global demand, the value of imports is expected to have declined more sharply.

Thursday
September sentiment surveys will dominate the data flow on Thursday, including the release of European Commission’s preliminary consumer confidence indicator and French INSEE business survey, which are expected to report a modest deterioration in conditions at the end of the third quarter. Meanwhile, in the US, existing home sales figures for August, as well as the Philly Fed business outlook survey and Conference Board’s leading indicators are also due.

Friday
The flash September PMIs will be released from the major economies, which will be watched closely for developments in economic momentum at the end of Q3. While the Japanese surveys are expected to remain consistent with ongoing expansion, the European indices are expected to imply continued contraction in both the euro area and UK, with a further loss of momentum in the services sector and significant challenges in the manufacturing sectors. UK retail sales figures are also due. While we might expect some partial rebound from the weather-dampened drop in July (-1.2%M/M), they are likely to suggest lacklustre consumer spending over the summer. Friday will also bring Japanese CPI figures for August, which are expected to see the headline inflation rate easing 0.3ppt to 3.0%Y/Y, which would be the lowest rate for a year. But when excluding fresh foods and energy, the BoJ’s preferred core CPI rate is forecast to have moved sideways at 4.3%Y/Y, the joint highest rate since the early 1980s.