The BoJ: At long last, first steps towards policy normalisation?
After Friday’s announcement by Japan’s trade union confederation Rengo that the initial average pay settlement in this year’s spring wage round beat market expectations with bumper growth of 5.28% – almost 1.5ppts stronger than last year and more than 3ppts above the average of the prior five years – the BoJ surely now has sufficient evidence to justify a belated first step to normalising its monetary policy.

Indeed, with CPI inflation having exceeded the 2% target for almost 2 years, the Bank’s preferred core inflation measure still at 3½%Y/Y, and the BoJ having before the spring pay round expected inflation to fall only 0.1ppt shy of the target over the next two fiscal years, a decision not to end the current policy settings – which appear tailored more for a crisis environment rather than the current period of macroeconomic normality – would seem more confusing for investors. And after the latest US inflation data led the market to revise up its view of the outlook for Fed rates, the external environment as well as Japanese financial markets appear highly conducive for a move from the BoJ this week.

Given the complexity of the BoJ’s current policy framework, tomorrow’s policy announcement will be multifaceted. We expect the following:

• In terms of interest rates, we expect an end to the -0.1% negative rate policy, which has been in place for the past eight years. On balance, we also think the BoJ will replace the three-tier framework for bank reserve remuneration with a simple single interest rate on excess reserves set at +0.1%. As such, the BoJ will likely target a range of 0.0-0.1% for the uncollateralised overnight call rate, which in practice, should rise from a little under 0.0% to just below 0.1%, effectively representing a hike of 10bps from the status quo – an amount that should have a minimal impact on the outlook for growth and inflation.
• In terms of asset purchases, we expect yield curve control (YCC) to be ended. In its place, a regular QE programme will likely be introduced, maintaining the current JGB purchase pace of close to JPY6trn per month for the time being. But the BoJ’s purchases of ETFs and J-REITs will likely be formally ceased, confirming the Bank’s evident determination to resist further exposing its balance sheets to those markets over recent months. It is unlikely just yet, however, to set out what it intends to do with its stock of ETFs and J-REITs accumulated over the past decade.
• In terms of forward guidance, given the recent extended run of above-target inflation prints, the BoJ’s overshooting commitment – whereby the Bank pledged to continue expanding the monetary base until inflation exceeded the target in a stable manner for an extended period – could well be dropped. But Ueda will emphasise continuity of policy, insisting that the monetary stance will remain accommodative for an extended period, and downplaying the likelihood of a series of rate hikes over coming quarters.

With markets having for some time been pricing the likelihood that both the negative policy rate and YCC would be ended this spring, if tomorrow’s policy announcements proceed as we expect, we would not expect major market shifts to occur. Yields might well move higher as tightening is confirmed. But the BoJ’s determination to avoid discontinuity, including the pledge to sustain purchases of JGBs around recent rates, should reduce risks of any significant spike in yields. Based on our current economic outlook, we do not expect 10Y yields to rise above 1.0% for a sustained period this year. And given the likelihood that rate differentials with other currencies will remain wide over the horizon, the yen should remain soft. Meanwhile, the recent absence of purchases of ETFs and J-REITs means that the BoJ’s announcements should be taken broadly in their stride by those markets too.

Looking ahead, we share the view, implied by current market pricing, that any further tightening over the rest of 2024 will be very modest, with the rate on excess reserves likely merely to reach 0.25% by year end. Thereafter, however, with uncertainty about Japan’s natural rate of interest barely less than those of other major markets, the extent of further tightening possible in 2025 and beyond is admittedly much less clear-cut. But BoJ rates certainly won’t be going anywhere near the lofty heights of those currently in place at the Fed, ECB and BoE.

Of course, it can’t be ruled out yet that the BoJ might decide that, while steps towards policy normalisation are now merited, the end of fiscal year might not be the best time to end negative rates and YCC. So, there is still the outside possibility that it delays the move this week. But, in that circumstance, it might still be expected to give a strong signal that the first steps to policy normalisation will be made in April. If not, the market confusion and associated turbulence and damage to BoJ credibility that might be triggered would probably be more damaging than anything triggered by a decision to tighten policy this week.

The Fed: Dots to be less dovish & FOMC’s inflation outlook at risk of an upwards nudge?
The Fed’s policy decision this week is set to be straight forward – rates will inevitably be left unchanged. Despite the recent couple of uncomfortable upside surprises in the inflation data, we don’t expect meaningful changes from the March FOMC statement. And most notably, the Committee’s easing bias should remain intact.

However, the new dot plot of FOMC member views about the future path for the fed funds rate is more uncertain. On balance, we still expect the FOMC median view to signal the likelihood of three rate cuts before the end of the year and expects the dots for 2025 again to suggest the expectation of 100bps of cuts next year. But we don’t reject the possibility that the median dot will imply just two cuts totalling 50bps this year. And in his press conference, Fed Chair Powell might well significantly downplay the likelihood that rates will be able to be cut as soon as May.

In terms of the Committee’s economic projections, the inflation outlook might well be revised up to reflect recent disappointments. But the unemployment rate projection could at the same time be nudged up too. Meanwhile, on other matters, Chair Powell might note in his press conference that officials had an initial discussion of the Fed’s current programme of quantitative tightening, which could suggest that a decision to slow the pace of balance sheet run-off will probably be made in June.

BoE: Rates & guidance to be unchanged & backed by a larger majority
Like the Fed, the BoE is bound to leave rates unchanged this week. And, with the MPC’s tightening bias already dropped last month, we also expect minimal changes to be made to its forward guidance. But the Committee will need to take stock of recent data and news, including the weaker-than-expected end to last year for GDP, firm signs of a pickup in growth in Q1, the downside surprise to inflation in January and the February CPI report (due on Wednesday), as well as the government’s modest easing of fiscal policy earlier this month.

While Governor Bailey is now less concerned about second-round effects on inflation emanating from the labour market, and the near-term inflation outlook might be judged by the Bank to have improved again somewhat compared to its February projections, the majority on the MPC will still consider it too soon to cut rates. Indeed, while inflation next quarter is likely to fall below 2.0%Y/Y, at least until new projections are published in May it will consider that a lasting return of inflation to target will not materialise before 2025.

As such, the MPC’s statement will repeat this week that monetary policy will need to be restrictive for an extended period. And the Committee’s guidance will reiterate that the underlying tightness of labour market conditions, wage growth and services price inflation remain the most important variables in its reaction function for determining when rates might be cut.

Indeed, we expect that, once again, only one member (the uber-dove Dhingra) will vote for a cut. But we also expect one of the hawks (Haskel) to shift from backing a rate hike to supporting the status quo. And so, there is likely to be only one member (Mann) still voting for extra tightening this month. Our baseline forecast assumes that rates will be cut for the first time this cycle in August, with additional cuts to come at each successive meeting thereafter in to 2025. But a cut in Q2 still cannot be ruled out.

This week’s data:

Monday:
Japan’s machinery orders data, published overnight, saw private sector core orders – which offer a guide to capex growth three months ahead – fall a steeper-than-expected 1.7%M/M in January, with growth in December also downwardly revised 0.8ppt to 1.9%M/M. The weakness was led by the manufacturing sector (-13.2%M/M), with a notable drop in orders placed in the chemicals industry reversing the increase in December. More encouragingly, orders placed by non-manufacturers rose for the first month in four and by the most since June (6½%M/M). Today will also bring updated euro area HICP inflation figures for February. The flash inflation estimates saw the headline HICP rate fall 0.2ppt to 2.6%Y/Y, despite a smaller drag from energy amid a jump in petrol prices. Food inflation dropped to its lowest level in more than two years, while core goods inflation fell to its softest rate since mid-2021 and the services component resumed a downtrend. As such, core HICP inflation fell 0.2ppt to a near-two-year low of 3.1%Y/Y. Today’s release will provide more granular detail, which will allow other measures of underlying inflation watched by ECB policymakers to be calculated. And, on balance, these should flag continued easing of price pressures last month. Euro area goods trade figures for January might well report a widening in the trade surplus, in line with the jump in German exports that month.

Tuesday:
Tomorrow will bring the first of the week’s European sentiment surveys, with the German ZEW investor survey for March. While sentiment for the coming six months will benefit from expectations of lower interest rates, investors will remain downbeat about the current situation, with the balance firmly in negative territory and consistent with contraction in Germany. In the US, housing starts figures for February are expected to have partly reversed the weather-assisted slump at the start of the year (-14.8%M/M), that saw single-family starts drop 4.7%M/M and multi-family starts decline 35.6%M/M. Updated Japanese industrial production figures for January are likely to confirm the marked decline in the initial release (-7.5%M/M) as car production went into sharp reverse amid a temporary shutdown at several plants.

Wednesday:
We expect UK inflation figures to report a drop in the headline CPI rate to 3.4%Y/Y in February – a touch below consensus and the BoE’s expectations – which would be the lowest since September 2021. While the energy component will again add to inflation, we expect the other major components to more than offset that impact. Most notably, in part reflecting a significant base effect from a year earlier when prices in the category rose the most in any February on the series, services inflation is also likely to drop about ½ppt to 6.0%Y/Y or less for the first time since January 2023. As a result, we expect core inflation to fall a chunky 0.6ppt to 4.5%Y/Y, which would be the lowest since December 2021. Meanwhile, the European Commission’s preliminary consumer confidence indicator for March will likely report only modest improvement, while euro area construction output for January is likely to have benefitted from unseasonably mild weather at the start of the year. Aside from the data, ECB President Lagarde will give a keynote address at the start of the ECB Watchers conference, while Chief Economist Lane and influential Executive Board member Schnabel will participate on panel discussions

Thursday:
The flash March PMIs will be the main focus in Europe and likely to support our view that GDP returned to modest positive growth in both the euro area and UK this quarter. Admittedly, despite rising to an eighth-month high in February (48.9), the euro area composite output PMI might well remain below the key-50 “unchanged” level for a ninth consecutive month in March due to ongoing contraction in the manufacturing sector, particularly in Germany. But the services activity index is likely to point to a return to growth. Meanwhile, having risen to its highest level since May 2023 (53.0), the UK composite PMI is expected to move broadly sideways in March consistent with moderate expansion, similarly supported by the services sector. The Philly Fed sentiment survey is also due, while existing home sales figures are expected to report renewed weakness in February in line with a drop in pending home sales to remain at the bottom of the recent range. Japan’s goods trade report for February is also scheduled for release. Having recorded the first surplus since May 2021 in January, the trade balance is expected to have deteriorated in February, although the timing of the Chinese New Year holiday often distorts results at this time of year. 

Friday:
Focus at the end of the week will turn to Japan’s CPI figures for February. In line with the findings of the Tokyo CPI report, headline CPI is forecast to have jumped that month, by 0.7ppt to 2.9%Y/Y, a four-month high, due to base effects associated with the introduction of household energy support last year. When excluding energy and fresh foods, the BoJ’s preferred core CPI measure is expected to have moderated for a sixth successive month, albeit remaining above 3%Y/Y for a 15th consecutive month. Meanwhile, UK retail sales data for February might well slip back slightly following the discounting-driven rebound of 3.4%M/M in January. And we expect the GfK consumer confidence index for March to reverse the modest 2pt drop seen in February to remain well below the long-run average albeit well above the lows of the past two years. Following the flash PMIs, Germany’s ifo business survey will also offer further insight into recent developments in the construction and retail subsectors. Overall, the current assessment balance will remain consistent with contraction at the end of Q1.