Monetary policy

Fed to leave policy unchanged, but Powell’s press conference to be watched closely for guidance into the timing for the first rate cut and possible tapering of QT
All eyes this week will be on the conclusion of the Fed’s FOMC meeting on Wednesday. The immediate policy decision seems highly likely to keep the FFR target range unchanged at 5.25-5.50%, supported by still robust growth momentum at the turn of the year. But with the inflation outlook becoming more favourable, the FOMC might well amend its forward guidance in the policy statement to more neutral language in anticipation of the start of the rate-cutting cycle later this year. And Chair Powell will certainly be pushed in his post-meeting press conference for more insight into the likely timing of the first cut. Meanwhile, Powell might well also provide more guidance on the tapering of the Fed’s balance-sheet normalisation.

BoE to leave rates unchanged, but downward revision to inflation projection should prompt more dovish rate guidance
Thursday will bring the BoE’s latest monetary policy announcement and updated macroeconomic projections, which will steer the MPC’s rate decision and forward guidance. Like the Fed, the BoE is expected to keep Bank Rate unchanged at 5.25%. But having previously maintained a tightening bias in its forward guidance, the MPC statement should certainly drop its rate-hike bias and acknowledge that, if inflation follows the path assumed in its projection, the next move in rates is likely to be down. Indeed, we would not be surprised if one MPC member (Swati Dhingra) voted to ease policy at this meeting, and expect at most only one member (Catherine Mann) compared to three in December to continue to vote for a hike.

Certainly, since the December MPC meeting, the November CPI inflation data surprised significantly on the downside. And while the December CPI figure was above the market consensus at 4.0%Y/Y, it was still 0.6ppt below the BoE’s projection for the month. Importantly too, at 6.4%Y/Y, services inflation – which is currently one of the key variables in its policy reaction function – undershot the BoE’s forecast by 0.5ppt. Pay momentum over the past few months has arguably also slowed to levels consistent with the achievement of the inflation target over the medium term. And GDP has been softer than previously assumed, with recent hard data – including retail sales and output in manufacturing and construction – pointing to a possible second successive slight contraction in Q4, despite the positive signals from the PMIs. Nevertheless, the economic outlook for 2024 appears to have brightened somewhat since the publication of the November Monetary Policy Report, thanks in part to a loosening of fiscal policy, declining energy prices from three months ago and a reduction in mortgage rates. So, the BoE will see a significant improvement in real household disposable income compared to its previous forecast, and accordingly revise up its projection for private consumption and GDP. While firmer activity will mean that less economic slack accumulates over the course of the year, the recent softening of momentum in services inflation and private pay growth, as well as a lower path for household energy and petrol prices, will allow for a significant downwards shift in the BoE’s inflation forecast. The Bank previously expected inflation to fall below 2.0%Y/Y in 2025. We now expect inflation to fall below 2.0%Y/Y in Q224, return to about 2.0%Y/Y through the second half of the year, but then fall back close to but below 2.0%Y/Y in 2025. Please see Friday’s euro wrap-up for more detailed insight.

Data highlights

Euro area flash January inflation and Q4 GDP estimates in focus
This week will bring plenty of top-tier euro area data, including the flash January inflation estimates and preliminary estimates of Q4 GDP. The near-term inflation profile remains highly uncertain, not least given a range of tax and subsidy changes at the start of the year as governments continued to withdraw policy support to consumers and businesses, as well as a reweighting of the inflation basket to reflect the shift in consumption patterns last year. In line with the consensus, our expectation is for headline euro area inflation (due Thursday) to ease slightly, albeit not fully reverse December’s pickup, taking the HICP rate down 0.2ppt to 2.7%Y/Y. Given an anticipated further drop in non-energy industrial goods inflation, we also forecast core inflation to maintain a moderate downwards trajectory, by 0.1ppt to 3.3%Y/Y, which would be the lowest since March 2022. We see the risks to those forecasts as skewed to the downside, but the figures from Germany and France (Wednesday) and Spain (tomorrow) will offer some guidance ahead of the euro area figures.

In terms of economic activity, the first estimates of Q4 GDP (tomorrow) will be downbeat. In line with the Bloomberg consensus, we forecast euro area GDP to contract by 0.1%Q/Q for a second successive quarter. The economic performances of the member states will likely be mixed. Destatis already reported with its advance full-year estimate that German GDP likely declined by 0.3%Q/Q while Friday’s Irish figures reported a drop of 0.7%Q/Q to represent a fifth consecutive quarterly fall in GDP. Among the larger member states still to report, we also expect a modest contraction in Italy (-0.1%Q/Q), but positive growth in France (0.1%Q/Q) and Spain (0.2%Q/Q). Among other data due in the coming week, the European Commission’s latest business and consumer surveys (tomorrow) will also flag a lack of economic momentum at the start of the year, while euro area unemployment figures for December (Thursday) are expected to report that the headline rate was unchanged at the series low of 6.4%.

US payrolls report and employment cost index the data focus in the week ahead
In the US, the key data highlight will be Friday’s release of the January employment report. With sluggish hiring trends in cyclical areas (transportation and warehousing and financial services) and anecdotal reports of layoffs picking up, underlying conditions in the labour market appear to be softening. The figures may also be distorted by unusually cold weather during the data collection period. This notwithstanding, Daiwa America’s Lawrence Werther expects non-farm payrolls to have increased a solid 185k, close to the average in the H223. Admittedly, the unemployment rate could tick higher to 3.8% due to a rebound in the labour force, following the plunge in December (-676k compared with +284k in the first eleven months of 2023). An anticipated solid pace of hiring could support growth of average hourly earnings at a pace close to the 2023 average of +0.3%M/M, which would see annual growth of 4.1%. Meanwhile, the employment cost index for Q4 – the Fed’s preferred comprehensive measure of wage growth – (due Wednesday) is expected to report total compensation growth of 1.0%Q/Q, a touch softer than the averages of 1.1% in the first three months of 2023 and 1.2% in 2022. Also of interest this week will be the results of the January Conference Board consumer confidence survey (tomorrow), manufacturing ISM survey (Thursday), and December factory orders figures (Friday).

Business inflation and pay expectations the data focus in the UK
In the UK, the most noteworthy data this week will probably be the January results of the BoE’s Decision-Maker Panel business survey (Thursday). The December survey reported a welcome decline in firms’ inflation expectations for the coming year (to 4.0%Y/Y) and the medium term (2.9%Y/Y). But the survey also reported a pickup in 12-month wage-growth expectations to the highest in nine months (5.4%Y/Y). Other new data due this week include December’s bank lending figures and the January BRC shop price survey (tomorrow), the Nationwide house price index for January (Wednesday), and the final January manufacturing PMIs (also Thursday). According to the flash estimates, the manufacturing sector had a disappointing start to the year, with the output PMI falling 0.5pt to a three-month low of 45.0, marking the eighteenth sub-50 “contractionary” reading out of the past nineteen months, and leaving the index some 1.3pts below the Q4 average. The flash PMIs also reported a further decline in domestic orders as well as a weakening in export demand. But arguably of most interest for the BoE, will be the pickup in input cost burdens amid increased supply-side disruptions associated with events in the Red Sea.

Japanese industrial production, retail sales and labour market figures due
Finally, the week ahead will bring a deluge of month-end top-tier releases from Japan, kicking off tomorrow with the latest labour market report, which is expected to see the unemployment rate unchanged at 2.5%. December’s industrial production data (Wednesday) are expected to bring a notable rebound in output that month following the decline of 0.9%M/M in November. Indeed, forecast growth of 2.5%M/M would leave output up more than 4½%Q/Q in Q4, the most in five quarters. In contrast, the value of retail sales is expected to merely move sideways in December, to leave it down around ½%Q/Q in Q4. January’s consumer confidence survey will provide an update on households spending intentions at the start of 2024.