Monetary Policy

Fed to keep interest rate on hold, with Powell likely to reiterate that case for a rate cut has diminished
The main monetary policy decision this week will be the Fed’s announcement on Wednesday. But given the ongoing flow of stronger-than-expected data – including not least last week’s Q1 final private domestic demand estimate and PCE deflators – and more hawkish commentary from various FOMC members, the Fed certainly won’t amend its FFR target range from 5.25%-5.50%. And the message from the policy statement and Powell’s post-meeting press conference will likely have a hawkish tone, with the Fed Chair likely to reiterate that further progress on inflation might be slow and the FOMC will need to be patient. And while we will have to wait until June for updated economic projections and dot plot charts, Powell is likely to restate that the case for a rate cut has diminished. Beyond the interest rate outlook, Powell might well give further insights into discussions on potential adjustments to QT, with the minutes from the March FOMC meeting suggesting a desire to halve the pace of redemptions (currently $60bn for Treasury securities and up to $35bn per month for agency debt and agency MBS). On balance, however, Daiwa America’s Lawrence Werther expects the announcement to taper QT to come in June.

Data highlights in the week ahead

Today:
This morning brought the release of the European Commission’s economic sentiment survey indices, which arguably provide the best guide to euro area GDP growth. But while consumer confidence rose to a two-year high, and the flash PMIs suggested that economic recovery momentum has picked up a little further at the start of Q2, the headline ESI fell back in April reflecting a broad-based deterioration in business sentiment.

Today’s flash April inflation figures from Germany are likely to report a modest pickup in the headline HICP rate reflecting not least higher prices of auto fuel and the end of the reduced VAT rate on household energy. Spanish inflation also ticked slightly higher in April, with the EU-harmonised HICP rate up 0.1ppt to 3.4%Y/Y. But this principally reflected higher gas prices, while the VAT increase in electricity bills to 21% from 10% also came into effect this month. When excluding fresh foods and energy, the national core CPI measure fell 0.4ppt to a 27-monht low of 2.9%Y/Y.

The first estimate of Ireland’s GDP for Q1 - which often has a significant impact on the euro area figure - will also be closely watched.

Tuesday:
A busy day will bring top-tier releases from across the major economies. The highlights from the euro area will be flash estimates of inflation in April and GDP growth in Q1. Having dropped in March to 2.4%Y/Y, the bottom of the range of the past 2½ years, we expect headline consumer price inflation to be unchanged in April. But that likely reflected higher energy. Most importantly, we expect core inflation to drop for a ninth consecutive month, by a chunky 0.4ppt to 2.5%Y/Y, the lowest since January 2022, benefitting in part from a significant base effect in services inflation. Meanwhile, the preliminary estimates of economic output in Q1 should be relatively encouraging too. Following a flat fourth quarter, euro area GDP looks to have returned to positive growth in Q1, and probably by 0.2%Q/Q, 0.1ppt above the ECB’s projection. Growth in Q1 appears to have been flattered by a rebound in construction output, particularly in Germany, where GDP looks to have edged up 0.1%Q/Q following the drop of 0.3%Q/Q in Q4. We also think that growth in France ticked up 0.1ppt in Q1 to 0.2%Q/Q. But growth in Italy and Spain might have moderated from Q4 to 0.1%Q/Q and 0.3%Q/Q respectively.

In the US, the Employment Cost Index– the Fed’s preferred measure of compensation – is expected to report a slight uptick in Q1 to 1.0%Q/Q, thanks to firm wage growth. While this would leave compensation growth a touch below the average in 2022 (1.2%) and 2023 (1.1%), it would still be inconsistent with the Fed’s 2% inflation target. The Conference Board’s consumer survey indices are expected to see headline confidence dip for a third successive month amid a pickup in gasoline prices and economic uncertainties.

In Japan, March figures for industrial production and retail sales will be watched for further insights into Q1 GDP. Having declined in January and February due to a temporary halt in operations at Toyota’s small-car unit, manufacturing production is expected to have jumped in March as car production resumed. But despite a forecast rise of 3 ½%M/M, this would still leave output down almost 5½%Q/Q in Q1 and therefore a non-negligible drag on GDP. Meanwhile, the value of retail sales is expected to have fallen for the first month in three (-0.3%M/M), albeit leaving the Q1 average slightly higher than Q4. The latest labour market figures are also due.

In the UK, the BoE’s bank lending figures for March are likely to signal a further modest increase in mortgage approvals, reinforcing improved demand amid signs of a turnaround in the housing market. Meanwhile, the BRC shop price index for April is also due.

Wednesday:
In the US, the manufacturing ISM for April will be the highlight. But while the headline index moved into expansion territory in March following 16 consecutive sub-50 ‘contractionary’ readings, the broader performance in the factory sector remains uneven amid an uncertain economic outlook. The JOLTS figures for March and ADP employment report for April area also due. Elsewhere, final April manufacturing PMIs from the UK and Japan are also due.

Thursday:
In the US, the Q1 estimate of nonfarm productivity will be the highlight. The output measure that feeds into the calculation of nonfarm productivity rose moderately in Q1 (1.3%Q/Q ann.), with available data suggesting that hours worked rose at a similar pace. As such, Daiwa America’s Lawrence Werther expects nonfarm productivity to have slowed sharply in Q1 to around 0.3%Q/Q ann., down from an average of 3.7%Q/Q ann. in the previous three quarter. The combination of potentially anemic productivity growth and a brisk increase in wages suggest a jump in unit labour costs in Q1.

In the euro area, final manufacturing PMIs are expected to confirm that the output component remained firmly in contractionary territory, albeit suggesting the softest pace of decline in twelve months in April.

Friday:
Attention on Friday will be firmly on the US labour market report. Having jumped a stronger-than-expected 303k in March, the rise in payrolls this month is expected to have moderated slightly, albeit still implying solid jobs growth. Daiwa America’s forecast is for a rise of 235k, a touch below the Bloomberg survey consensus of 250k that is broadly in line with the average in 2023. This would leave the unemployment rate unchanged at 3.8%. Meanwhile, average hourly earnings are expected to remain close to the average in Q1 of 0.3%M/M, consistent with annual growth of 4.0%. Meanwhile, the services ISM is expected to signal ongoing positive momentum in the sector amid solid domestic demand.

In the euro area, unemployment figures for March will point to ongoing resilience in the labour market. In particular, the unemployment rate is likely to remain for a fifth successive month at the series low of 6.5%.

Final services PMIs for April also due from the UK. According to the flash PMIs, UK economic momentum at the start of Q2 picked up further led predictably by the services sector. Most notably, the composite PMI jumped in April by 1.2pts, well above expectations and the most since December, to an 11-month high of 54.0, bang in line with the average in the two decades before the pandemic. The flash survey also reported a notable increase in cost pressures, although the composite output price PMI fell to an eight-month low, suggesting that these were increasingly being absorbed by margins.