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Weekly Focus – Upbeat PMIs Paint Two-Sided Risks for the Central Banks

The January Flash PMIs painted a somewhat less negative growth outlook, reflecting lower energy prices and generally easing financial conditions. Both manufacturing and services indices recovered in the euro area, bringing the composite index above 50 for the first time since last June, and pointing towards recovering activity. US indices have remained at recessionary levels, but the January uptick suggests that the risk of a hard landing has eased. Broadly, we expect the global manufacturing PMI to bottom during Q1, which is earlier than we anticipated previously. See the details in Research Global – Global manufacturing PMI heading higher in H1, 25 January, where we also revised our forecast for US GDP growth higher to +0.3% for 2023 (from -0.2%) and +0.9% for 2024 (from +0.5%).

The uptick in developed market demand coincides with the brisk reopening-driven recovery in China. We will get more colour on Chinese holiday spending next week, when the January PMIs are due for release. For central banks, the early pick-up in activity is not purely a positive factor, as higher global demand could also mean more persistent inflation. While the European energy situation has eased markedly over the past months following warm weather and lower demand, the supply side still remains tight. Similarly, while US economy clearly lost steam towards the end of 2022, labour market conditions remain tight.

We think the ECB will remain firmly on tightening path, and hike its policy rates by 50bp in the next Thursday’s meeting, which is fully priced in the markets. While the final ECB members’ commentary has been mixed, we expect Lagarde to strike a hawkish tone and guide the markets towards another 50bp hike in March. Ultimately, we see ECB’s terminal rate at 3.25% in May, but risks remain tilted to the upside, see our ECB Preview – Set for another 50bp rate hike, 26 January. January Flash HICP figures will be released just ahead of the meeting on Wednesday; we look for an uptick both in headline (9.6%; from 9.2%) and core (5.4%, from 5.2%) terms. We discuss both economic and technical inflation factors related to the turn of the year in Euro inflation notes – January surprises, 25 January.

While markets are well priced for a 25bp hike from the Fed next Wednesday, we discussed the conditions for future Fed rate cuts in our Fed preview – What it takes for the Fed to cut rates, 24 January. In brief, if the recent decline in inflation expectations continues towards year-end, Fed could turn toward cutting the nominal policy rate to avoid high real rates driving the economy into an unnecessarily deep recession. That said, the recent uptick in commodity prices combined with the tight labour markets point towards upside risks as well. We still expect Fed to deliver three consecutive 25bp hikes before ending the cycle.

The latest ISM manufacturing, ADP, and JOLTs data will be released on the afternoon ahead of the FOMC meeting, and resilient signals from the labour markets could further support the hawkish narrative. Consensus expects lower nonfarm payrolls print in the Jobs Report next Friday, but we still expect relatively strong employment growth at 200k.

Rounding out the central bank week, we expect the Bank of England to deliver a 50bp hike. It will be a close call between 25 and 50bp, divided markets are leaning towards the latter. In our Bank of England Preview – Topside risk to EUR/GBP, 27 January, we revised our call with one more 25bp hike in March on the back of the recent strong data releases.

Danske Bank
Danske Bank
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