Weekly Focus – Hawkish Messages from the Fed and ECB

In a big central bank week, the ECB delivered a 25bp hike, which was no surprise, but an upward revision to the 2025 inflation forecast to 2.2% from 2.1% clearly indicated that the ECB has more work to do. ECB President Lagarde confirmed that the hiking journey is not over yet and that a rate increase in July was “very likely“. As expected she left little guidance beyond July as uncertainty is high and they take a meeting-by-meeting approach. However, we continue to expect the ECB to reach the rate peak in September at 4.0% as there are no signs that the super tight labour market is easing in the coming months, see ECB Review – ‘Very likely to hike again in July‘, 15 June.

The Fed on the other hand paused its rate hiking cycle on Wednesday as widely anticipated, but they delivered a hawkish message as the updated median rate projection signalled two more 25bp rate hikes by the end of 2023. The 2023 GDP forecast was lifted to 1.1% (from 0.4%), suggesting that the outlook for more rate hikes relies on a fairly optimistic growth assumption. As we remain more pessimistic on the macro outlook for H2, we also think that the projected rate hikes will not end up materializing, and stick to our previous forecast of no rate changes by the Fed for the remainder of the year, read more from our Fed review: Powell’s hawkish bluff, 14 June, and see also our thoughts on the latest inflation data and outlook from Global Inflation Watch – Euro area inflation pressures remain sticky, 14 June.

The Chinese central bank is going against the global trend and cut the policy rate by 10bp this week. It follows signs of a sputtering recovery and data on Thursday confirmed weakness in housing and manufacturing in May, while the service sector is holding up still. We expect to see a broader stimulus package soon aimed at providing more support to housing and sustaining demand from consumers. Bank of Japan did not make any changes on Friday but we expect to see a moderate tightening in July or September.

Bond yields trended higher this week on the back of the hawkish signals from the Fed and ECB with especially short end yields rising. The central banks didn’t scare stock markets, though, which saw further upside taking S&P500 to the highest level in more than a year, not least driven by a strong rally in tech stocks. EUR/USD also rebounded again lifted by a stronger rise in euro short end rates relative to the US.

Next week the key focus will be Flash PMI’s for May in US and the Euro zone.  Manufacturing has been weak lately while service has been strong. Will we see some convergence this month? We also have a range of Fed speakers that may cast more light over Fed’s view on future tightening. Inflation data in Japan will be key to gauge the outlook for a possible tightening of monetary policy. In Emerging markets, the central bank meeting in Turkey on Thursday will be interesting following new appointments of Simsek as finance minister and Erkan as central bank governor. Also look out for possible stimulus announcements in China. On Tuesday we will publish Nordic Outlook with updated macro forecasts for the Nordics as well as the global economy.

Full report in PDF.