This week, the ECB delivered a 25bp hike which, combined with a dovish message, we see as a compromise in a stagflationary-ish environment. We were quite surprised by the limited optionality for further hikes in the statement, although Lagarde naturally refused to write off the possibility. We see the ECB’s approach now focusing much more on the time horizon for rates being in restrictive territory. As the new staff projections kept the forecast for headline and core inflation in 2025 above 2%, the road to neutral rates could end up being a long one. Our baseline is for the ECB to abstain from further hikes, and we see the next move being gradual cuts starting in the summer 2024 (see Flash ECB Review Confirmed: A final rate hike, but restrictive policies are not over, September 14).
Next week, focus turns to Federal Reserve which we expect to keep rates unchanged despite an upside surprise in August core CPI this week. The uptick in core was driven by faster services inflation, particularly airfares, but overall, underlying price pressures seem to have remained slightly higher than anticipated in early Q3. In this context, we think markets will keep a close eye on how FOMC participants assess the need for later hikes. In June, 12 out of 18 dots looked for one more hike, but we doubt it will materialise. Markets have bought into the ‘higher for longer’ narrative, and in our view, the consequent tightening in financial conditions limits the need for further hikes (see Research US: Fed preview – Plotting the way forward, 15 September).
We believe the Riksbank will deliver one final rate hike next week, as core inflation is still too high, and they want to be sure they are not relaxing monetary policy too early. Weaker SEK fuels inflation for imported products, and hence, Riksbank cannot deviate too much from ECB’s policy. Luckily for Riksbank, this time, ECB’s dovish hike weakened the euro versus the hard-hit Swedish krona. Also in Sweden, rates will remain high for some time, and we do not expect rate cuts until Q2 next year. Starting in Apr-2024, we expect 25bp cut at each meeting, taking the policy rate to 3.0% by year-end.
We also expect both Norges Bank and the SNB to deliver their final 25bp hikes next week accompanied, and we expect this to mark the peak for both central banks. For Bank of England, we also expect a 25bp hike to 5.50% but the August CPI print ahead of the meeting could prove decisive.
We expect no changes in monetary policy by Bank of Japan next Friday. We do however expect another tweak to YCC later this year. On Thursday, the People’s Bank of China (PBoC) announced a 25bp cut to the reserve requirement ratio for most banks. They also injected a net CNY191bn into the financial system through 1-year policy loans while keeping the lending rate unchanged. We see room for further policy support, if needed, to counter problems in the country’s real estate sector.
In terms of data releases, next week’s focus will be on September preliminary PMIs from euro area and the US on Friday. While global manufacturing has been in a contractionary territory for 12 consecutive months, service sector has kept the engine running, but in August, euro area service PMI fell below 50. We also expect modest weakening in the US driven by service sector.