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The Bank of Canada cut the overnight rate to 4.50% (from 4.75%), while stating that it will continue with Quantitative Tightening (QT).

The Bank outlined a relatively dovish take on the economy, stating that "…the economy's potential output is still growing faster than GDP, which means excess supply has increased. Household spending, including both consumer purchases and housing, has been weak. There are signs of lack in the labour market. The unemployment rate has risen to 6.4%, with employment continuing to grow more slowly than the labour force and job seekers taking longer to find work."

On inflation, the Bank painted a less dovish picture than what was communicated in their June decision. However, it still noted that headline inflation moderated last month, preferred core measures remained below 3%, and that the breadth of price increases in the CPI is near its historical norm.

The accompanying Monetary Policy Report (MPR) showed a downgrade to annual average real GDP growth in 2024 (1.2% vs 1.5%), reflecting a weaker-than-expected first quarter performance. However, growth in 2024Q3 is seen as accelerating to 2.8% annualized. For 2025, the Bank's GDP growth forecast is relatively unchanged at 2.1%. Despite the dovish overall tone in the statement, we're still below the Bank in terms of expected GDP growth next year. This reflects our relatively more cautious view around consumption (and housing) that will continue to feel the pinch of elevated rates. In 2026, the Bank now sees growth at 2.4% versus 1.9% in the April MPR.

The Bank upgraded its 2024 forecast for overall inflation (2.4% on a Q4/Q4 basis, versus 2.2% in April). In 2024Q3, inflation is expected at 2.3%. Meanwhile, it's 2025 and 2026 forecasts were downgraded a touch (2.0% in both years versus forecasts of 2.1%). Meanwhile, core inflation (expressed as the average of the Bank's preferred measures) is seen at 2.4% this year, before easing to 2% in 2025 and 2026. For the latter two years, inflation is expected to remain well behaved, even with economic growth forecast to exceed potential, as slack built up this year is absorbed.

Key Implications

And just like that, Canadians were treated to a bit more rate relief today. With job market slack rapidly building, the economy in excess supply, inflation expectations continuing to normalize and U.S. policymakers now openly musing about lowing their own policy rate, the Bank of Canada was comfortable enough to trim its policy rate. The BoC doesn’t appear overly concerned about the recent regression in core inflation trends. We should note that even with today's move, a 4.50% policy rate that's well north of inflation is still quite restrictive and as such, the economy will still its pressure.

Where do we go from here?  In our June outlook, we'd incorporated a year-end target of the 4.25%, with the final cut set to take place in the fourth quarter. While the ultimate destination may remain the same, the dovish lean in today's Statement raises the risk of more easing by year-end than what we've penciled in. All eyes now turn to Governor Macklem's press conference at 10:30 am.

The euro edged lower on Wednesday but has recovered. In the North American session, EUR/USD is trading at 1.0860, up 0.07% on the day at the time of writing.

Eurozone PMIs weaker than expected

Eurozone PMIs can be viewed as monthly report cards for the services and manufacturing services. The July PMIs decelerated and indicate a bumpy eurozone recovery. The Services PMI eased to 51.9, down from 52.8 and shy of the market estimate of 53. It was a similar trend for the Manufacturing PMI, which dipped to 45.6, down from 45.8 in May and below the market estimate of 46.1. Manufacturing has now been in contraction territory for over two years and there doesn’t seem to be a light at the end of the tunnel, as global demand remains weak.

The PMI reports won’t set off alarm bells but points to sluggish growth for the eurozone. The year started off on an optimistic note as GDP climbed 0.3% in the first quarter q/q, up from -0.1% in the fourth quarter of 2023. There are signs that the second quarter won’t be able to keep pace and today’s soft PMIs reinforce that concern.

The European Central Bank took the plunge in June and cut interest rates, so it wasn’t a surprise that the ECB elected to hold rates last week. The markets are expecting more cuts before the end of the year and weak data such as today’s PMIs strengthen the case for a rate cut in the near term, which could inject some life into the economy. The ECB hasn’t provided any hints about rate cuts, although ECB President Lagarde noted at last week’s meeting that growth in the eurozone likely slowed in the second quarter.

EUR/USD Technical

• EUR/USD tested support at 1.0832 earlier. The next support level is 1.0812
• 1.0865 and 1.0885 are the next resistance lines

Markets

Monthly PMI’s were the headline story on global markets. EMU surveys at least were no happy reading. The composite EMU HCOB PMI declined from 50.9 to 50.1 suggesting an near standstill in activity. The decline was mainly driven by a deepening contraction in German manufacturing (42.6). France also stays in sub-50 territory (composite 49.5), but improved. The EMU manufacturing index dropped further (45.6 from 45.8, 7 month low). This was still compensated by growth in services but momentum waned with growth at the slowest level in 4 months. (composite 51.9 from 52.8). According to S&P/HCOB “New orders fell for the second month running and business confidence dropped to a six[1]month low, leading firms to halt a spell of hiring which began at the start of 2024.” Subdued activity for now doesn’t translate into a congruent easing of price pressures. Input prices even increased sharply, especially in services but also manufacturing costs picked up. Output prices increased at a softer pace as weak demand limited company’s pricing power. This stagflationary message doesn’t make things easier as the ECB assesses the option of a next 25 bps cut for September. Still, the German yield curve steepens further (2-y -4.5 bps 30-y +1.0 bp). Despite persistent cost pressures, markets almost fully discount two additional 25 bps ECB cuts (September/December). The 2-y EMU swap yield almost touched the 3.0% barrier. European equities opened in red after disappointing earnings from some US bellwethers yesterday, dropped further after the PMI’s, but currently trade off the intraday lows (Eurostoxx 50 -1.0%). The euro shows a similar pattern touching a short-term low near 1.0826 after the PMI’s, but reversing of the full intra-day loss (EUR/USD 1.086).

Elsewhere, the UK activity performed better than its European counterpart with activity improving and prices tentatively slowing (cf infra). It doesn’t provide a clear signal going into next week’s BoE meeting. Short-term UK yields decline less than in the US and EMU (2-y -2.0 bps). EUR/GBP is again testing the 0.84/0.8383 support area. US yields in the meantime follow the broader steepening move (3-y -6 bps; 30-y +1.0 bp, 2-y decline of 8 bps contains benchmark change). In the meantime, lower short-term yields in the US and EMU further fuel an impressive comeback of the yen (USD/JPY 153.9 from 155.6, EUR/JPY 167.1 from 168.9). US PMI’s (published at the time of finishing this report) show a mixed picture. The composite index improved to a strong 55.0, including a contraction in manufacturing (49.6 from 51.6) but an improvement in services (56 from 55.3). A first market reaction stays limited.

News & Views

UK PMIs parted ways with the European ones, showing business confidence improved in July. The composite gauged rose from 52.3 to 52.7. The manufacturing sector posted the sharper increase in activity, catching up with stronger order book volumes and reducing outstanding workloads. Services activity picked up more moderately from 52.1 to 52.4 due to a faster increase in new work. This influx is attributed to improved market confidence and the securing of new contracts, which took a breather prior to the general elections. Staffing numbers rose at a fastest rate in over a year. Manufacturing input prices (especially those for transport thanks to the Red Sea crisis) rose sharply but were more than offset by an opposing trend in services (lowest in 41 months). Prices charged slowed to its weakest since February 2021, driven by a softer increase at service companies, but the pace stayed above its long-run trend. To finish it off, UK business confidence for the year ahead rebounded from a six-month low to a level just below the two-year high seen in February with the prospect of rate cuts, improving demand conditions and political stability cited as key reasons.

People familiar with the Bank of Japan’s thinking in a Reuters scoop today said the outcome of next week’s policy meeting is far less certain than consensus currently expects. In a Reuters poll about 75% expects the BoJ to stand pat but the sources said that the decision is a much closer call, labelling it is a judgment call in terms of whether to act now or later this year. Above-target (but not at all runaway) inflation lies in the balance with weak household sentiment and uncertainty over the outlook. At next week’s meeting, the BoJ is also poised to release details on how it is going to taper bond purchases (currently JPY 6tn per month). The sources said the central bank will probably follow the dominant market view to avoid unwelcome volatility. Based on a broad market inquiry last week, it may end up halving the monthly pace in 1.5 to 2 years time.

Graphs

EUR/GBP: divergent PMI performance between UK and EMU triggers new test of key 0.84/0.8383 support area.

EMU 2-y swap nears 3.0% barrier as markets expect poor growth to force the ECB to extend its easing cycle.

EUR/JPY: yen extends impressive comeback as ST core yields decline and BOJ is seen nearing further tightening.

Nasdaq: market reaction to first results from Tech bellwethers suggets bar for further gains is high.

US PMI Manufacturing fell from 51.6 to 49.5 in July, a 7-month low. PMI Services jumped from 55.3 to 56.0, a 28-month high. PMI Composite rose from 54.8 to 55.0, a 27-month high.

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence said:

"The flash PMI data signal a 'Goldilocks' scenario at the start of the third quarter, with the economy growing at a robust pace while inflation moderates.

"Output across manufacturing and services is expanding at the strongest rate for over two years in July, the survey data indicative of GDP rising at an annualized rate of 2.5% after a 2.0% gain was signaled for the second quarter.

"The rate of increase of average prices charged for goods and services has meanwhile slowed further, dropping to a level consistent with the Fed's 2% target.

"The good news is qualified, however, with both the growth and inflation pictures containing some worrying elements to monitor in the coming months.

"From the output perspective, growth has become worryingly skewed, with manufacturing slipping back into contraction as the service sector gains further strength. Some of the production decline was linked to staff shortages, so could prove temporary – something which is supported by the sector reporting improved confidence about future growth prospects. However, both manufacturers and service providers are reporting heightened uncertainty around the election, which is dampening investment and hiring.

"In terms of inflation, the July survey saw input costs rise at an increased rate, linked to rising raw material, shipping and labour costs. These higher costs could feed through to higher selling prices if sustained, or cause a squeeze on margins."

Full US PMI release here.

BoC cuts overnight rate by 25bps to 4.50% as widely expected. The Governing Council is carefully assessing the "opposing forces" on inflation, where excess supply is lowering inflationary pressures, but shelter and some services are holding inflation up. Future monetary policy decisions will be guided by incoming inflation and the assessment on the inflation outlook.

In the new economic forecasts, annual GDP growth is projected to be at 1.2% in 2024 (downgraded from 1.5%), 2.1% in 2025 (downgraded from 2.2%), and 2.4% in 2026 (upgraded from 1.9%.

CPI inflation is projected to be at 2.6% in 2024 (unchanged), 2.4% in 2025 (upgraded from 2.2%) and then 2.0% in 2026 (downgraded from 2.1%).

Full BoC statement here.

The Bank of Canada today reduced its target for the overnight rate to 4½%, with the Bank Rate at 4¾% and the deposit rate at 4½%. The Bank is continuing its policy of balance sheet normalization.

The global economy is expected to continue expanding at an annual rate of about 3% through 2026. While inflation is still above central bank targets in most advanced economies, it is forecast to ease gradually. In the United States, the anticipated economic slowdown is materializing, with consumption growth moderating. US inflation looks to have resumed its downward path. In the euro area, growth is picking up following a weak 2023. China's economy is growing modestly, with weak domestic demand partially offset by strong exports. Global financial conditions have eased, with lower bond yields, buoyant equity prices, and robust corporate debt issuance. The Canadian dollar has been relatively stable and oil prices are around the levels assumed in April's Monetary Policy Report (MPR).

In Canada, economic growth likely picked up to about 1½% through the first half of this year. However, with robust population growth of about 3%, the economy's potential output is still growing faster than GDP, which means excess supply has increased. Household spending, including both consumer purchases and housing, has been weak. There are signs of slack in the labour market. The unemployment rate has risen to 6.4%, with employment continuing to grow more slowly than the labour force and job seekers taking longer to find work. Wage growth is showing some signs of moderating, but remains elevated.

GDP growth is forecast to increase in the second half of 2024 and through 2025. This reflects stronger exports and a recovery in household spending and business investment as borrowing costs ease. Residential investment is expected to grow robustly. With new government limits on admissions of non-permanent residents, population growth should slow in 2025.

Overall, the Bank forecasts GDP growth of 1.2% in 2024, 2.1% in 2025, and 2.4% in 2026. The strengthening economy will gradually absorb excess supply through 2025 and into 2026.

CPI inflation moderated to 2.7% in June after increasing in May. Broad inflationary pressures are easing. The Bank's preferred measures of core inflation have been below 3% for several months and the breadth of price increases across components of the CPI is now near its historical norm. Shelter price inflation remains high, driven by rent and mortgage interest costs, and is still the biggest contributor to total inflation. Inflation is also elevated in services that are closely affected by wages, such as restaurants and personal care.

The Bank's preferred measures of core inflation are expected to slow to about 2½% in the second half of 2024 and ease gradually through 2025. The Bank expects CPI inflation to come down below core inflation in the second half of this year, largely because of base year effects on gasoline prices. As those effects wear off, CPI inflation may edge up again before settling around the 2% target next year.

With broad price pressures continuing to ease and inflation expected to move closer to 2%, Governing Council decided to reduce the policy interest rate by a further 25 basis points. Ongoing excess supply is lowering inflationary pressures. At the same time, price pressures in some important parts of the economy—notably shelter and some other services—are holding inflation up. Governing Council is carefully assessing these opposing forces on inflation. Monetary policy decisions will be guided by incoming information and our assessment of their implications for the inflation outlook. The Bank remains resolute in its commitment to restoring price stability for Canadians.

Information note

The next scheduled date for announcing the overnight rate target is September 4, 2024. The Bank will publish its next full outlook for the economy and inflation, including risks to the projection, in the MPR on October 23, 2024.

Daily Pivots: (S1) 1.0832; (P) 1.0865; (R1) 1.0885; More.....

No change in EUR/USD's outlook and intraday bias stays on the downside. Fall from 1.0947 short term top should extend to 55 D EMA (now at 1.0813). Sustained break there will argue that whole rebound from 1.0601 has completed with three waves up to 1.0947, and target 1.0601/0665 support zone. On the upside, above 1.0896 minor resistance will turn intraday bias neutral first. But, risk will stay on the downside as long as 1.0947 resistance holds, in case of recovery.

In the bigger picture, price actions from 1.1274 are viewed as a corrective pattern that's still be in progress. Break of 1.1138 resistance will be the first signal that rise from 0.9534 (2022 low) is ready to resume through 1.1274 (2023 high). However, break of 1.0665 support will extend the correction with another falling leg back towards 1.0447 support.

Daily Pivots: (S1) 1.2884; (P) 1.2911; (R1) 1.2935; More...

Range trading continues in GBP/USD and intraday bias stays neutral. Further rally is expected for with 1.2859 resistance turned support intact. Break of 1.3043 will resume the rise from 1.2298 and target 100% projection of 1.2298 to 1.2859 from 1.2612 at 1.3173, which is slightly above 1.3141 key medium term resistance. However, firm break of 1.2859 will turn bias to the downside for deeper decline.

In the bigger picture, corrective pattern from 1.3141 medium term top (2023 high) could have completed with three waves to 1.2298 already. This will now remain the favored case as long as 1.2612 support holds. Firm break of 1.3141 will target 61.8% projection of 1.0351 (2022 low) to 1.3141 from 1.2298 at 1.4022.

Daily Pivots: (S1) 0.8891; (P) 0.8908; (R1) 0.8930; More…

USD/CHF's sharp decline suggests that recovery from 0.8819 has completed at 0.8923, after rejection by 55 4H EMA. Intraday bias is back on the downside for 0.8819. Firm break there will resume whole fall from 0.9223. Next target is 61.8% retracement of 0.8332 to 0.9223 at 0.8672. For now, risk will stay on the downside as long as 0.8923 resistance holds.

In the bigger picture, with 0.9243 resistance intact, medium term outlook in USD/CHF is neutral at best. For now, more sideway trading is likely between 0.8332/9243. However, firm break of 0.9243 will indicate larger bullish trend reversal.