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Daily Pivots: (S1) 0.6580; (P) 0.6602; (R1) 0.6643; More...

AUD/USD's rebound extends to as high as 0.6629 so far today, breaking 38.2% retracement of 0.6877 to 0.6442 at 0.6605. Current upside acceleration as seen in 4H MACD indicates that further rally is underway. Intraday bias stays on the upside for 61.8% retracement at 0.6707 next. On the downside, below 0.6580 minor support will turn intraday bias neutral first.

In the bigger picture, price actions from 0.6169 (2022 low) are seen as a medium term corrective pattern to the down trend from 0.8006 (2021 high). Fall from 0.7156 (2023 high) is seen as the second leg, which might still be in progress. Overall, sideway trading could continue in range of 0.6169/7156 for some more time. But as long as 0.7156 holds, an eventual downside breakout would be mildly in favor.

Dollar is continuing its streak as the weakest performer for the week, amid a global surge in risk appetite. Major stock indices around the world, including S&P 500, NASDAQ, DAX, and CAC, have notched new record highs overnight. This wave of optimism has seamlessly transitioned into Asian session today. Investors have been absorbing the latest adjustment in central bank rate cut expectations rather well. While a bit later than originally thought, Fed and ECB are on course to deliver their first rate cuts in June. Focuses will now turn to non-farm payroll report from the US today, so further solidify the expectation on Fed.

Australian Dollar overtakes Yen's position as the best performer for the week so far. Aussie is buoyed by news from China's Guangdong Energy regarding its plans to import 80 million tons of coal from Australia this year. This move signals a return to pre-sanction trade levels between Australia and China, providing a notable lift to Australian Dollar. Meanwhile, despite paring much of earlier gains, Japanese Yen is currently in the second spot in terms of strength, support by increasing bets on BoJ rate hike later this month.

Conversely, Swiss Franc is only marginally outperforming the Dollar, with Canadian Dollar trailing closely as market participants await Canadian employment data for further direction. Euro and the British Pound find themselves in a relatively neutral position, with Pound having a slight advantage.

Technically, Yen has pared back much gains against most but Dollar. For example, EUR/JPY recovered strongly after dipping to 160.54. Current development open up the case that fall from 163.70 is merely a near term corrective pullback. Sustained trading above 55 D EMA (now at 162.51) would argue that this correction has completed and bring stronger rebound back to 163.70. If realized in this way, Yen's reversal in crosses might help USD/JPY bounce from 38.2% retracement of 140.25 to 150.87 at 146.81. Let's see how it plays out.

In Asia, at the time of writing, Nikkei is up 0.47%. Hong Kong HSI is up 1.22%. China Shanghai SSE is up 0.11%. Singapore Strait Times is up 0.65%. Japan 10-year JGB yield is up 0.0014 at 0.735. Overnight, DOW rose 0.34%. S&P 500 rose 1.03%. NASDAQ rose 1.51%. 10-year yield fell -0.012 to 4.092.

Japan's household spending falls -6.3% yoy in Jan, deepening contraction

Japan's household spending fell -6.3% yoy in January well below expectation of -4.3% yoy. That's the 11th consecutive month of contraction, and the biggest annual drop since February 2021. On a seasonally adjusted, spending fell -2.1% mom, versus expectation of 0.4% mom increase.

The Ministry of Internal Affairs and Communications noted that one-off factors such as decreases in new car purchases amid factory suspensions and lower energy bills due to warm weather contributed to the spending drop. Also, the bigger-than-expected fall was also against the backdrop of higher spending in the same month last year from post-pandemic travel subsidies.

NFP takes center stage, S&P 500 hits record, Dollar Index falters

The main focus of the day is February US non-farm payroll report, with the market anticipating headline job growth of 200k. Unemployment rate is expected to hold steady at 3.7%. Attention is particularly focused on average hourly earnings, anticipated to grow by 0.2% mom, amidst a backdrop of mixed employment indicators from related data sources.

The manufacturing sector, as represented by ISM manufacturing employment index, witnessed a decline from 47.1 to 45.9, while the services sector, through ISM services employment figure, also saw a decrease from 50.5 to 48.0. ADP private employment report indicated a modest job growth of 140k. There was a slight uptick in four-week moving average of initial jobless claims from 208k to 212k. Together they suggest the labor market's resilience may be cooling. These indicators collectively temper expectations for a significant upside surprise in the NFP data, while wage growth presenting an unpredictable element as usual.

Investors are particularly interested in how the payroll data might reinforce the likelihood of a June rate cut by Fed. A favorable set of data supporting this case would at least align Fed with its projected path of three rate cuts this year, with the other two in Q3 and Q4, as in the latest dot plot projections.

S&P 500 closed at new record high overnight as its recent uptrend continued. For now, outlook will stay bullish as long as 5056.82 support holds. Next target is 138.2% projection of 3808.86 to 4607.07 from 4103.78 at 5206.91. Firm break there will pave the way to 161.8% projection at 5395.28. Nevertheless, considering bearish divergence condition in D MACD, break of 5056.82 should indicate short term topping, and bring deeper pullback first.

Dollar Index's close below 102.90 support overnight argues that rebound from 100.61 has completed much earlier than expected at 104.97. Risk will now stay on the downside as long as 55 D EMA (now at 103.69) holds. Deeper decline would be seen back towards 100.61 support, aligning with rally in stock markets. But strong support should emerge around 100 psychological level to bring rebound, to extend medium term range trading.

Looking ahead

Germany industrial production and PPI, France trade balance and Eurozone GDP revision will be featured in Euroepan session. Later in the day US non-farm payrolls and Canada employment will be the main focuses.

AUD/USD Daily Report

Daily Pivots: (S1) 0.6580; (P) 0.6602; (R1) 0.6643; More...

AUD/USD's rebound extends to as high as 0.6629 so far today, breaking 38.2% retracement of 0.6877 to 0.6442 at 0.6605. Current upside acceleration as seen in 4H MACD indicates that further rally is underway. Intraday bias stays on the upside for 61.8% retracement at 0.6707 next. On the downside, below 0.6580 minor support will turn intraday bias neutral first.

In the bigger picture, price actions from 0.6169 (2022 low) are seen as a medium term corrective pattern to the down trend from 0.8006 (2021 high). Fall from 0.7156 (2023 high) is seen as the second leg, which might still be in progress. Overall, sideway trading could continue in range of 0.6169/7156 for some more time. But as long as 0.7156 holds, an eventual downside breakout would be mildly in favor.

Economic Indicators Update

Key insights from the week that was.

Australian Q4 GDP printed broadly as expected, rising 0.2% (1.5%yr). Once again, consumer spending was in the spotlight, up just 0.1% in Q4 following a –0.2% decline in Q3 (revised down from zero) to be broadly unchanged versus end-2022. The picture is much weaker when one considers population growth, per capita consumption declining 2.5% over 2023. It was encouraging to see household real disposable income rise 1.5% in Q4 – in line with the gross income gain as the impact from inflation, interest costs and tax payments offset – but given its weak performance over the past year (0.3%yr), consumer financial health remains fragile.

Other parts of the domestic economy were soft too. The main detractor from domestic demand was housing investment, contracting –3.8% in Q4, with weakness reverberating through both new dwelling construction (–3.5%) and renovation activity (–4.2%). Business investment was unable to make up for this weakness (+0.7%). Highlighting the growing breadth of the economic slowdown beyond the consumer, private demand was flat in the quarter. If it were not for the ongoing support of the public sector – up 0.4% (4.7%yr) – the domestic economy would be weaker still.

As elaborated on by Chief Economist Luci Ellis in this week’s essay, the outlook for the consumer – and by extension the broader economy – is set to improve through the remainder of the year as inflation slows and, in the second half, the stage 3 tax cuts take effect and the RBA begin a modest easing cycle. Still, it is important to emphasise that we believe recovery will prove gradual, with growth not anticipated to return to trend until end-2025.

On trade, Australia’s current account surplus widened from a thin $1.3bn in Q3 to $11.8bn in Q4. That was associated with a pull-back in import volumes (–3.4%) and a rising terms of trade (+2.3%), together driving a $10.2bn improvement in the trade surplus – a trend which extended into January for goods. In real terms, the decline in import volumes (–3.4%) more than outpaced that of exports (–0.3%), leading net exports to add a material 0.6ppts to GDP in the quarter.

Before moving offshore, a final note on housing. This week’s updates were on the softer side. The value of monthly housing finance approvals tumbled 3.9% in January, an extension of weakness present at year-end. Raising questions over the strength and quality of loan demand, the past two months have retraced roughly half the gains in total approvals over the past year and closer to three-quarters for the owner-occupier segment. This, together with signs of weakening turnover and softer price growth, suggest the impact of the RBA’s tightening cycle is still crystalising. Tightness on the supply-side will remain a driver of housing market outcomes near-term too. While January’s update on dwelling approvals provided little new insight given seasonal volatility at this time of year, another monthly decline is consistent with the weak underlying trend present over the past year.

Over in Europe, the European Central Bank (ECB) kept its key rates steady. New projections showed a downgrade for inflation over 2024 and 2025 while the Council remained constructive on growth’s recovery, expecting above-trend growth in 2025 and 2026 following two weak years. To ward off any speculation that there would be a rate cut at the next meeting, President Christine Lagarde emphasised more data was necessary before any decision. Lagarde also emphasised that discussion within the Governing Council was focussed on conditions needed to start discussing a rate cut rather than when a rate cut would occur. Concerns around services inflation and wages remain. Highlighting this, Lagarde outlined a wide range of wages measures the ECB is assessing beyond the national accounts measure. A June first cut is most probable despite the market pricing some chance for April.

Earlier in the week, the Bank of Canada held rates steady at 5.0% citing strong underlying inflation and risks that inflation remains above the 2% target. Inflation eased to 2.8%yr in February, but shelter prices remain sticky and are at risk of keeping inflation higher for longer. Governor Macklem cited it was still too early to consider rate cuts. The statement was little changed reflecting the continuity of data since their last meeting in January. Market pricing for the first rate cut remains for July. The April meeting will offer a suite of new forecasts and greater context of the risks.

In the US, key releases and Chair Powell’s testimony before Congress gave market participants further reason to believe the FOMC is also on track to begin cutting in June. The Beige Book pointed to materially slower growth in early-2024 than late-2023. And regarding the labour market and inflation, balance between demand and supply was being seen.

In a similar vein, the JOLTS report showed little change in the hiring and separation rates. The ISM non-manufacturing PMI meanwhile signalled downside risks for the labour market, the employment index more than 4pts below its average of the past 20 years. Released last week, the ISM manufacturing survey’s employment measure is similarly positioned.

Back across the pond, February’s Decision Maker Panel Survey in the UK for February showed easing inflation expectations. Over the last three months, CPI expectations fell to 3.6% for the year ahead and 2.8% for three years hence. However, expectations of output prices remained robust, highlighting some lingering risk. Expectations of wage growth, a metric the Bank of England looks at closely from the survey, remained steady at 5.2%yr. Strong wages growth and ensuing services inflation are a key risk preventing the BoE from moving on rates despite a deteriorating economy. Chancellor of the Exchequer Jeremy Hunt also delivered the Budget, manoeuvring tight public finances to amend tax rules among other policies which are expected to have little impact on inflation but should support the economy.

Coming back to Asia, China’s 2024 National People’s Congress met expectations with respect to key policy actions, but disappointed in terms of sentiment – market participants clearly hopeful the new year would bring a more aggressive policy style. As was the case throughout 2023, the market and China’s authorities currently have very different perspectives on the economy’s immediate health and the long-term path to prosperity, with authorities’ confidence in the dividend from trade and investment ex-housing intact but the market of the belief that housing must again take a leading role in China’s growth story. We expect time will prove authorities’ case, with growth of “around 5.0%” probable in both 2024 and 2025.

The main focus of the day is February US non-farm payroll report, with the market anticipating headline job growth of 200k. Unemployment rate is expected to hold steady at 3.7%. Attention is particularly focused on average hourly earnings, anticipated to grow by 0.2% mom, amidst a backdrop of mixed employment indicators from related data sources.

The manufacturing sector, as represented by ISM manufacturing employment index, witnessed a decline from 47.1 to 45.9, while the services sector, through ISM services employment figure, also saw a decrease from 50.5 to 48.0. ADP private employment report indicated a modest job growth of 140k. There was a slight uptick in four-week moving average of initial jobless claims from 208k to 212k. Together they suggest the labor market's resilience may be cooling.
These indicators collectively temper expectations for a significant upside surprise in the NFP data, while wage growth presenting an unpredictable element as usual.

Investors are particularly interested in how the payroll data might reinforce the likelihood of a June rate cut by Fed. A favorable set of data supporting this case would at least align Fed with its projected path of three rate cuts this year, with the other two in Q3 and Q4, as in the latest dot plot projections.

S&P 500 closed at new record high overnight as its recent uptrend continued. For now, outlook will stay bullish as long as 5056.82 support holds. Next target is 138.2% projection of 3808.86 to 4607.07 from 4103.78 at 5206.91. Firm break there will pave the way to 161.8% projection at 5395.28. Nevertheless, considering bearish divergence condition in D MACD, break of 5056.82 should indicate short term topping, and bring deeper pullback first.

Dollar Index's close below 102.90 support overnight argues that rebound from 100.61 has completed much earlier than expected at 104.97. Risk will now stay on the downside as long as 55 D EMA (now at 103.69) holds. Deeper decline would be seen back towards 100.61 support, aligning with rally in stock markets. But strong support should emerge around 100 psychological level to bring rebound, to extend medium term range trading.

Japan reported significant decline in household spending in January, marking the 11th consecutive month of contraction. The decrease of -6.3% yoy was well below expectation of -4.3% yoy, representing the steepest annual drop since February 2021. Furthermore, on a seasonally adjusted month-on-month basis, spending fell by -2.1%, starkly contrasting with the expected 0.4% increase.

The Ministry of Internal Affairs and Communications highlighted several one-off factors contributing to this pronounced decrease. Notably, reduction in new car purchases, attributed to factory suspensions, played a significant role. Additionally, lower energy bills, a result of unusually warm weather, further depressed spending levels.

Moreover, the Ministry pointed out that the comparison with the same month last year is skewed due to a temporary boost in spending from post-pandemic travel subsidies.

This week’s national accounts confirmed our view that the domestic economic is soft, especially the consumer. Pressures on households should start to ease in the period ahead.

The big-picture themes from the national accounts for the December quarter were largely as expected. The Australian economy is soft, expanding just 0.2% in the quarter and 1½% over 2023 as a whole. Domestic demand in the December quarter was weaker still, especially in the private sector. Almost all the 0.1% increase in domestic demand in the quarter came from the public sector.

Much of 2023’s weakness stemmed from the household sector. Consumption has been weak and this remained the case in the December quarter. Discretionary spending continues to decline, with overseas holidays especially weak. Part of this might be the result of shifting seasonal patterns in spending and holidaying. Even so, households are objectively limiting their spending in the face of income pressures. Consumption per person has been falling in Australia, unlike in most peer economies. It is no wonder that consumer sentiment has been so depressed.

We have been highlighting these income pressures for some time. The triple squeeze of a rising cost of living, increasing tax take and higher interest rates has required households to respond.

It has been less recognised that the squeeze from rising taxation as a share of income has been greater than from rising net interest payments. (Indeed, the ABS revised down the interest flow series this week, relative to previous releases.) This does not mean monetary policy has done little to slow the economy or combat inflation – there are other channels of monetary policy transmission beyond the immediate effect on household cash flows. But it does put the role of fiscal policy, and particularly bracket creep, in perspective.

There is light at the end of the tunnel for households. As inflation has declined, the squeeze on real household incomes from this source has diminished. The drag from taxation and net interest payments has also eased a little. Some of the former might reflect timing effects for tax return lodgements. Meanwhile the November increase in the cash rate would have taken effect in people’s debt repayments too late to have boosted the quarterly total for net payments by much.

As a result, real household disposable income increased in the quarter. It was only barely above the level a year previously, though. Once the growth in population over the same period is accounted for, real household disposable income is still going backwards.

Inflation’s grip on households’ spending power will continue to ease over the course of 2024. That is the desired outcome. With tax cuts – and, we believe, some reductions in the cash rate – coming in the second half of the year, that triple squeeze will truly begin to unwind.

It would not be appropriate to interpret the coming turnaround in real incomes as an upside risk that threatens an upsurge in demand-driven inflation. Rather, it represents an extraordinary phase in the household sector’s experience coming to a close. Two years of declining real incomes in the face of a tight labour market is not a combination that should be regarded as normal. And there are some potential offsets to this turnaround, especially from the labour market, which is expected to slow with a lag given current slow growth in activity. There are also some increases in net interest payments yet to come through.

Businesses have also adjusted to the slow demand. Some of them have run down their inventories, while investment in new equipment declined in the quarter. Consistent with our forecasts, the resilience that was believed to have prevailed in the first half of 2023 has not carried through into the second half. Activity in non-residential construction has held up, and opportunities in energy transition, resources and elsewhere remain. But with ongoing cost pressures and soft demand, many businesses would understandably seek to delay or rationalise their spending on new equipment.

The RBA would be comfortable with these outcomes. They have been seeking to slow demand because they want to bring the level of demand back into balance with supply. The December quarter outcome certainly helps achieve that objective. It also supports our house view that the RBA will reach the point of being prepared to reduce some of the contractionary stance of policy late in the year, most likely starting from September.

The RBA would also have been heartened by the ongoing turnaround in labour productivity, which increased as they – and we – expected. The second consecutive quarterly increase in this series does not make a trend. But it does lend weight to our view that much of the earlier slump was an artefact of the population surge. Over time, the capital stock will catch up – as long as investment does not decline precipitously.

Where they might be less comfortable is on the housing front. The potential wealth effect of a renewed upsurge in housing prices is unlikely to be the main concern given any additional consumer demand needs to be set against the weak starting point.

Rather, the issue at present is the low rate of new production of housing in the context of high construction costs and ongoing (if more moderate) population growth. New housing construction is one of the most important channels of the transmission of monetary policy, here and overseas. The current low rate of dwelling investment is therefore an expected outcome of the RBA’s policy actions. To the extent that higher interest rates have dampened dwelling investment, however, they exacerbate Australia’s current housing affordability challenges in the medium term. These challenges also relate to some of the other headwinds affecting the industry, including the competing bid for resources from non-residential construction. The inflation–employment trade-off is therefore not the only short-term policy dilemma that policymakers must navigate.

China’s National People’s Congress for 2024 and the market response again highlighted how far apart the views of China’s authorities and global investors are on both the current health of the economy and the way to achieve long-term prosperity.

China’s 2024 National People’s Congress met expectations with respect to key policy actions, but disappointed in terms of sentiment – market participants clearly hopeful the new year would bring a more aggressive policy style. As was the case throughout 2023, the market and China’s authorities currently have very different perspectives on the economy’s immediate health and the long-term path to prosperity, with authorities confidence in the dividend from trade and investment ex-housing intact but the market of the belief that housing must again take a leading role in China’s growth story.

According to the 2024 government work report delivered at the NPC, GDP growth of “around 5%” is expected to again be achieved in 2024 after a 5.2% gain in 2023. Year-over-year, direct support from the central government is little changed, 2024’s deficit target of 3.0% the same as 2023.

October’s late revision of the 2023 deficit target to 3.8% will also support activity in 2024, as will an additional RMB1trn in sovereign special bonds – a stop-gap measure to sure-up infrastructure investment while local government funding through land sales is impaired. Still, there is no evidence of authorities believing their support for the economy must be dialled up.

Whereas the growth and fiscal targets are best considered hard targets, authorities 3.0% CPI projection is more a symbol of intent. What the target speaks to is a plan to bolster household employment and incomes through trade and investment and, in time, justify a sustained rebound in consumer perceptions of their family finances and wealth. In doing so, authorities will encourage the use of existing and new capacity and thereby create a supportive environment for profitability, wage growth and consequently domestic inflation.

For consumer views of family finances to fully heal however, further targeted support for housing construction is also necessary. While this began in 2023, 2024 must see a material expansion through additional funding and liquidity being made available for developers and local governments as well as clear direction from the Central Government that their reform process is complete.

A core focus of the housing reforms has been the re-shaping of the construction pipeline to focus on the development of housing for low and middle-income households to ‘live in’ as opposed to product for investors. With interest rates and deposit rates having been cut significantly, an end to uncertainty over developers’ finances should quickly see the investment pipeline refill and investment begin to grow on households’ terms not direct Government support.

The property sector’s healing is likely to take place over 2024 and 2025. In the meantime, there is cause to believe 2023’s consumption momentum can be sustained throughout 2024, with Lunar New Year anecdotes suggesting a growing number of Chinese consumers are increasing their discretionary spend. Highlighting the potential scale of pent-up demand for 2024 and beyond, retail sales have only increased 4% annually the past four years (2020-2023) having grown closer to 10% between 2015 and 2019.

In our view, the above consumer narratives are sustainable trends which can help support GDP growth “around 5%” in both 2024 and 2025. The other foundation is business investment, itself dependent on trade.

Throughout 2023, we detailed at length the strength anticipated then seen in high-tech manufacturing. For the year, fixed asset investment related to chemical products, automobiles and electrical machinery grew by 13%, 19% and 32% respectively. Utilities also grew 23%, and other infrastructure 6%. High-tech manufacturing is unlikely to grow as fast in 2024 and 2025; but now being of similar scale to housing, its contribution to growth will remain large. Importantly, as the new capacity investment is creating comes online, the trade position will benefit, drawing and accumulating income from exports while also reducing lost wealth and income through imports.

This recursive loop between investment and trade and the consequent scaling up of national income is the foundation for Chinese authorities long-run prosperity ambitions. If these gains can be recycled into new jobs and wealth across the economy, not only will they deflate the significance of the nation’s existing debt, but also offer capital to fund sustainable growth in consumption and housing. Income, not debt, is set to remain the focus of China’s authorities, with risks related to the latter expected to resolve themselves as growth persists, and property investment to follow growth elsewhere in the economy.

The USD Index (DXY) dipped below the 103.00 support level for the first time since early February, indicating a significant decline in the US dollar. The focus on March 8 will be on the release of Non-farm Payrolls, the Unemployment Rate, and a speech by the Fed’s J. Williams. EURUSD reached new multi-week highs near 1.0950 after the ECB decided to maintain monetary conditions unchanged. GBPUSD surged to fresh 2024 highs above 1.2800, driven by increased selling pressure on the US dollar. USDJPY fell to new five-week lows below the 148.00 support level, influenced by lower US yields and speculation about the BoJ’s potential actions.

EURUSD - D1 Timeframe

Following the violation of the previous low as indicated by the horizontal arrow, we’ve seen price action on the Daily timeframe of EURUSD climb back up rather quickly to retest the recent supply zone that brought about the break of structure. There is also a resistance trendline, as well as the Fibonacci retracement levels which could be considered as confluences in favour of a bearish sentiment.

Analyst’s Expectations:

• Direction: Bearish
• Target: 1.08568
• Invalidation: 1.10040

GBPUSD - D1 Timeframe

The daily timeframe of GBPUSD, following the break below the previous low, is currently trading within the supply zone formed right before the break of structure. As a result, I am considering the possibility of a bearish pressure on GBPUSD as a result of the NFP data; this is based off of the Fibonacci retracement levels and the supply zone purely - I’ll be cautious here though, since there aren’t several confluences to consider.

Analyst’s Expectations:

• Direction: Bearish
• Target: 1.26629
• Invalidation:1.30024

USDJPY - D1 Timeframe

Here on the daily timeframe of USDJPY we clearly see the uptrend as indicated by the moving averages, with the 50 and 100 period moving averages providing ample support for the price action at the moment. Combining this with the bullish array of the moving averages and the Fibonacci retracement levels, I presume the market could regain bullish momentum in a short while - possibly as a result of the NFP data.

Analyst’s Expectations:

• Direction: Bullish
• Target: 149.718
• Invalidation: 145.815

CONCLUSION

The trading of CFDs comes at a risk. Thus, to succeed, you have to manage risks properly. To avoid costly mistakes while you look to trade these opportunities, be sure to do your due diligence and manage your risk appropriately.

• Today, the ECB decided to keep policy rates unchanged, as unanimously expected by markets and analysts. The new staff projections saw a downward revision of the 2024 projection across growth, headline and core inflation. For 2025, the ECB revised down the projections for 2025 by 0.1pp and 0.2pp for headline and core respectively. Core inflation for 2026 was revised 0.1pp lower.
• Lagarde was quite clear with guidance for a June rate cut, and while April was not ruled out, she said they will know a little more in April, and a lot more in June. We doubt that the incoming data ahead of the 11 April meeting will be sufficiently weak to change that view.
• Markets initially reacted with lower yields across the curve; however, they gradually drifted higher through the afternoon. The move was a parallel shift in the 2y+ area. For 2024, markets added 3bp to now have a 95bp cut priced in.
• Lagarde said she has a strong expectation that the operational framework will be completed at the 13 March (non-monetary policy) meeting.

Acknowledging the progress

The ECB meeting today was a predictable one with no deviation from the prevailing ECB narrative on delivering a rate cut this summer. President Lagarde acknowledged that most measures of underlying inflation have eased further; however, it was nevertheless highlighted that domestic price pressure remains high, in part 'owing to strong growth in wages'. On the other hand, Lagarde also highlighted that growth in wages has started to moderate, and firm profits will absorb part of the increased labour costs. The ECB focused on its internal wage growth tracker and the job portal Indeed for timely wage indications. Both measures have the advantage of being more timely than the usual favourite gauge, namely the compensation per employee, which will be released tomorrow covering Q4 23. The staff projections – which saw a revision of the core projection for 2025 – don't rule out an April rate cut, but with the limited data by then (one PMI print, inflation, SPF and BLS) we do not think they will deliver a rate cut there.

The ECB didn't discuss cutting rates at 'this meeting', but Lagarde said they have 'just begun' discussing dialling back the restrictiveness of monetary policy. This tallies very well with her comment on little more information by April and a lot more by June. Lagarde said they do not commit to a specific pace, rhythm or magnitude of future rate moves.

Staff projections see inflation at 2% target in 2025, but the ECB is not yet sufficiently confident to start lowering rates

Lagarde characterised the current state of the economy as weak, especially since consumers are holding back spending and foreign demand is low. However, surveys point to a gradual recovery in growth this year as real income rises and global growth increases.

On the back of the economic assessment, new staff projections lowered the inflation projections for 2024 and 2025, while 2026 was unchanged. Headline inflation is now expected at 2.3% in 2024 (vs 2.7% in December), 2.0% in 2025 (vs 2.1 % in December) and 1.9% in 2026 (vs 1.9% in December). The downward revision for 2024 compared with the December projection mainly reflects a lower contribution from energy prices. Lagarde said the ECB is more confident in the expected decline in inflation, but not yet sufficiently confident to start lowering rates.

Lagarde stressed that wage growth is a key upside risk for inflation and that it is currently causing domestic inflation, which is mainly services, to remain high. This is also visible in the projections for core inflation. The ECB revised down projections for core inflation to 2.6% in 2024 (vs 2.7% in December), 2.1% in 2025 (vs 2.3% in December) and 2.0% in 2026 (vs 2.1% in December). Wage growth is expected at 4.5% in 2024, down from 4.6% in the December projections. The ECB expects wage growth at 3.6% and 3.0% in 2025 and 2026, respectively, down from 3.8% and 3.3% in December. Lagarde noted that they await more data, especially on wages, before they are sufficiently confident of inflation returning to the 2% target.

The near-term growth projections were revised down as financing conditions are restrictive and past interest rate increases continue to weigh on demand. The growth forecast for 2024 was revised down to 0.6% (from 0.8% in December), remained at 1.5% in 2025 and was revised up to 1.6% in 2026. Hence, growth is expected to remain subdued in the near term and then start to pick up, supported initially by consumption and later also by investments.

Limited FX market impact

As we expected, the FX market impact of the meeting was very limited. EUR/USD initially experienced a slight decline as the EUR weakened, broadly due to downward revisions in the ECB's inflation outlook, which in turn caused front-end European yields to decline and added to rate cuts for ECB pricing this year. However, we saw a reversal of these moves during Lagarde's press conference, as Lagarde guided that the first rate cut is more likely in June than April. We recently discussed the possibility of a short-term rise in EUR/USD due to USD weakness resulting from softer US data. This hypothesis has been supported by cooling signs in the US labour market, coupled with lower-than-expected ISM manufacturing and services. The biggest potential catalyst for the cross this week is the US February jobs report. If our expectation of a softer US labour market holds true, we could see EUR/USD rise further in the very near term.

However, over the course of the year, we still expect EUR/USD to trend lower. We believe the US economy is in a stronger position relative to the euro area, based on factors such as relative terms of trade, real rates, and relative unit labour costs. There are also signs that underlying inflation appears more persistent in the US compared with the euro area, which, all else being equal, should support the USD. A strong USD, coupled with tighter financial conditions, is a necessary condition for the Fed to sustainably achieve its inflation target of 2%. We forecast EUR/USD to reach 1.05/1.04 within a 6/12M horizon.