Thoughts

September 15, 2023 | 13:21

ECB is Done, BoE is Close, BoJ is Mincing Along

Economist

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

Jennifer Lee

Senior Economist and Managing Director
Economics

Jennifer has been wi... (Read more)

It is the beginning of the end.

No, not of the world as we know it. Don't be silly. Rather, the end of the ECB's tightening campaign. It probably did a little more than needed, but that is neither here nor there

The end is not 100% guaranteed. During the press conference, President Lagarde could not say that rates have peaked. But, if the Staff forecasts are accurate (growth will slow meaningfully over the course of the rest of this year, spilling over into 2024, and inflation gets to 2% by 2025) then the central bank should be parked on the sidelines for a while. In fact, rate cuts may enter the conversation sooner rather than later. In any event, after the meeting, some policymakers emerged to support the messaging, but one is not giving up yet and mentioned “December”. Interesting.

A hike was likely not needed. Prior to the latest move, the ECB had tightened a total of 425 bps, and the impact has been felt. The Euro Area’s economy has already slowed materially, with Germany bordering on recession. Inflation has been halved (from last fall’s peak of 10.7% to 5.3%, currently), but core is still sticky at 5.3%. Euro Area labour costs continue to ease (+4.5% y/y in Q2, from +5.9% y/y in 2022Q4.) Beyond that, one of Europe’s biggest trade partners (China) is struggling mightily to not lose more economic momentum. Energy prices are another wildcard, with strikes in Australia pressuring natural gas prices.

The main point from the Statement was this... the ECB is now of the view that rates have reached a level that, if there for a long time, will really help haul inflation back to target.

The Week Ahead: Aside from the FOMC, two major central banks are also making policy decisions next week. One is not expected to be edge-of-the-seat exciting. The BoJ is widely expected to keep its “highly accommodative” policies running, despite some less-dovish chirps coming from the Policy Board. But the majority is likely to back a continuation of the current policies, even though core inflation remains elevated. Of course, the weak JPY works against that policy, even after Governor Ueda gave it a short-lived boost earlier this week when he mused about “various options” the Bank could take if it is convinced that inflation is rising along with wages.

Then, there is the BoE. We expect Governor Bailey to deliver one final rate hike. The economy has slowed and the job market is loosening, but inflation remains hot (services CPI is at a 3-decade high) and there is record-high wage growth. Inflation expectations need to be massaged further… the latest BoE/Ipsos Inflation Attitudes survey showed a pickup again in August. There is also plenty of political and public pressure on the Bank, pleading that it stop raising rates, though that should not play a role. The BoE has a mandate: monetary stability. And 6.9% core CPI is not that.

FX View from Stephen Gallo: A deeper correction lower in EURUSD heading toward year-end is not the base case, but downside risks have increased, particularly with the global trade backdrop looking poor and transatlantic economic divergence set to remain wide for another quarter or so. Closer ties between Russia and North Korea also portend higher levels of geopolitical risk in relation to the war in Ukraine. The EUR is likely to struggle to maintain topside momentum over the near-term. However, the base case is for moderate EURUSD strength to push the exchange rate back to $1.10 around the turn of the year.