GDP growth

We add Brand24’s shares to the long side of our monthly portfolio. Brand24 is the company for which we prepare the reports for the Warsaw Stock Exchange SA within the framework of the Analytical Coverage Support Program 3.0. Rationale: (i) 1Q23 good financial results (in consequence, the realization of our FY revenues and profits forecasts is higher than a year ago) imply ceteris paribus the upside risk for our current FY forecasts, (ii) investors’ positive sentiment towards companies related to AI development/ implementation, and (iii) pending strategic options review.This is an excerpt from the Polish version of DM BOŚ SA’s research report prepared for the Warsaw Stock Exchange SA within the framework of the Analytical Coverage Support Program 3.0.   Upcoming events 1. Release of selected KPIs for 2Q23: mid-July2. Release of 2Q23 financial results: October 23. Release of selected KPIs for 3Q23: mid-October4. Release of 3Q23 financial results: November 295. Completion of the (co-funded by EU) AI project (Abstrakcyjna sumaryzacja danych multimodalnych): by 2023-end6. Completion of the strategic options review: by 2023-end   Catalysts 1. ARPU/ MRR growth ahead of expectations2. More dynamic new clients acquisition3. Commercial success of new products (e.g. Insights24)4. Progression of financial results ahead of expectations5. Stronger USD vs PLN6. Agility in the AI field proves to be the right approach7. Strategic options review effects boosting the Company’s development on foreign markets   Risk factors 1. Lower availability of Internet data, higher cost of their acquisition2. IT infrastructure/ software malfunction3. Maintaining financial liquidity4. Product concentration5. Inability to adapt promptly to changes in ways of presenting/ consuming content in the Internet6. FX risk (USD weakening vs PLN))7. Adverse changes in search engines algorithms8. Rise in competitive pressures in the sector9. Hike in R&D needs10. Transfer pricing risk11. RODO risk12. Inability to attract new clients and retain the existing ones13. Rising churn14. Low share liquidity15. Smaller than assumed further rise in ARPU/ MRR16. Losing eligibility to use the IP BOX tax relief   We add Brand24’s shares to the long side of our monthly portfolio. Brand24 is the company for which we prepare the reports for the Warsaw Stock Exchange SA within the framework of the Analytical Coverage Support Program 3.0.   Rationale:  1Q23 good financial results (in consequence, the realization of our FY revenues and profits forecasts is higher than a year ago) imply ceteris paribus the upside risk for our current FY forecasts, (ii) investors’ positive sentiment towards companies related to AI development/ implementation, and (iii) pending strategic options review.        BASIC DEFINITIONSA/R turnover (in days) = 365/(sales/average A/R))Inventory turnover (in days) = 365/(COGS/average inventory))A/P turnover (in days) = 365/(COGS/average A/P))Current ratio = ((current assets – ST deferred assets)/current liabilities)Quick ratio = ((current assets – ST deferred assets – inventory)/current liabilities)Interest coverage = (pre-tax profit before extraordinary items + interest payable/interest payable)Gross margin = gross profit on sales/salesEBITDA margin = EBITDA/salesEBIT margin = EBIT/salesPre-tax margin = pre-tax profit/salesNet margin = net profit/salesROE = net profit/average equityROA = (net income + interest payable)/average assetsEV = market capitalization + interest bearing debt – cash and equivalentsEPS = net profit/ no. of shares outstandingCE = net profit + depreciationDividend yield (gross) = pre-tax DPS/stock market priceCash sales = accrual sales corrected for the change in A/RCash operating expenses = accrual operating expenses corrected for the changes in inventories and A/P, depreciation, cash taxes and changes in the deferred taxes   DM BOŚ S.A. generally values the covered non bank companies via two methods: comparative method and DCFm method (discounted cash flows). The advantage of the former is the fact that it incorporates the current market assessment of the value of the company’s peers. The weakness of the comparative method is the risk that the valuation benchmark may be mispriced. The advantage of the DCF method is its independence from the current market valuation of the comparable companies. The weakness of this method is its high sensitivity to undertaken assumptions, especially those related to the residual value calculation. Please note that we also resort to other techniques (e.g. NAV-, DDM- or SOTP-based), should it prove appropriate in a given case.   BanksNet Interest Margin (NIM) = net interest income/average assetsNon interest income = fees&commissions + result on financial operations (trading gains) + FX gainsInterest Spread = (interest income/average interest earning assets)/ (interest cost/average interest bearing liabilities)Cost/Income = (general costs + depreciation)/ (profit on banking activity + other net operating income)ROE = net profit/average equityROA = net income/average assetsNon performing loans (NPL) = loans in ‘basket 3’ categoryNPL coverrage ratio = loan loss provisions/NPLNet provision charge = provisions created – provisions released   DM BOŚ S.A. generally values the covered banks via two methods: comparative method and fundamental target fair P/E and target fair P/BV multiples method. The advantage of the former is the fact that it incorporates the current market assessment of the value of the company’s peers. The weakness of the comparative method is the risk that the valuation benchmark may be mispriced. The advantage of the fundamental target fair P/E and target fair P/BV multiples method is its independence of the current market valuation of the comparable companies. The weakness of this method is its high sensitivity to undertaken assumptions, especially those  to the residual value calculation. Assumptions used in valuation can change, influencing thereby the level of the valuation.   Among the most important assumptions are: GDP growth, forecasted level of inflation, changes in interest rates and currency prices, employment level and change in wages, demand on the analysed company products, raw material prices, competition, standing of the main customers and suppliers, legislation changes, etc. Changes in the environment of the analysed company are monitored by analysts involved in the preparation of the recommendation, estimated, incorporated in valuation and published in the recommendation whenever needed.   KEY TO INVESTMENT RANKINGS This is a guide to expected price performance in absolute terms over the next 12 months:   Buy – fundamentally undervalued (upside to 12M EFV in excess of the cost of equity) + catalysts which should close the valuation gap identified; Hold – either (i) fairly priced, or (ii) fundamentally undervalued/overvalued but lacks catalysts which could close the valuation gap; Sell – fundamentally overvalued (12M EFV < current share price + 1-year cost of equity) + catalysts which should close the valuation gap identified.   This is a guide to expected relative price performance: Overweight – expected to perform better than the benchmark (WIG) over the next quarter in relative terms Neutral – expected to perform in line with the benchmark (WIG) over the next quarter in relative terms Underweight – expected to perform worse than the benchmark (WIG) over the next quarter in relative terms     The recommendation tracker presents the performance of DM BOŚ S.A.’s recommendations. A recommendation expires on the day it is altered or on the day 12 months after its issuance, whichever comes first. Relative performance compares the rate of return on a given recommended stock in the period of the recommendation’s validity (i.e. from the date of issuance to the date of alteration or – in case of maintained recommendations – from the date of issuance to the current date) in a relation to the rate of return on the benchmark in this time period. The WIG index constitutes the benchmark. For recommendations that expire by an alteration or are maintained, the ending values used to calculate their absolute and relative performance are: the stock closing price on the day the recommendation expires/ is maintained and the closing value of the benchmark on that date. For recommendations that expire via a passage of time, the ending values used to calculate their absolute and relative performance are: the average of the stock closing prices for the day the recommendation elapses and four directly preceding sessions and the average of the benchmark’s closing values for the day the recommendation expires and four directly preceding sessions.         This report has been prepared by Dom Maklerski Banku Ochrony Środowiska SA registered in Warsaw (hereinafter referred to as DM BOŚ SA) and commissioned by the Warsaw Stock Exchange SA (hereinafter referred to as WSE SA) pursuant to the agreement on the research report preparation between DM BOŚ SA and WSE SA within the framework of the Analytical Coverage Support Program 3.0 described on the WSE SA website: https:/www.gpw.pl/gpwpa (hereinafter referred to as the Agreement). DM BOŚ SA will receive a remuneration for the research report in accordance with the Agreement.  

France: consumption plunges while inflation moderates The second quarter got off to a poor start in France, with household consumption falling for the third consecutive month in April, and the outlook has been revised downwards. Against a backdrop of falling demand, inflationary pressures are moderating more quickly than expected.   Consumption continues to plummet In April, for the third consecutive month, consumer spending on goods fell. This time, the fall was 1% over the month, following a 0.8% fall in March. Household consumption of goods is now 4.3% lower than a year ago and 6.3% below its pre-pandemic level. The fall is due to lower energy consumption (-1.9% over one month) and a further fall in food consumption. Food consumption is now 11% below its pandemic level.   The magnitude of the fall shows the significant impact of the inflationary context and the fall in purchasing power, which has led households to significantly alter their consumption habits.   These figures were eagerly awaited, as they are the first real activity data available for the second quarter. And we can now say that the second quarter got off to a poor start. It is clear that the French economy is slowing sharply. It is unlikely that consumption will make a positive contribution to GDP growth in the second quarter, especially as the slowdown is beginning to have an impact on the labour market, as suggested by the employment climate data published by INSEE last week.   The prospect of a recovery later in the year seems to be fading. This has led us to revise our growth outlook slightly downwards. We are now expecting GDP growth of 0.6% in 2023 and 0.7% in 2024, with the risks still tilted to the downside. Although France escaped recession last winter, today's indicators are a reminder that a recession in the coming months cannot be ruled out.   Strong moderation in inflationary pressures Against this backdrop of falling demand, inflationary pressures are moderating. As expected, the pace of consumer price inflation eased in France in May. Inflation stood at 5.1%, down from 5.9% in April, while the harmonised index, which is important for the ECB, reached 6% in May, compared to 6.9% in April. The good news is that the fall in inflation is now visible in all consumer categories. Energy inflation fell sharply to 2% year-on-year in May.   Unlike in other European countries, it remains positive, however, as the rise in household energy bills did only take place at the start of 2023, rather than in 2022, as a result of the "tariff shield" introduced by the government last year. Food inflation remains very high but is starting to fall, to 14.1% in May from 15% in April.   At 4.1% year-on-year, compared with 4.6% in April, growth in the prices of manufactured goods is also moderating, as is that of services, which stood at 3% compared with 3.2% in April. These last two developments are very good news, as they signal that the inflation peak is behind us, but also that inflation is likely to fall rapidly over the coming months. Indeed, the signs of moderation in inflationary pressures are mounting.   For example, tensions in supply chains have disappeared and the growth in industrial producer prices, which gives an indication of changes in production costs for the manufacturing sector, slowed sharply to 5% year-on-year in April (compared with 9.5% in March). Over one month, producer prices fell sharply, by 4.1%, after +1.2% in the previous month. This indicates that growth in the prices of manufactured goods is set to slow markedly over the coming months.   Furthermore, business forecasts for selling prices fell sharply in May, particularly in the industrial and construction sectors, but also in services. Inflation in services should therefore continue to weaken over the coming months.   Finally, given the fall in agricultural commodity prices on international markets and the weakness of demand, food inflation should continue to fall gradually, and more rapidly once the impact of the price agreement between food producers and big retailers has been absorbed, i.e. during the summer. Ultimately, inflation is likely to fall over the coming months, helped by weak demand. We are expecting inflation to average 4.7% over the year (5.7% for harmonised inflation).

FXMAG.COM: Do you expect any radical moves of EUR/GBP price in the near future? What can cause such fluctuations?  As forex traders keenly observe the EUR/GBP currency pair, there is speculation surrounding the likelihood of substantial price movements in the near future. Examining the underlying factors that can trigger notable fluctuations is essential for making informed decisions in the market.   Macroeconomic indicators, including GDP growth, inflation rates, and employment figures, offer valuable insights into the potential for significant moves in the EUR/GBP price.   Based on the latest available data for Q1 of 2023, Eurozone GDP growth experienced a 1.3% increase, while the UK maintained a stable growth rate of 0.10%. Political developments exert a considerable impact on the EUR/GBP exchange rate. Notably, events such as the recent UK election or updates related to Brexit have proven to be catalysts for volatility.   Staying well-informed about key political developments is crucial, as they can significantly influence the price of this currency pair. Central bank policies play a pivotal role in shaping the EUR/GBP exchange rate.   The European Central Bank (ECB) and the Bank of England (BoE) periodically announce monetary policy decisions that affect this currency pair. It is important to keep a close watch on interest rate adjustments, quantitative easing programs, and forward guidance statements.   As of the latest interest rate decision on February 2, 2023, the ECB maintained rates at 3%, while the BoE held rates at 4.5% with a slight increase of 0.25% on May 11, 2023. Global economic trends and market sentiment can also influence the EUR/GBP price.   Trade relations between the Eurozone and the UK, as well as global economic conditions, can cause significant fluctuations. Monitoring geopolitical events, risk appetite indicators, and market sentiment can provide valuable insights into potential radical moves in this currency pair.   Predicting significant shifts in the EUR/GBP price is a complex task. However, analysing key factors such as macroeconomic indicators, political developments, central bank policies, and global economic trends can enhance your understanding of potential fluctuations. As of the latest available data on May 23, 2023, at 12:51, the EUR/GBP exchange rate stands at 0.87057. Stay well-informed about the latest news and events to navigate the market effectively and make informed trading decisions.

A hawkish hold from the Bank of Canada next week We expect the BoC to leave the policy rate at 4.5% next week, but after stronger-than-expected consumer price inflation and GDP and with the labour data remaining robust we cannot rule out a surprise interest rate increase. The market is pricing a 25% chance of a hike on 7 June, and a hawkish hold should be anough to keep the Canadian dollar supported.   Canadian resilience means a rate hike can't be ruled out The Bank of Canada last raised rates on 25 January and have held it at 4.5% ever since. The statement from the last meeting in April commented that global growth had been stronger than expected and that in Canada itself, “demand is still exceeding supply and the labour market remains tight”. The bank warned that it was continuing to “assess whether monetary policy is sufficiently restrictive and remain prepared to raise the policy rate further” to ensure inflation returns to 2%.   Since then we have had additional warnings from Governor Tiff Macklem that the bank remains concerned about upside inflation risks with the latest CPI report showing a month-on-month increase in prices of 0.7% versus a consensus forecast of 0.4%, resulting in the annual rate of inflation rising to 4.4%. The economy added another 41,400 jobs in April, more than double the 20,000 expected with wages rising and unemployment remaining at just 5%. The resilience of the economy was then emphasised further by first quarter GDP growth coming in at 3.1% annualised, beating the 2.5% consensus growth forecast. Consumer spending was the main growth engine, rising 3.1%.     But we favour a hawkish hold – signalling action unless inflation softens again soon Nonetheless, the BoC accept that monetary policy operates with long and varied lags and continue to believe that “as more households renew their mortgages at higher rates and restrictive monetary policy works its way through the economy more broadly, consumption is expected to moderate this year”. This will help to dampen inflation pressures and with commodity price softening we still believe that inflation can get close to the 2% target by the early part of 2024.   With the US economic outlook also looking a little uncertain, we doubt that the BoC will want to restart hiking interest rates unless it is certain that inflation pressures will not moderate as it has long been forecasting. Consequently we favour a hawkish hold, signalling that if there isn’t clearer evidence of softening in price pressures it could raise rates again in July.     The loonie's resilience can continue The Canadian dollar has been the best G10 performing currency in the past month, largely thanks to its high beta to the US economic narrative and a repricing of Canada’s domestic rate and growth story. These factors have outshadowed crude’s subdued performance in May and some risk sentiment instability.   A hawkish tone by the Bank of Canada at the June meeting is clearly an important element to keep the bullish narrative for CAD alive. As shown below, the recent repricing in Fed rate expectations caused a rebound in short-term USD swap rates relative to most currencies (like the euro), while the USD-CAD 2-year swap rate differential has remained on a declining path also throughout the second half of May.     As long as the BoC does not push back against the pricing for a hike in the summer, we expect CAD to remain supported. Some lingering USD strength in June can put a floor around 1.33/1.34 in USD/CAD, but we expect a decisive move to 1.30 in the third quarter and below then level before the end of the year.  

ECB Preview: Don’t look back in anger A 25bp rate hike looks like a done deal for next week’s European Central Bank meeting. However, with growth disappointing, the economic outlook getting gloomier and inflation dropping, arguments for several more rate hikes are becoming weaker. That said, the ECB is likely to ignore this.   Macro developments since the May meeting have clearly had more to offer the doves than the hawks at the ECB. Headline inflation has continued to come down but remains far off 2%, survey-based inflation expectations have also started to slow, growth has disappointed and confidence indicators seem to have peaked. In previous times, such a backdrop would have been enough for the ECB to consider pausing rate hikes and wait for the effects of the rate hikes so far to fully unfold. However, the ECB is fully determined right now to err on the side of higher rates.   Minutes of May meeting point to ongoing tightening bias This tightening bias was also reflected in the minutes of the ECB’s May meeting. The surprisingly weak Bank Lending Survey ahead of the last meeting clearly scared some ECB members enough to slow the pace of rate hikes but not enough to start thinking about an end to, or at least a pause in, the hiking cycle. In fact, a large number of ECB members assessed the risks to price stability as being clearly tilted to the upside over the policy-relevant horizon.   High underlying inflation and stubbornly high core inflation were the main reasons behind the ECB’s view that the conditions were not in place to “declare victory” or to be complacent about the inflation outlook.     Staff projections won't bring substantial change Next week’s meeting will also bring a new round of ECB staff projections. While gas prices have dropped further since the last projections in May, oil prices are broadly back at where they were in March. Market interest rates have also hardly changed and only the slightly weaker euro could technically add some inflationary pressure. At the same time, however, it will be interesting to see how the ECB is dealing with the disappointing soft and hard macro data of late.   Remember that back in March, the ECB expected eurozone GDP growth to return to its potential quarterly growth rate of 0.4% quarter-on-quarter from the third quarter of 2022 onwards. This was a surprising forecast given the delayed adverse impact from monetary policy tightening and ongoing structural transitions. It was also remarkable as at the same time, inflation was forecast to return to 2% by the end of 2025. An economy growing at full speed which also gradually allows inflation to disappear is a very unlikely phenomenon.     For next week, we expect slight downward revisions to the ECB’s GDP growth forecasts for this year and next but hardly any revisions to the inflation forecasts. This would mean that the ECB sticks to the 2025 forecast of 2.1% for headline and 2.2% for core inflation.     Hiking will continue, and not only next week Despite the recent decreases, actual headline and core inflation and expectations for inflation only to return to target in two years from now are clear arguments for the ECB to not only continue hiking by 25bp next week but to also keep the door open for rate hikes beyond then.   However, the eurozone economy has turned out to be less resilient than anticipated a few weeks ago and confidence indicators, with all the caveats currently attached to them, point to a weakening of growth momentum again. As headline inflation is gradually retreating, the risk increases that any additional rate hike could quickly turn out to be a policy mistake; at least in a few months from now. Still, the ECB simply cannot afford to get it wrong again.     This is why they are putting more than usual emphasis on actual inflation developments. Even if this completely contradicts forward-looking monetary policy, the ECB is in no position to take a chance and is not giving any impression that it might look back in anger.  

In 1Q23, we believe the Czech economy may have ended a soft recession, given the previous QoQ decline of 2H22 turned into stagnation but remained still negative in YoY terms (-0.4%). We expect the annual growth of GDP to remain negative in the first half of 2023.   This reflects a continued decline in household consumption, which fell deeply by 6.4% YoY, following a sharp decline in the inflation-driven fall of purchasing power of households, while corporates cut their investment on the back of weak foreign demand and high costs of lending. On a positive note, inflation is on a declining trend owing to an ongoing decline in core inflation, given a slowdown of food and fuel prices. This is likely to prevent the CNB from increasing interest rates despite the still tight labour market and the risk of a potential wage-inflation spiral.

Benefiting from an unusual context of political stability (which we expect to continue) and positive investor sentiment, the economy continues to perform decently, with help from increasing public investment spending.   Yet, having not used the high GDP growth from 2021-22 to accelerate deficit reduction, the government finds itself in an uncomfortable budgetary position. Sticking to the 4.4% of GDP budget deficit target this year is proving more than just challenging, as public wage requirements are catching up after two years of high inflation, while budget revenues are not increasing as planned. Historically, cutting investments was the general solution to stick within the deficit, hence we do not exclude this option. And this is just for 2023 budget. Moving lower to a 3.0% of GDP deficit in 2024 as per current strategy looks very ambitious to say the least.

Despite positive spillover from the Russia-Ukraine conflict, Uzbekistan’s growth momentum is waning on a sluggish agriculture sector, gas supply disruptions, elevated inflation and unemployment amid growing population.   Fiscal policy has been generous so far but is now likely to face some consolidation. Still, with GDP growth of around 5-6% pa, a relatively sound fiscal and external position, and ongoing reform agenda, the country looks attractive. A move to investment grade could be a trigger for the local FX (which is now under gradual depreciation pressure), but the prospects of that are clouded by the recent constitutional reform and the increase in trade with Russia, which might entail higher risks of secondary sanction scrutiny by the US and EU.

World trade is changing – can the CEE profit? Since September 2022, world trade has fallen by around 4%. The pandemic shock to global consumption has played a large role in trade trends in recent years. The initial phase of the pandemic resulted in lopsided consumption towards goods, which has now reversed towards services demand. Businesses also increased inventories early last year as supply chain problems persisted, which is now reversing.   While the ‘bullwhip effect’ of stockpiling across the supply chain added to trade volumes earlier, the process of stock reduction now creates extra slack in the figures. Although this process was not finished yet in the first quarter of 2023, we expect trade to recover mildly over the course of this year on the back of the reopening of China and further easing of supply chain problems, starting at the end of the first quarter. All in all, we expect total trade to grow at just 1% compared to last year, with 2024 offering a 2% gain in trade volume. This means trade will drop below global GDP growth and is expected to continue in the slow lane compared to long-term averages.   The upside risks to this outlook relate to our sluggish growth outlook for advanced markets. If a faster growth pace was to be maintained, this would clearly increase our expectations for global trade growth. Also, the current consumption mix is still favouring services compared to goods as consumers are catching up on leisure activities that were restricted during lockdowns. If that were to switch back more quickly, this would be a boon for global trade.   Recent years have been characterised by wake up calls for global trade. From lockdownled supply-chain disruptions to the US-China trade war, and from the Suez blockage to war and sanctions, the very globalised production model has been challenged a fair bit. In response, deglobalisation has become a key theme in economics, but the question is how that is really going to play out. It looks like diversification of sourcing products is the most dominant response to the supply chain problems seen in recent years.   Since 2016, we have seen steady increases in diversification of imports from advanced economies. Interestingly, we do see notable differences between Europe and the US. In the EU, we note relatively little diversification so far outside of the pandemic shock.   The US is the main diversification force at the moment. American imports are now a lot more diversified than they were in 2016 and this is mainly driven by a clear trend towards a lower dependency on China for imports.   Still, we expect diversification of imports to also increase further when looking at Europe; think of the swift move away from imports from Russia. ‘Friendshoring’, or closer trade ties with geopolitical allies, is likely to be a theme of the coming years and the big question is whether CEE can gain from this development. With world trade growing moderately, there are still opportunities to accelerate export growth if positioned well towards the right markets.

Armenia has benefited from a spillover of the war in Ukraine through net immigration of middle-class Russians and other CIS citizens, boosting services exports, domestic consumption and GDP, increasing its two-way trade with Russia and boosting budget revenues. Yet unless there is a new wave of immigration, growth is set to normalise amid still high unemployment and sluggish credit growth. Budget policy, prudent so far, may face higher military spending if tensions with Azerbaijan re-emerge.   Activity moderates but remains strong Following a significant 12.6% spike in GDP in 2022 thanks to the increase in migration, trade and capital flows from Russia (in addition to a post-Covid rebound in tourism) and 12.2% YoY in 1Q23, Armenia’s GDP growth is set to moderate in 2023, but to remain robust at around 7-8%. As most Russian immigrants, equating to around 2% of Armenia’s permanent population, are likely to stay in the medium-term, consumption seems well supported. Meanwhile, with unemployment high in double digits, private credit growth negative, and fiscal policy not generous, local domestic support factors appear muted. On the plus side, the deceleration of CPI from 10.3% at mid-2022 to 3.2% YoY in April amid a stronger Armenian Dram (AMD) and higher base effect, creates room for cautious cuts in the key rate from the current 10.75%.   GDP growth and CPI   Key parameters of consolidated budget   Fiscal discipline in focus In 2022, Armenia showed fiscal restraint in the face of extra revenues, allowing it to halve the fiscal deficit to 2.2% GDP. Military tensions with Azerbaijan, despite recent diplomatic momentum, create upward risks to military spending, which totalled 5.6% GDP in 2022 and exceeded the initial plan by 40%, and with a 20%+ weight in total spending may put the overall fiscal discipline to the test. In 2023-25, the deficit may gravitate towards 3% GDP and is likely to be financed mostly domestically in AMD amid little competition with private sector borrowing and elevated FX depreciation risks following AMD’s 24% appreciation to USD vs the end-2021 level, the strongest appreciation in the peer group. The FX appreciation in 2022 was also a key factor in reducing government debt ratios, which will remain sensitive to FX movements.   Current account, remittances and Armenian Dram (AMD)     Correction in AMD not excluded Immigration of c.65,000 people from CIS led to a positive balance of payments shock and 24% appreciation of USD/AMD since end-2021. Higher export of services (inward travel) was the main driver of a narrowing of the current account deficit by US$350m YoY to -US$170m. The merchandise trade deficit widened by US$500m due to proxy trade with Russia which accounts for 28% of exports and 43% of imports.   Net inflow of personal money transfers increased by US$1.7bn YoY to US$2.6bn but remained as FX within the banking system, not increasing the net capital inflow or lending. Mid-2022, AMD appreciation slowed to 2% per quarter, and the 4Q22 BoP points to a normalisation of flows, signalling potential correction in AMD. Yet the extra US$0.9bn accumulated by the Central Bank in 2022 could be used to smooth future AMD moves.    

Country strategy: a balanced play As holder of vast gas reserves Azerbaijan is set to benefit from Russia’s tensions with the EU through higher fuel exports and budget revenues amid conservative fiscal policy.   At the same time, the country’s trade ties with Russia are limited and diplomatic relations are relatively distant, lowering the risk of secondary sanctions and underpinning Azerbaijan’s beneficial position. Meanwhile, outside of strong foreign trade and financial position, Azerbaijan is challenged by a stagnation of the oil sector, slowing growth in non-fuel sectors, sticky elevated inflation, high dependency on food imports from Turkey and Russia, and the need to maintain relatively tight monetary policy.   Tensions with Armenia, despite the recent diplomatic momentum, remain a risk and could also become a trigger for some easing in fiscal policy.     GDP and oil/non-oil contribution (%YoY, ppt) Activity to slow Azerbaijan’s GDP growth slowed to 4.6% in 2022, on lower oil production and a tighter fiscal stance (see below). In 2023-24, growth is set to moderate further to 2.0-2.5 pa on stagnation in oil output and an end to the positive spillover from the Russia/Ukraine conflict. In 4M23, GDP growth was 0.1% YoY amid a 2.4% YoY drop in oil-led industrial production. Later, support will still come from the growing gas trade with the EU and some pickup in consumer and lending activity.   While the fiscal policy has some scope for easing, monetary policy is unlikely to provide support because of the elevated CPI, currently at 13%, which prevents the Central Bank of Azerbaijan (CBAZ) from materially lowering the key rate, currently at 9.00%. In 2023, average CPI may slow to 10%, but the outlook is vulnerable to negative developments given the 43% dependence on imports from Russia and Turkey.    Fiscal balance and breakeven oil price   Fiscal stance remains tight In line with our expectations, the consolidated budget surplus was 6% of GDP in 2022 on higher oil prices, healthy non-oil revenue collection and relatively restrained spending. Breakeven oil increased from US$52/bbl in 2021 to US$64/bbl, which is still comfortable.   The reintroduction of fiscal rules in 2022 should limit further expansion in spending, as the non-oil deficit is targeted to narrow by 5ppt of GDP by 2026. Meanwhile, high inflation, tensions with Armenia, despite the recent diplomatic momentum, and capex on new territories of around 3% of GDP pa create moderate upward risks to spending.   Each US$10/bbl oil price increase assures around 1.5% of GDP of oil revenues, and the recent and upcoming windfall translates into higher state savings (62% of GDP) and early redemption of debt, currently at only 20% of GDP (including guarantees).   Key exports indicators   Exports to be supported by growing gas supplies In 2022, Azerbaijan’s current account surplus spiked by US$15bn to US$23.5bn, or 30% of GDP thanks to higher oil prices, as well as higher volumes and prices of gas supplies. Fuel accounts for 93% of exports, of which c.65% is attributable to oil. In 2023, the current account should remain at around US$20bn, as a decline in oil and gas prices will be partially offset by growing gas supplies amid stable exports.   Gas exports to the EU went up from 8.1bcm in 2021 to 11.4bcm (51% of total gas exports) in 2022 and are targeted to reach 20bcm by 2027, supporting the current account and economic activity. Azerbaijan’s relatively distant relationship with Russia (outside of Russia’s 21% share in Azerbaijani imports) lowers the exposure to the risk of secondary sanctions.    

Country strategy: Wasted time It took five rounds of inconclusive snap elections in just over two years to end up with the political scene looking pretty much the same as it did at the start. During this time, Bulgaria missed the opportunity to join the Eurozone and Schengen area from 2024 and has lost precious time in absorbing EU funds from the Recovery and Resilience Facility.   Even the usually praised prudent fiscal stance is coming under question as the interim governments had limited capacity to steer spending. Following the latest elections in April 2023, a grand coalition between GERB and Continuing the Change is shaping up. While common ground seems to have been found in the overall pro-EU policy direction, some details of the agreement (eg, prime minister rotation every nine months) are making the coalition a fragile one. Nevertheless, this is as good as it gets for now.   Forecast summary   Decoupling from politics only lasts so long One year of real negative wage growth and two years of political uncertainty have dampened consumer morale. This has led to a slowdown in private consumption as revealed by the retail sales numbers that show three consecutive months of contraction (February-April 2023), a first since 2009. We believe this could be a bottom for consumption as the strong wage advances (which we estimate at 15.0% for 2023) should prop-up consumer spending.   A stable government will also give a boost to EU-funded investments, though it might be too late to reap the benefits in 2023. We expect a fairly anaemic 1.7% GDP growth in 2023, followed by an acceleration to 3.1% in 2024 should political stability prevail.   Real GDP (%YoY) and contributions (ppt)   Moving lower but not low enough With past energy prices out of the statistical base and current prices on a downturn, inflation started to ease considerably over the past couple of months. We estimate that HICP inflation will average 9.2% in 2023, from 13.0% in 2022. In 2024, HICP inflation could average around 4.5% which would mean that Bulgaria will not be even close to meeting the price stability criterion for Eurozone entry.   We currently estimate the average for the three best performing EU member states to be below 2.0% in 2024. Given the significant real convergence that Bulgaria still needs to deliver (which could come with some associated inflationary pressures), it will take quite an indulgence by the EU to overlook the price stability criterion.   Inflation (%YoY) and main components (ppt)   BGARIA credit: Some hope for political stability While it remains uncertain how successful a grand coalition will be in implementing structural reforms and how stable such a government may be, the recent agreement offers some hope for an end to the political uncertainty that has plagued Bulgaria and therefore a reduction in the political risk premium. In the longer term, signs of concrete progress towards Eurozone accession will be key.   Bulgaria is one of the weaker performers YTD among CEE EUR sovereigns and underlying fundamentals are very strong (current account near balance, low government debt and strong FX reserve position).    BGARIA credit spreads vs BBB EUR sovereigns (bp)        

The Eurozone and Schengen entrance on 1 January 2023 sealed the completion of Croatia’s EU integration story. The economy has shown a remarkable resilience through the pandemic and RussiaUkraine conflict, marking a striking difference compared to the 2008-09 global financial crisis.   While there is a long way to go in terms of catching-up with the Eurozone average in almost all aspects, the authorities seem quite determined to make good use of the EU’s Recovery and Resilience Facility, increasing fixed investments while keeping public deficits within very reasonable levels. Better terms of trade compared to 2022 and a tourism boost from Schengen entry might rebalance the external sector earlier than expected while quasi-balanced budgets could push the public debt ratio below the dreaded 60% of GDP over the next couple of years.   Forecast summary   At the right speed given the context Unlike most of its main EU partners that are experiencing mediocre growth at best, Croatia still managed to produce above potential growth rates in 2022. Momentum looks good in 2023 as well. Trends are clearly moderating in industry, construction and retail trade, with retail exposed to a generally weaker consumer confidence. However, this is likely to change for the better as real wage growth has already turned positive in 1Q23 but it will take a couple of quarters for consumers to start noticing the wage dynamics. All aside, the prospects for the tourist season look very good, authorities expecting a record year both in terms of number of tourists and revenues. We therefore reinforce our above-consensus GDP growth estimate of 2.7% for 2023 with upside risk.   Real GDP (YoY%) and contributions (ppt)   On the right track The revised official targets for the 2023 budget gap point to a 0.7% of GDP deficit, compared to an initial deficit estimate of 2.3%. In essence, as in 2022 that ended with a 0.4% of GDP surplus, the government is partly using the better-than-anticipated budget revenues to improve its budget metrics. In this context, the country has already returned to running primary balance surpluses which are expected to continue in the coming years.   We estimate that this will enable the debt-to-GDP ratio to dip below the dreaded 60% of GDP in 2025, having exceeded this level for 15 years. Looking forwards, we still anticipate the country to run small negative fiscal balances, as the phasing out of energy support measures will overlap increased social spending.   Public debt and fiscal balance (% of GDP)   Inflation is coming down but wage pressure remains After marking the top at 13.0% back in November 2022, the harmonised index of consumer prices (HICP) inflation has continually slowed to reach 8.5% in May, mostly on the back of energy price base effects. As the import price pressure starts to fade as well, the producer price growth is also visibly - though not as rapidly - decelerating. Core inflation, on the other hand, is reacting with lagged effects and we expect it to stay roughly 0.5ppt above headline inflation for the rest of the year.   The clear upside risks stem from wage pressures, as the purchasing power loss from 2H21 and 2022 now needs to be compensated. This comes on the back of an already tight labour market as the unemployment rate might hit record lows this year.   HICP inflation and wage rates    

In 1Q23, we believe the Czech economy may have ended a soft recession, given the previous QoQ decline of 2H22 turned into stagnation but remained still negative in YoY terms (-0.4%). We expect the annual growth of GDP to remain negative in the first half of 2023.   This reflects a continued decline in household consumption, which fell deeply by 6.4% YoY, following a sharp decline in the inflation-driven fall of purchasing power of households, while corporates cut their investment on the back of weak foreign demand and high costs of lending. On a positive note, inflation is on a declining trend owing to an ongoing decline in core inflation, given a slowdown of food and fuel prices. This is likely to prevent the CNB from increasing interest rates despite the still tight labour market and the risk of a potential wage-inflation spiral.   Forecast summary   Macro digest After two consecutive declines in GDP growth during the second half of 2022, the Czech economy in 1Q23 stagnated but remained negative in YoY terms (-0.4%). The main obstacle in economic recovery remained private consumption, which declined in the first quarter of 2023 by 6.4% YoY, as double-digit inflation squeezed markedly the purchasing power of households, while high interest rates and soft foreign demand led companies to reduce the growth of investment.   We expect the annual growth of GDP to remain negative in the first half of 2023 due to still declining household consumption. During the remainder of 2023, however, the economy is likely to show signs of a recovery, as gradually receding inflation will weigh less on the real purchasing power of households and the ongoing improvement of the external environment should support a recovery of exports. Yet, investment demand is likely to remain weak due to persistently high interest rates.    Real GDP growth structure (ppt of YoY growth, SA adj)   The unemployment rate (ILO) fell 3.6% to 3.5% in May. However, it stagnated at 3.6% on a seasonally adjusted basis. Nevertheless, the overall labour market in the Czech Republic remains extremely tight, even though firms in the PMI survey reported further layoffs in May due to fewer new orders. However, recent developments in the Czech industry and retail sector are not very favourable, which could be reflected in the pressure to lay off employees. For the time being, however, companies are still trying to hold on to employees in the hope of a recovery in demand. The overheated labour market is thus also reflected in rapid wage growth, particularly in industry and construction. The first quarter showed nominal growth of 8.6% YoY, but in real terms growth is deep in negative territory and a turnaround can only be expected in the third quarter.    Czech PMI underperforming region   Inflation, in our view, posted its last double-digit reading in May and will continue its swift disinflation for the rest of the year. The slowdown or even decline in inflation can be seen across the consumer basket. However, the main drivers are and will be food, fuel and housing prices.   Food and housing prices in particular, in our view, still have the potential to collapse faster than expected and headline inflation will surprise more to the downside. At the moment, year-end inflation should be around 8% YoY and, thanks to a large base effect and the re-pricing of energy prices, we should be in the 3-4% range as early as January next year.   Structure of inflation (ppt)   Government promises fiscal package to tame deficit   May's state budget deficit of CZK270bn, the worst result in history, confirmed the trend of weak tax revenues. For this year, the government is projecting a deficit of CZK295bn, however, given current developments, it plans to introduce measures to tame the growing deficit. Thus, for this year, we expect a general government deficit of 3.8% of GDP.   Looking ahead, for the next two years, the government has unveiled a large consolidation package that will soon enter the legislative process. The government is targeting a deficit of 1.8% for next year and 1.2% of GDP for 2025, which would be by far the lowest number in the region. We expect slightly higher numbers (2.3% and 1.8%), but in any case, consolidation will be ongoing, which makes a difference.   General government balance (% of GDP)

The worst might be behind Hungary. Yes, the economy is still in a technical recession, but we see a way out from it by the second half of 2023. A key source of the recovery lies in the growing disinflation process. The collapse of the domestic demand erases the repricing power of companies. Thus, we see a single-digit headline inflation by the year-end and further normalisation in 2024.   This means a positive real wage growth yet again from late-2023. However, with depleted household savings and tighter fiscal headroom, we hardly see a boom in domestic demand. The recovery will be export driven, thus we see a quick return to surplus in the current account balance. Improving external financing needs and the new era of monetary policy (eg, persistent positive real interest rates from late-2023) lead us to be constructive towards Hungarian assets.   Forecast summary   Macro digest The Hungarian economy has been stuck in a technical recession for three quarters (3Q22–1Q23) due to sky-high inflation suffocating economic activity. Consumption has been markedly slowing down since last autumn, as households cope with double-digit price increases, resulting in deteriorating purchasing power. On top of this, the high interest rate environment prompted a collapse in private investment activity, coupled with the government’s mandated freeze on public investments.   The only silver lining has been net exports, recently. Export activity is helped by pent-up production in car and battery manufacturing, while imports slow on lower energy demand.   Contribution to YoY GDP growth (ppt)   We expect the economy to emerge from the technical recession in the second quarter of this year, although the year-on-year growth will remain negative. As most economic sectors are still struggling amid weak domestic demand, the one sector that stands out on the positive side is agriculture.   The reason for this lies in base effects, which this time will help a lot, as last year’s energy crisis and drought wreaked havoc on the performance of agriculture.   Though this year’s weather has been favourable as well. In this regard, the fate of the overall 2023 GDP growth rather depends on the performance of agriculture as domestic demand will remain weak for the remainder of the year, curbing industry, construction and services.   Key activity indicators (swda; 2015 = 100%) In parallel with an acceleration of the disinflationary process, we expect the economy to display a rebound from the third quarter, delivering growth in every aspect for the remainder of the year. However, we expect a modest growth rate of 0.2% for 2023 followed by a 3.1% GDP expansion next year, boosted by both returning consumption growth and rising investment activity next to positive net exports.   Headline and underlying measures of inflation (%YoY)     Headline inflation retreated to 21.5% YoY in May, after peaking in January, while core inflation has also improved, with services being the only component where we see upside risks in the short run. As for the other components, food inflation has moderated for five months, while both motor fuel and household energy prices have recently declined, supported by a fall in global energy prices and a stronger HUF. We expect inflation to continue to retreat gradually in the coming months, as demand is vastly constrained by the loss of household purchasing power. In addition, base effects are contributing significantly to this year’s disinflationary process, which will accelerate from the third quarter onwards, thus we see the year-end reading dipping comfortably below 10%. At the same time, we expect inflation to average around 18% for this year, with balanced risks to our forecast. However, after two years of double-digit average inflation figures, we expect the full-year average to come in at around 5% in 2024

Country strategy: growth to recover, but FX risks mount Kazakhstan is generally benefiting from Russia’s geopolitical tensions through an inflow of high-skilled labour and businesses and opportunities for increased trade with the EU. That said, high dependence on the Russian pipeline infrastructure and the need to balance its relationship with the EU are the risk factors. In 2023, growth momentum may strengthen, but domestic constraints include a deteriorating inflationary outlook and high dependency on the oil sector, prone to sudden maintenance issues. Financially, Kazakhstan’s fiscal and external balances remain comfortable. Nevertheless, the scope for further strengthening of the Kazakhstani Tenge (KZT) appears limited given the expected return of the current account to deficit and likely normalisation of net private capital inflows in the face of risks of secondary sanctions related to ties with Russia.   Forecast summary   GDP growth and major contributors (%YoY, ppt)   Economic activity gaining momentum Following a 1ppt slowdown to 3.3% GDP growth in 2022, Kazakhstan is on track to post GDP acceleration in 2023-24 thanks to continued growth in consumption and a recovery in industrial (including oil production after a somewhat erratic 2022). 1Q23 GDP growth was 4.9% YoY. Support factors include the presence of c.100,000 Russian immigrants (1% of the permanent population) and relocated companies, growing consumer lending and wages, expansion of oil production and exports to the EU.   Meanwhile, sticky elevated inflation remains a concern, preventing any easing of monetary policy, while fiscal support is also limited. Kazakhstani oil exports’ dependence on Russia is a growing concern, with 80% of oil exports going through the Caspian Pipeline Consortium (CPC) pipeline and extra supplies to the EU via the Druzhba pipeline. Also, Kazakhstan is on the US/EU watch in terms of compliance with Russian sanctions.   Key fiscal indicators (% GDP, lhs) (US$/bbl, rhs)   Fiscal policy tends to return to conservatism Last year was lucrative for the budget, as thanks to a US$20/bbl increase in the Brent oil price and recovery in production after a sluggish 2020-21, along with some restraint on the expenditure side, the consolidated budget deficit shrank by 3ppt to 1.3% of GDP, and breakeven Brent fell from US$140/bbl to US$116/bbl. The new budget rules introduced in 2023 suggest that the government is targeting a cautious approach to spending to limit the breakeven, which is still elevated. A tighter limit on the sovereign fund (NFRK) outlays suggests a higher role of borrowing, mostly domestic, in financing the Republican budget deficit (which should remain at 2- 3% of GDP pa as most of the oil revenues go to the sovereign fund directly). The public debt should remain limited at around 25-30% of GDP unless the policy is eased.   Key balance of payment items and KZT (US$bn, lhs)    KZT increasingly reliant on volatile capital flows After showing a US$8.5bn surplus in 2022, the current account returned to a US$1.5bn deficit in 1Q23 and is likely to remain negative on moderation of oil prices and growth in imports. In fact, the current account surplus has been shrinking since 2Q22, the breakeven Brent increased from US$77/bbl to US$81/bbl in 2022, and the KZT appreciation since 3Q22 was based on the substantial atypical net private capital inflow of c.US$3bn per quarter, which could prove volatile.   USD/KZT has now almost recovered to levels seen before February 2022, and the new fiscal rule assumes lower state sales of FX out of NFRK. In addition, risk of Russia-related secondary sanctions may push Kazakhstan to be more cautious about its financial and trade flows.    

Benefiting from an unusual context of political stability (which we expect to continue) and positive investor sentiment, the economy continues to perform decently, with help from increasing public investment spending. Yet, having not used the high GDP growth from 2021-22 to accelerate deficit reduction, the government finds itself in an uncomfortable budgetary position. Sticking to the 4.4% of GDP budget deficit target this year is proving more than just challenging, as public wage requirements are catching up after two years of high inflation, while budget revenues are not increasing as planned. Historically, cutting investments was the general solution to stick within the deficit, hence we do not exclude this option. And this is just for 2023 budget. Moving lower to a 3.0% of GDP deficit in 2024 as per current strategy looks very ambitious to say the least.   Forecast summary   GDP (YoY%) and components (ppt)   Investments offsetting the slowdown in consumption With a bit of help from the external context as well, which in the end hasn’t performed as badly as expected, the economy remained on track and continued to post solid quarterly advances throughout 2022. The environment is clearly weaker in 2023, with a quasistagnant first quarter growth, despite hard frequency data looking rather solid.   A welcome rebalancing in growth drivers from consumption to investments looks in the making, though we are not in a hurry to celebrate that, as the latest social demands might be partially satisfied by cutting into investment spending. This spending shift might in fact be growth supportive in the short term, though clearly not ideal from a medium- and long-term perspective.   On the brighter side, real wage growth turned positive in March as the average net wage advanced by an eye-catching 15.7%, with above-average growth visible in sectors such as agriculture, IT services, transportation and construction, while the public sector has generally seen below-average wage growth.   As real wage growth is set to accelerate further this year, a reacceleration of consumer spending could be envisaged in the second part of 2023.   Supply side GDP (YoY%) and components (ppt)   With a significant electoral year ahead, discussions about future economic policies and tax revamps are all over the place. This is blurring to some extent the policy visibility post-elections, though we tend not to put a too heavy emphasis on the headlines these days. Should it want to continue to tap into the RRF money, any future government will need to deliver the already agreed reforms as per the National Recovery and Resilience Plan, with very little room for manoeuvre. While some delays are already accumulating and losing some parts of future tranches cannot be excluded, the vast majority of political parties seem to strongly support sticking with the agreed plan.   Construction sector holding on (YoY% growth)   On the monetary policy front, we expect the National Bank of Romania (NBR) to cut rates when the first opportunity arises. Our central scenario assumes a rate cut once inflation inches below the key rate, which should happen in 1Q24. Nevertheless, if other regional central banks were to move ahead with cutting rates before the end of this year, we cannot rule out the NBR doing the same. For 2024, we expect a total of 150bp of rate cuts to 5.50%. 2024 inflation is likely to allow for even larger cuts, but we believe that the NBR will want to consolidate the lower inflation prints and will maintain a relevant positive differential between the key rate and inflation. The relative stability of the exchange rate should help as usual, with the EUR/RON rate expected to move upwards in small 1.0-2.0% increments each year.

Industrial production contracted by 2.0% in 2022 and 4.6% year-todate. As of March 2023, it remains almost 6.0% below its prepandemic levels (ie, January 2020). Among the few brighter spots are the food, automotive and pharma sectors which have continued their upward trend and are above both the pre-pandemic period and the similar period from 2022. On the downside, the textile and chemical industries are both some 35% below their pre-pandemic levels, followed by the metallurgical industry at 30% below. The latest confidence data does not look particularly encouraging as production expectations and capacity utilisation collapsed in May 2023 to a two-year low. The number of employees remained fairly constant, though significant shifts occurred within subsectors.   Industry still below pre-pandemic levels   Fiscal picture is improving but we are not there yet   Elections and social demands could derail the adjustment The 4.4% of GDP budget deficit target for 2023 was shaping up to be quite challenging and it definitely is. As of April 2023, the budget deficit reached 1.72% of GDP and already prompted the government to come up with a mild (read: insufficient) spending optimisation plan, amounting at best to some 0.3% of GDP.   Given the social demands for higher wages (at the time of writing there is an ongoing major strike in the public education sector) and the lower GDP growth (leading to lower budget revenues), a more substantial adjustment is likely to be needed at the usual mid-year budget revision. The good news is that sticking to the 4.4% of GDP target for 2023 seems to be a priority.   The bad news is that it might involve cutting public investments which were just catching up some speed.   Current account deficit remains Achille’s heel (% of GDP)   Inflation (YoY%) and main components (ppt)   Economic slowdown and lower fiscal gap are helping The current account deficit (CAD) surpassed the worst fears in 2022 as it reached 9.4% of GDP, from 7.3% in 2021. We estimate that at least 1ppt of the 2022 deterioration came from worsening terms of trade, which should be largely reversed in 2023. As mentioned many times already, we remain particularly worried about the stickiness of the CAD and blaming it on the fiscal deficit only holds so much. More positively, the financing structure of the CAD looks relatively sound.   We estimate that over the next 3-4 years, between 70% and 80% of the deficit can be covered via non-debt-creating inflows such as FDIs and EU funds. As a consequence, we estimate that a CAD of 4.0-5.0% of GDP could be considered a ‘natural’ level for an emerging economy like Romania. But we’re not there yet…   Switching to single digits by the Autumn After remaining consistently at the lower end of inflation forecasts, it seems things are finally turning our way: inflation looks set to touch 7.0% by the end of 2023, driven by base effects, lower energy prices and an easing of food prices.   We reduce our 2024 year-end estimate to 4.0% from 4.3% previously, while maintaining the view that inflation will not reach NBR’s 1.5-3.5% target range over the next two years. These developments alone (especially those from 2024) would allow the NBR to cut the key rate quite significantly and still maintain a positive real rate. However, we believe that the NBR will want to consolidate the lower inflation prints and will maintain a relevant positive differential between the key rate and inflation, at least until we see inflation within NBR’s target range.

The Stand-By-Arrangement (SBA) with the IMF concluded in late 2022 seems to have been an inspired policy choice, as it fostered better-than-expected twin deficits, while foreign direct investments remained strong. In this context and underpinned by stable ratings, Serbia successfully retuned to capital markets, issuing two Eurobonds in early 2023. It is not all rosy though, as relatively sound economic policies overlap major other challenges. In May 2023, the European Parliament voted with a large majority to validate a report which clearly states, among others, that Serbia’s EU integration should be dependent on aligning with the EU on sanctions against Russia and on normalising the relations with Kosovo. At the limit, this could mean a limbo-time for Serbia until policymakers are ready to take decisive actions on most sensitive issues.   Forecast summary   Real GDP (%YoY) and contributions (ppt)   From hero to almost zero   The economy has been losing speed for a while as the growth pace gradually decelerated from double digits in mid-2021 to marginal advances in 4Q22 and 1Q23. The growth structure has been changing as well, as private consumption has begun to fade lately, after more than one year of real negative wage growth. With investments and net exports only partially offsetting the slower growth in consumption, we maintain a below consensus 1.6% GDP growth estimate for 2023.   Geopolitics aside, we tend to see risks skewed to the upside, as Serbia’s main trading partners should recover in 2H23 boosting exports. On the domestic front, doubledigit wage growth will provide a backstop to slowing consumption while public investments are set to remain close to historical highs.   FX stability remains the main policy tool   No deviation from the tight managed floating policy After raising the policy rate by 525bp to 6.25% in a bit more than one year, the NBS might be taking its time now and contemplate the effects of past monetary tightening. We believe that the next policy decision will be a rate cut in 1Q24 when we will finally have positive real rates. However, despite the inflation peak being clearly behind, our central scenario does not envisage the headline inflation back within NBS’s 1.5-4.5% target range over the next two years, but rather a stabilisation in the 5.00-6.00% interval. We maintain our expectations for an essentially flat EUR/RSD profile for the rest of 2023 and even through 2024, with FX interventions likely to occur in a rather narrow range around the 117.30 level.   SERBIA EUR credit vs ROMANI (z-spread, bp)   SERBIA credit: Geopolitics drives headline risk The recent flare up in Kosovo tensions (violent protests and calls for new regional elections) has opened up value for Serbia’s Eurobonds - headline noise is likely to continue but should be contained by US and EU mediation. At the same time, credit fundamentals are recovering well from last year’s energy shock, with a steady accumulation of FX reserves, narrowing current account deficit and government debt-to-GDP back on a downward trend. IMF support should also act as a policy anchor even if progress towards EU integration is slow

President Erdogan was re-elected and the Erdogan-led People’s Alliance won a simple majority in Parliament. The macro outlook points to a need to rebalance the economy given that: (1) the current account deficit has remained on an expansionary path; (2) total capital flows have remained weak; (3) there is a major fiscal expansion; and (4) the extra fiscal burden and the CBT’s supportive stance create further pressure on already elevated inflation.   In this environment, the main policy debate focuses on interest rate policy and whether there will be a return to a more conventional policy setting post-elections. The appointment of Mehmet Simsek as Minister of Economy and Finance shows an intention to return to conventional economic policies, though it is too early to decide the degree of orthodoxy. The signals imply that actions will be taken without delay following formation of new economy management.   Forecast summary   Macro digest 1Q23 Turkish GDP growth came in at 4.0% year-on-year, slightly better than market consensus, on the back of private consumption, government consumption and gross fixed capital formation, while net exports were a drag once again. On a quarter-on-quarter basis, 1Q23 GDP growth was 0.3% after seasonal adjustments, showing some momentum loss compared with a relatively strong reading in 4Q22 of 0.9%.   Moderating sequential performance is attributable to: (1) a deceleration in household consumption to the lowest growth rate since the last quarter of 2020, also likely reflecting the impact of the earthquake disaster; and (2) government expenditure turning negative while stocks positively contributed to the headline and investment appetite remained solid.   Early indicators for 2Q23, on the other hand, hint at an acceleration in the GDP expansion on a yearly basis in comparison to 1Q23 given: (1) realisations of real sector confidence and capacity utilisation reflecting a continued strengthening in manufacturing, leaving the effects of the earthquake disaster behind; (2) further improvement in PMI to above the first quarter average, while confidence indicators for retail, construction and services show further improvement.   As growth forecasts for 1H23 imply a better-than-expected performance, the macro indicators point to a need to rebalance the economy. In this regard, the assignment of a new economy management team and guidance on policy direction will be key for the outlook, in our view.   GDP growth, on a quarterly basis (% YoY)   PMI and IP (seasonally adjusted, 3m-ma, % YoY)   Annual inflation has remained on its downward path in May thanks to: (1) TurkStat's implementation of the ‘zero price’ method for natural gas subsidies. Accordingly, the natural gas sub-group saw a monthly price decline of 100%; (2) the 2003-based index average for May in the last five years pointed to a favourable base effect for this year. Core inflation (CPI-C) rose to 46.6% on an annual basis.   This suggests that the exchange rate and commodity price-driven improvements in core inflation indicators in recent months may have come to an end. The underlying trend for the headline markedly recovered in comparison to the previous month thanks to goods inflation, while the services group has maintained the elevated trend given continuing pressures in rent, catering and telecommunication services. Despite the elections being behind us, at this stage uncertainty about exchange rates and interest rates persists, but it is expected that the new economy management team, led by Mehmet Simsek, will bring about significant changes in the CBT and the monetary and exchange rate policy to be implemented in the short term.   Accordingly, a lira adjustment postelection and potential adjustments in wages and administered prices are likely to weigh on inflation momentum, while a new equilibrium in rates will be key to return to disinflation in the period ahead.   Inflation (% YoY)

Country strategy: limited benefits Despite positive spillover from the Russia-Ukraine conflict, Uzbekistan’s growth momentum is waning on a sluggish agriculture sector, gas supply disruptions, elevated inflation and unemployment amid growing population. Fiscal policy has been generous so far but is now likely to face some consolidation. Still, with GDP growth of around 5-6% pa, a relatively sound fiscal and external position, and ongoing reform agenda, the country looks attractive.   A move to investment grade could be a trigger for the local FX (which is now under gradual depreciation pressure), but the prospects of that are clouded by the recent constitutional reform and the increase in trade with Russia, which might entail higher risks of secondary sanction scrutiny by the US and EU.   Forecast summary   Growth momentum waning Despite an inflow of c.100,000 (0.3% of the regular population) of immigrants from Russia and doubling of remittances to 18% of GDP, Uzbekistan’s GDP growth slowed by 1.7ppt to 5.7% in 2022 on weak agriculture output (25% of GDP) and limited consumption on high unemployment. In 2023, growth is set to remain at 5-6% (1Q23 GDP is up 5.5% YoY). Support comes from a 3ppt cut in VAT and wider fiscal deficit in 1Q23, but constraints include normalisation of financial inflows from Russia, neutral effect of re-export/import of goods to/ from Russia, gas supply disruptions (from Turkmenistan) in early-2023 and elevated inflationary pressure.   CPI was 11% YoY in April and likely to stay double-digit (year average) with a weak Uzbekistani Sum, monetary easing (key rate decline in past month from 17% to 14%), Source: National sources, ING expected liberalisation of tariffs mid-2023 and local harvest issues.    GDP growth by components (% YoY and ppt)

Activity data was very weak The main body of activity data can be summed up in one word. Disappointing. Retail sales is the figure we have been focussing on, as it is at the moment, the only functioning engine of Chinese growth. And although the year-on-year growth rate of 12.7% looks impressive, this equates to a seasonally adjusted decrease in month-on-month sales and shows that the re-opening momentum is falling.  Breaking the numbers down to look at what is driving growth, and catering is still the major driver, which won't do a lot to boost domestic production and manufacturing, though it does lift GDP. Vehicle sales is the only other notable contributor to growth, after which very little else is showing much signs of life, including consumer confidence bellwethers, like clothing.    Industrial production rose 3.5%YoY, though this was well down on the 5.6% rate of growth in April, and the year-to-date growth figure was unchanged at 3.6%.  Urban fixed asset investment slowed from 4.7% to only a 4.0% pace, which may illustrate the problems local governments are having trying to boost growth in the absence of cash from land sales. Some more central government support may be of help here if it is forthcoming.    Also, property investment continues to weaken and is now falling at a 7.2%YoY pace, down from -6.2% in April. We had been hoping for more of a flat line from property development in China in 2023 after what we calculate was about a 1.5pp drag on GDP growth in 2022. It could be worse than this.    Contribution to year-on-year retail sales growth

The productivity/unit labour cost conundrum Let’s start with the RBA’s assessment that depressed productivity growth and rising unit labour costs are an issue that they need to be mindful of when setting policy. Both issues are mentioned in the text accompanying the RBA’s latest rate decision and also in Governor Philip Lowe’s 5 April speech on Monetary policy, demand and supply.  In the view of this author, productivity is a much-misused concept. It sounds real enough, but it is a construct of both economic growth and employment (whether measured as the number of jobs or hours worked). In a sense, therefore, productivity doesn’t really exist at all but is simply a residual that drops out of consideration of these other concepts. So, if you know what is happening to GDP growth, and you know what is happening to employment or hours worked, productivity measures add nothing to your understanding of the economy and are basically just a ratio of these other measures.   The same goes for unit labour costs, which can be thought of as output per unit of wages. We could write these relationships in the following simplistic way: Productivity = Output/Labour Average Wages = Wages / Labour Unit labour costs  = Output / Wages (or re-arranged  = Productivity/average wages)   And all these measures are quite cyclical. Output slows in a recession. So does employment, though it tends to lag well behind GDP and slow much later. Wages growth lags even with these changes in employment.     The result is that in an economic slowdown, productivity drops, and unit labour costs rise. And yet this is not in the slightest bit inflationary, because the overarching piece of information is that the economy is slowing, and that will lead to weaker price pressures. This is as true for Australia as it is anywhere else, where productivity has been declining as growth has slowed, and unit labour costs have risen. And we are still looking for inflation to fall. Contributions to QoQ GDP (pp)  

What about the forecast changes? Perhaps the most important change will be that, as the extreme risk scenarios have now disappeared, the central bank will hopefully also narrow the updated forecast ranges when it presents the main figures in the June Inflation Report. A narrowing of the forecast range downward would send a rather strong message regarding GDP growth in 2023. This would put the central bank in the ranks of those who do not think it likely that GDP growth of 1.5% will be achieved this year. However, as the economic outlook now depends largely on the performance of agriculture, it may still be justified to maintain a wider band.   ING's expectations regarding the NBH's forecasts   There is a lot of uncertainty around GDP growth next year, so perhaps there is no point in seriously revising expectations. As for inflation, the NBH is likely to raise its forecast, if only because of the change in the excise duty from 1 January 2024. In addition, an inflation rate clearly above 3% could also send an important message to markets, supporting the central bank's new stance that sustained tight monetary policy with a continuous real positive interest rate environment is needed to achieve the inflation target in a sustainable manner.   Our market views The Hungarian forint has come under pressure for the first time in a while, reaching its weakest level against the euro since the end of May. We see EUR/HUF in a 368-378 range for the rest of the year and see the current higher values as only temporary. The market will probably want to wait for the NBH meeting to see how it sees the situation. However, we believe the market will use weaker forint levels as an opportunity to build new positions and benefit from the highest FX carry within the region. Thus, we expect the forint to return more towards the lower end of our range around EUR/HUF 370 next week.   In the rates space, we see the market more or less fairly pricing in the rate cuts this year and the super short end is thus anchored. However, looking at the longer 1-3y horizon, we see room for the market to further price in some normalisation of NBH policy. Our long-term view thus remains unchanged and the 2s10s spread should steepen with the entire curve moving lower, and catching up with the market. In the short term, for next week, we see major scope for a move within the short end of the curve and a flattening in the 1s3s segment that may get the market's attention.   Hungarian Government Bonds (HGBs) have had a massive rally in recent weeks and are posting the highest overall returns in the CEE region this year. We continue to like HGBs, which benefit the most from the whole story in Hungary, further supported by government measures and funding fully under the control of the debt agency. In the coming days, we could see some profit-taking and upward yield pressure from core rates, however, we still see HGBs as expensive relative to CEE peers. On the other hand, it is hard to see a significant trigger for a sell-off and we expect the market to continue to like HGBs.

But there are also more cautious voices on the topic. Just as Lagarde pointed out in yesterday’s panel, interest rates remain the ECB’s primary monetary policy tool. In another background report by Econostream released in the afternoon, ECB officials signalled that the current passive run-off was sufficient, and especially speeding it up via the changes to the PEPP guidance and/or reinvestments would unnecessarily risk financial stability.   After all, the possibility to flexibly reinvest PEPP holdings is one of the main tools that the ECB still has to quickly react to spread widening pressures in bond markets. At some point the ECB has to decide on the balance sheet size it wants to target, which goes hand-in-hand with an ongoing review of the ECB’s operational framework. Yesterday, Lagarde flagged that this work could hopefully be completed in the next “six to nine months”. This indicates some upside risk to previous communication which saw the review being concluded by the end of the year.   Today's events and market view Inflation remains the central banks’ one needle in the compass that dictates their policy nowadays. This puts the focus squarely on today’s inflation readings out of Germany and Spain. German headline and core rates are seen higher on the back of base effects and statistical tweaks. Spain’s headline rate is seen falling below the 2% level but, more importantly, the core rate is seen to come down only marginally.   Alongside Italy’s data from yesterday this should already give a good idea of where tomorrow’s eurozone reading is headed – and it should signal no let up in the pressure on central banks to continue to act forcefully.   In this set-up yield curves will remain inverted for some time. Markets will see the softness in wider data, such as in yesterday’s eurozone credit growth which shows that policy transmission is working. Still, if there is anything that could turn the market it is surprises in the inflation data, which markets might be quicker to extrapolate even if central banks themselves might want to see confirmation from more than just one reading.   In other data we will get the initial jobless claims out of the US, pending home sales, as well as a third reading for first quarter GDP growth.

According to the CME FedWatch tool, markets are currently seeing a ~74% probability that a hike will not take place at the Fed monetary policy committee meeting in June. In addition, expectations of future rate cuts closer to the end of 2023 and continued rate cuts through 2024 are increasing, further boosting investor sentiment, supporting valuations of technology companies, growth sectors in general and contributing to the upward trajectory of the market.   Lower inflation has also played a role in the positive market performance. Inflationary pressures continue to fall, allowing consumers to maintain their purchasing power and businesses to plan for the future with greater certainty, removing uncertainty about inflation. This favourable inflation environment has strengthened investor confidence in the resilience of the economy in the 2nd half of the year, given the expected policy shift from the Fed. Moreover, the US economy has demonstrated its resilience, continuing to show growth despite relatively high interest rate levels. Key economic indicators such as GDP growth, employment figures, labour market strength and consumer spending are showing signs of stability, indicating sustained and balanced economic growth. Expectations of a soft economic landing have allayed fears of a prolonged recession and laid a solid foundation for market recovery.

Glimmers of hope for US inflation slowdown The Federal Reserve's favoured measure of inflation slowed fractionally more than expected, but there was clearer evidence of softening in the so-called "super core" measure that Fed Chair Jay Powell has been focusing on. There is also evidence of a loss of momentum in spending which will dampen prices pressures further down the line   Incomes rose, but spending stalled in May The May US personal income and spending report in aggregate is a touch softer than predicted. Incomes rose 0.4% month-on-month, above the 0.3% MoM expectation, but then we had a corresponding 0.1pp downward revision to April's growth rate from 0.4% to 0.3%. The more interesting story is on the expenditure side with nominal personal spending rising only 0.1% MoM versus 0.2% expected and there were downward revisions to April (from 0.8% to 0.6%). This leaves "real" consumer spending softer at 0% and April was revised down to 0.2% MoM from 0.5%. This means the savings rate has risen from 4.3% to 4.6%.   2Q growth looks to be a fair bit weaker than 1Q as momentum fades For those that like digging into data, the MoM real consumer spending change was -0.03% MoM to two decimal places. This means if we get a +0.2% MoM real consumer spending print for June, we will have quarter-on-quarter annualised consumer spending of 1% for the second quarter, down from 4.2% in the first. 0.1% MoM for June works out at 0.9% QoQ annualised for 2Q. while 0% MoM reading for June real spending generates 0.8% QoQ annualised. This report suggests a fair bit of spending momentum has been lost as we progress through 2Q. We are currently pencilling in 0.2% MoM for real spending growth in June. So far, weekly chain store data (Redbook) has been soft and restaurant dining is currently (according to Opentable) running at -3% year-on-year and hotel occupancy is running at roughly -1.5% YoY for June (to June 24) according to our interpretation of STR data. TSA airport security check numbers are up though. A 1% QoQ annualised consumer spending number would leave us struggling to get GDP growth above 1.5% in 2Q.   Service sector inflation appears to be topping out (YoY%)   Early signs of softening in Fed's "super core" inflation measure Rounding the report out, we see the Fed's favoured measure of inflation, the core PCE deflator coming in at 0.3% MoM/4.6% YoY. A touch softer than the 0.3%/4.7% expected. At 4.6%, this is the slowest rate of core PCE inflation since October 2021. Based on my calculations, the core PCE deflator ex-energy and ex-housing (Fed Chair Powell is focusing on this as it is this component that is most heavily influenced by the tightness in the jobs market since wages make up the biggest cost input and in which demand has been robust) also slowed to 4.6% from 4.7% YoY while Bloomberg’s calculations back this up, saying on a MoM basis it came in at 0.23% MoM versus 0.42% in April. This is a really encouraging story since we need to see 0.1s or 0.2s MoM to get inflation to 2% YoY over time. It is early days, but NFIB corporate pricing intentions data and ISM prices series offer clear hope that we will soon consistently see these sorts of figures.

Monitoring Poland: National Bank of Poland looks set to ease Surprisingly, neither the ruling PiS party nor the opposition unveiled new social spending plans in June. We expect new announcements just before the elections, possibly in September. We expect a fast decline in CPI in 2H23, supporting – in our view – NBP policy easing in 2023. This offers a positive outlook for POLGBs, at least until the general elections.   We expect no policy changes from the National Bank of Poland (NBP) in July. The central bank will present new projections, likely reflecting a series of downside CPI surprises. However, we estimate that the chances of a rate cut after the August Monetary Policy Council break have increased to 65-70%. This follows the guidance provided by some MPC members, including President Adam Glapinski, and the recent lower-than-expected CPI print in June. We see more than one interest rate cut in 2023 as possible. Our short-term inflation forecast is optimistic, with CPI falling to single digits in August – something which should further strengthen the MPC’s dovish stance. Our long-term CPI forecasts are substantially less favourable though. Core inflation could stabilise around 5% year-on-year in 2024-25, given the tight labour market, another significant rise in the minimum wage and valorisation of the 500+ child benefits (to PLN800 per child per month).   Risks to our 2023 GDP of 1.2% growth forecast are mounting. Second-quarter growth most likely underperformed (with flat or negative year-on-year growth), given poor retail sales, industrial output and an only 45.1 point manufacturing PMI print in June. Consumer sentiment is improving but from a very low level. Moreover, real wages are set to only start to grow sometime in the third quarter, after around a year of negative growth. Also, the government’s recent cheap mortgage scheme has come too late to give a boost to housing construction this year. Given the likely lacklustre internal demand, net exports are set to be a key GDP driver this year.   FX and money markets The zloty continues to benefit from a mix of current account surplus, more FX sales on the market by the Ministry of Finance, inflows from Foreign Direct Investment and portfolio capital. Some investors seem to expect a more market-friendly political environment after the parliamentary elections. We expect all those factors to persist at least until the elections. We expect €/PLN to gradually sink towards, or slightly below, 4.40 in the coming weeks.   Domestic debt and rates Despite higher overall 2023 borrowing needs after the state budget amendment, the government aims to finance these via a reduction of the sizeable cash buffer (PLN117bn as of the end of May) and FX funding, hence limiting Polish government bonds (POLGBs) issuance compared to the initial budget bill. In tandem with the expectations for monetary policy easing (fueled by the recent CPI print), this suggests further drops in yields across the curve and some tightening in asset swaps.

French industrial production rebounds French industrial production rebounded in May more than expected, reaching its highest level since the start of the pandemic. Widespread rebound In May, French industrial production rebounded more than expected, increasing by 1.2% over the month, following a rise of 0.8% in April. Manufacturing output also rebounded, by 1.4% over the month (+0.6% in April). This rebound enabled manufacturing output to reach its highest level since the start of the pandemic, up by 2.9% year-on-year. March's weakness, due to strikes and production disruptions caused by protests over pension reform, has therefore been fully offset. Growth in May was seen across all the major product categories, although the energy-intensive industrial branches continued to suffer from the context of high energy costs. Production levels in steel, paper/board and basic chemicals remain between 13% and 24% lower than a year ago.   The outlook for industry remains difficult The rebound in industrial production is good news for the French economic outlook. In the short term, this should ensure that industrial production does not contribute negatively to GDP growth in the second quarter. Weak but positive growth seems most likely. Nevertheless, the outlook for industry over the next few quarters remains cloudy. According to survey results, business leaders' assessment of order books has remained very weak for several months, a sign of a major slowdown in global demand for industrial goods. At the same time, inventories of finished goods remain high. This means that production is likely to decline over the next few months as companies see no new orders coming in and have stocks to clear. The PMI indices for the manufacturing sector have been in contraction territory (below 50) since January.   Weak growth in 2023 and 2024 Ultimately, growth in the second quarter should be weak, but positive. Growth in the third quarter should have been better, supported by the strength of the tourism sector. However, the tense social context, with the recent protests and damage, means that there is a risk that this support will be slightly weaker than expected. Despite their significant microeconomic impact, events of this kind generally have an insignificant effect on economic growth. The fact that they took place at the beginning of the summer, at the height of the tourist season, may have a slightly greater negative effect (but probably no more than a 0.1 points reduction in growth).

The latest data show that eurozone growth is not picking up, with services now also losing steam. While it’s not all downhill from here, subdued growth is the best we can hope for. Inflation is now clearly coming down, but the European Central Bank is still set for two more rate hikes.   (Overly?) optimistic ECB growth outlook After negative growth over the winter quarters, the ECB’s staff forecasts pencil in a gradual acceleration of eurozone GDP growth to 0.3%, both in the second and third quarters of this year, and 0.4% from the fourth quarter onward. However, eyeballing the most recent data, it doesn’t look as if the eurozone economy is accelerating – on the contrary. The first real indicators for the second quarter, such as retail sales and industrial production, actually came out below the average of the first quarter. And sentiment indicators for May and June rather point to further deterioration. The €-coin indicator, a monthly tracker of GDP growth, averaged -0.3% for April and May. In that regard, we fear that second-quarter growth will be close to 0%, with a non-negligible probability of negative growth.   Manufacturing in recession and services is slowing    

Services are now also slowing We certainly don’t deny that the pick-up in wage growth, in combination with lower energy prices, is boosting consumers’ purchasing power, supporting consumption growth over the coming quarters. But at the same time, some increase in the savings ratio looks likely as the economic outlook has become more uncertain (in some member states unemployment has started to increase). All sectors are now signalling a deceleration in incoming orders, while inventories in industry and retail are at a very high level. Even services, which held up well despite the recessionary environment in manufacturing, are losing steam. The services confidence indicator fell in June below its long-term average. That doesn’t necessarily mean that the only way is down – we still expect a strong summer holiday season, supporting third-quarter growth. But after that things might become shakier again, as the US economy is expected to have fallen into recession by then. The bottom line is that we now only expect 0.4% growth in 2023. Subsequently, on the back of the low carry-over effect, we pencil in a 0.5% GDP expansion for 2024.   Downward trend in inflation continues The flash headline inflation estimate for June came out at 5.5%, while core inflation increased slightly to 5.4%. However, the increase in core inflation is entirely due to a base effect in Germany that will disappear in September. The growth pace of core prices, measured as the three-month-on-three-month annualised change in prices, now stands at 4.4%. That is still too high, but the trend is clearly downwards. The inventory overhang is leading to falling prices for goods. In the European Commission’s survey, selling price expectations softened again in all sectors, while the expected price trends in the consumers’ survey fell to the lowest level since 2016. It, therefore, doesn’t come as a surprise that we expect the downward trend in inflation to continue, with both headline and core inflation likely to be below 3% by the first quarter of 2024.   Selling) price expectations are coming down across the board

Hungary: Technical recession set to end soon Economic activity has slowed significantly in all sectors except for one. Base effects and favourable weather conditions have boosted the positive contribution from agriculture which could lift Hungary out of technical recession in the second quarter of 2023. In the meantime, we still won’t have too much to cheer about. A lack of domestic demand is weighing on retail sales, construction and industrial output, with the latter currently being supported mainly by export sales. We see GDP growth of just 0.2% in 2023. The only silver lining coming from the weak economy is that the pricing power of companies is rapidly diminishing, thus the disinflationary process has shifted into a higher gear. We see single-digit inflation in November 2023 with the full-year average being around 18%. Disinflation with preserved market stability helps the central bank’s agenda: the ongoing normalisation of monetary policy. We see 100bp of further cuts to the effective rate before it reaches the base rate at the September meeting. After that, we see the National Bank of Hungary remaining cautious. Weakening economic activity is hitting import demand which, combined with lower energy prices, is helping the country’s external balances improve. We expect the current account deficit to narrow to around -2.2% of GDP this year with positive risks. However, the marked drop in consumption is putting significant pressure on the budget’s VAT revenue stream, and key challenges loom. With structural improvements in all other aspects though, we do not expect any sovereign credit rating changes from rating agencies in the near future. We expect EUR/HUF to oscillate in the current range of 368–378, depending on the National Bank of Hungary's communication regarding the rate-cutting cycle and on progress with the EU. Regarding the latter, our base case remains an agreement and partial access to the Cohesion Fund before the year ends. Hungarian Government Bonds can benefit the most from monetary policy normalisation, further supported by government measures and debt agency funding control (for more details, check out our Monitoring Hungary).  

BoK likely to extend pause but stay hawkish The Bank of Korea will have a rate decision meeting next Thursday. As inflation slows to the 2% range, the central bank is expected to keep its policy rate at the current 3.50% level. We think the BoK continues to remain hawkish in order to not give market participants a premature easing signal.   Singapore GDP growth to see slight bounce Singapore’s second-quarter GDP is set for release next week. First quarter GDP showed the economy contracted from the previous quarter but still managed to eke out a 0.4%YoY gain. Singapore faces twin challenges of contracting exports and industrial production as global trade slows. One bright spot is retail sales, which have provided some support with the resurgence of visitor arrivals helping to offset softer demand caused by still high inflation.  We expect second quarter GDP to bounce back into expansion, albeit a shallow one of 1.4%YoY with growth likely stuck in these ranges until global trade prospects improve.   Key events in Asia next week

BoK likely to extend pause but stay hawkish The Bank of Korea will hold a policy meeting next Thursday. As inflation is slowing to the 2% range, the BoK is expected to keep its policy rate at the current 3.50% level. We think the central bank will continue to remain hawkish so as not to give market participants an easing signal too early.   Singapore GDP growth to see slight bounce Singapore is set to release second-quarter GDP figures next week. First quarter GDP showed that the economy contracted from the previous quarter but still managed to eke out a 0.4% YoY gain. Singapore faces the twin challenge of contracting exports and industrial production as global trade slows. One bright spot is retail sales, which have provided some support amid the resurgence of visitor arrivals. This has helped to offset softer demand caused by still-high inflation.  We expect second-quarter GDP to bounce back, with a shallow expansion of 1.4% YoY. Growth will likely be stuck in this range until global trade prospects improve.  

Hungary's retail sales and industrial output continue to plunge With domestic demand severely constrained, both the retail sector and Hungarian industry are struggling, and we don’t see a path for a swift recovery.   There is nothing surprising in the latest data release from the Hungarian Central Statistical Office (HCSO). As we predicted in our latest Monitoring Hungary report, the drop in real wages has been constraining both household consumption and domestic demand towards goods. Now the latest economic activity figures for May confirm this, as the volume of retail sales dropped by 12.3% year-on-year (YoY), while industry registered a 4.6% YoY plunge in the volume of production (both working-day adjusted data). As both sectors continue to struggle with weak domestic demand, the fate of GDP growth in the second quarter hinges vastly on the outperformance of agriculture.   Industry continues to face opposing forces    

As Germany holds the position of the largest economy in the European Union and is renowned as one of the world's leading manufacturing powerhouses, recent data concerning its manufacturing sector has raised concerns among investors. With Germany already experiencing a technical recession since the first quarter of 2023, there are growing uncertainties about the depth and duration of the downturn. To shed light on these matters, we engage in a conversation with Santa Zvaigzne-Sproge, CFA, to assess the latest data from German industry and its potential implications. The manufacturing Purchasing Managers' Index (PMI) indicators for both Germany and the entire Euro area are currently situated in the contraction territory, indicating the challenges faced by the manufacturing sector. High inflation and elevated credit costs have led to a decline in private consumption, further impacting manufacturing numbers. Until these factors normalize, a return to expanding private consumption may be hindered.   FXMAG.COM:  How do you assess the latest data from German industry? Do they hint that the recession in Germany will be deep and prolonged?    Santa Zvaigzne-Sproge, CFA:  As Germany is the largest economy in the European Union and is considered among the strongest manufacturing powerhouses in the world, the latest manufacturing data may cause some worry among investors.  Germany has been in a technical recession since the first quarter of 2023 and is expected to continue the contraction at least till the end of 2023. However, for the technical recession to be over in Germany by the end of 2023, we should start seeing some improvement in economic indicators such as the PMI soon. Meanwhile, both – Germany’s and the whole Euro area’s – manufacturing PMI indicators are deep in the contraction territory.    Private consumption in Germany has fallen mainly due to high inflation and more expensive credit, which has led to lower manufacturing numbers. Therefore, until neither of the factors has normalized, private consumption may not return to a more expanding territory.    Until now, the German economy’s contraction has been relatively mild with -0.3% GDP growth in the first quarter. However, comparing it to the initially expected +0.3% and the preliminary estimate of -0.1%, we may see that the actual data tend to turn out worse than expected. The GDP growth estimate for a full 2023 year in Germany now stands at -0.4%, however, it might be revisited as the second quarter GDP growth estimates start coming in.    On the bright side, German companies hired people at a faster pace in June than one month ago (which cannot be said about France, Italy, or Spain). Healthy employment is an important factor to support private consumption and at the same time an indicator that recession in Germany is kept at a relatively mild level.    To sum up, current German PMI data do not signal that a turnaround in the second quarter GDP growth data is likely. This may lead to slightly lowered expectations for full-year GDP growth in Germany. However, the length of a recession in Germany may be hard to assess based on the PMI data. It may be more dependent on future monetary and fiscal decisions by policymakers in the rest of the year’s time.   

Second half growth is expected to be too weak for a decent growth rate for 2023 The technical recession will, in our view, be followed by weak growth. Investment is expected to be the main drag on growth during the remainder of the year, as higher funding costs and weak sales expectations kick in. GDP growth in the second half of 2023 needs to come from the expansion of service consumption by households, higher service exports due to a further rebound of inbound tourism (especially in the third quarter) and public expenditures. We also forecast goods exports to pick up again, but only sluggishly. Public expenditures are assumed to rise a bit less than initially anticipated, due to the recent fall of the government: this is likely to put a stop to the execution of a number of policy plans. Consumption of households so far has held up well during the energy crisis, even though the Netherlands also experienced a terms of trade loss due to the high prices of imported gas and therefore the loss of consumer purchasing power. Very strong employment growth (+6.4% compared to pre-pandemic) and high net nominal income growth for lower-income households (who have a high marginal propensity to consume) explain why. As inflation is coming down in the second half of 2023 while wage increases remain high, household consumption is forecast to continue its (mild) growth, even though employment growth will not be as strong as in the past. Saving rates are coming down from still elevated levels, also providing support for consumption to remain decent. Despite this support for consumption, GDP is forecast to expand by only 0.3% for the full year 2023, adjusted for working days.     Inflation is falling in 2023 thanks to energy base effects Although lower than the inflation rate of 11.6% in 2022, our forecast for 2023 is still at a high of 4.7%. Food and bars and restaurants are important contributors to the higher price level in 2023. Yet, inflation has been falling throughout the year. Headline consumer price inflation fell recently, from 6.8% YoY (HICP) in May to 6.4% in June. Core inflation (inflation excluding volatile items like energy and food) came down from 8.2% in May to (a still high) 7.1% in June. The deceleration in June was due to services and fuel, industrial goods and food, beverages and tobacco.   For energy and fuel, the fall in prices was smaller than in May due to statistical base effects, i.e. due to movements in the price level in 2022: the month-on-month changes in June 2023 were slightly negative. Such base effects for energy are the main reason we project the headline year-on-year inflation rate to move close to 2% in the last quarter of 2023.     Inflation falling with large negative energy base effects Change in harmonised index of consumer prices for the Netherlands year-on-year in % and contributions in %-points     Firms signal lower selling price inflation We see overall inflation pressures falling in the near future: selling price expectations of businesses for the next three months fell for the eighth month in a row in June. There is one major exception: services. Inflation of services is not forecast to decelerate as quickly as for food and industrial goods. For now, we are working with the assumption of wages decelerating in 2024 compared to the high numbers (of around 6% for bargained wages) of 2023. The forecast for headline inflation to fall to 2.3% in 2024 depends on that assumption. This scenario has become more likely now that demand for personnel from the public sector might slow a bit, as the government is adopting a caretaker mode for many months to come.   New method for measuring energy inflation distorts headline picture June was the first month in which Statistics Netherlands (CBS) used a new method for measuring energy inflation. While it used to only look at the prices of new contracts, it is now also taking existing (fixed-term) contracts into account. If this new method was used in the past, the 2022 inflation rate would have been a lot (i.e. more than 3%) lower than actually recorded, while for 2023 the rate of change would be much higher than observed now. Since Statistics Netherlands is not legally allowed to revise historical inflation figures, this means that all year-on-year inflation rates are somewhat distorted. As of June 2024, this issue is gone. Fortunately, the price levels of the old and new methods have been already quite similar in recent months. As such, the introduction of the new method had only limited effects on our recent forecasts.     The Dutch economy in a nutshell (%YoY)  

Keeping up the recovery pace won’t be easy Mitsotakis’ second legislature will be a challenging one. The election result very likely reflected a call for continuity from the electorate, particularly in the economic domain. Securing continuity in growth against a backdrop of normalising monetary and fiscal policies will not be an easy task. A stable return to amply positive interest rates might complicate things on the private investment front, where Greece has yet to fill an investment gap since the times of the sovereign debt crisis. Here, keeping a strong focus on the implementation of the recovery and resilience plan might prove decisive. On the fiscal front, as elsewhere, the restoration of fiscal rules in 2024 will reintroduce constraints that had disappeared over the recent crisis years. The good news is that Mitsotakis is having his second term in office at the height of the summer tourism season, which is a good start.   Returning Greece to investment grade an obvious target Looking ahead, an obvious priority for Mitsotakis will likely be to bring Greece back into the investment-grade domain. With a possible new normal characterised by higher rates and restored fiscal discipline, rating agencies might wait for more reassuring evidence about future debt sustainability before pulling the trigger. Developments in state sector accounts until May point to a primary surplus already this year; this is a good starting point, but the resumption of the reform path, temporarily set aside over the pandemic/energy crisis years, will likely be as important to the eyes of the agencies. In the parliamentary debate, which culminated in a positive vote of confidence for his government, Mitsotakis talked about the plan for the next four years as a multi-dimensional reform. Time will tell. We expect Greece to remain a growth outperformer in the eurozone for at least a couple of years. For 2023, we project GDP growth of 1.7% year-on-year, with upside risks if the disinflation path proves faster than we are currently projecting. Greek economy in a nutshell (%YoY)

Solid household consumption is keeping the Belgian economy afloat, but a loss of competitiveness accompanied by worsening public finances and political hurdles will likely weigh on future growth. Solid consumer spending The sharp rise in energy prices through to autumn 2022 and fall in prices thereafter raised fears of a V-shaped recession, particularly for household consumption. This, however, was not the case in Belgium. On the contrary, household consumption remained very solid throughout the period, even when energy bills hit consumer budgets the hardest. Household consumption has actually remained the main driver of economic growth over the last four quarters, as shown in the first chart below. There are several reasons for this:   Labour market strength First, the labour market remains very solid. Despite slowing economic growth in the last quarter of 2022, 75,000 jobs were created in 2022 and 11,500 in the first quarter of this year alone. Job creation has therefore become a key driver in supporting both household income and consumption.   Automatic wage indexation Second, automatic wage indexation has remained in place and has resulted in a nominal increase in wages of at least 10%. It should be noted that, depending on the sector, the indexation mechanism comes into play at different times. A large number of workers, for example, saw their nominal wages increase by more than 11% at the start of 2023. It should also be noted that indexation applies to pensions and all social benefits too.     Government support measures Third, significant additional measures have been taken by the authorities to soften the impact of rising energy prices on household bills – including the first few months of 2023, when gas and electricity prices were falling sharply.   Consumption remains the main support for GDP growth Quarterly GDP growth decomposition, demand side  

Moderate outlook From a sectoral point of view, the strength of demand for tourism-related activities and the high level of bookings for this summer should support French economic activity in the third quarter, but the support should diminish thereafter. At the same time, the industrial sector is suffering from weakening global demand. According to survey results, business leaders' assessment of order books has remained very weak for several months. At the same time, inventories of finished products remain high. This means that production is likely to decline over the coming months, as companies see no new orders coming in and have to clear their inventories. The PMI indices for the manufacturing sector have been in contraction territory (below 50) since January. In short, the growth outlook for the French economy is moderate. Growth in the second quarter will be weak, with a fall in GDP remaining a risk. Growth in the third quarter should be slightly better, supported by the good health of the tourism sector, which continues to benefit greatly from the post-pandemic recovery. But this is likely to lose momentum in the fourth quarter, and the end of 2023 and 2024 look weaker, against the backdrop of a global economic slowdown and high interest rates that will have an increasing impact on demand. We are expecting growth of around 0.5% this year. For 2024, the gradual recovery in household purchasing power thanks to lower inflation is likely to be offset by even weaker global demand. As a result, we are less optimistic than the central banks and are forecasting French GDP growth of 0.6% in 2024 (compared with a forecast of 1% by the Banque de France).   The trend toward disinflation has begun and will continue Inflation in France stood at 4.3% in June, compared with 5.1% in May, thanks to a fall in energy prices and slower growth in food prices. The fall in inflation is set to continue over the coming months. Growth in producer price indices has slowed markedly. In addition, business price intentions are moderating sharply: price intentions in the manufacturing sector are at their lowest since early 2021, while in the services sector they are at their lowest since November 2021. These figures are in addition to those for the prices of agricultural products, which are falling sharply, which should lead to a sharp fall in food inflation over the coming months. The trend toward disinflation is therefore clearly underway and will continue. However, this trend will probably be slower in France than in other countries, due to less favourable base effects for energy. The tariff shield and fuel rebates prevented a sharp rise in energy prices over the summer and autumn of 2022. As a result, energy inflation is likely to return to positive territory in France in the coming months, with energy prices for the remainder of 2023 likely to remain higher than their levels in 2022, unlike in other countries. This will probably keep overall inflation higher in France than elsewhere this autumn and at the end of 2023. But this does not change the overall picture: ultimately, although less visible than elsewhere, disinflation is well underway and will continue to be seen in France over the coming months. While this trend is clearly encouraging, it does not mean that the problem of inflation is completely over. There is still a major risk pocket, namely services inflation, which is likely to increase in the months ahead and will probably become the main contributor to French inflation by the end of the year. The successive increases in the minimum wage, particularly in January and May 2023, which are being passed on to all wages, will continue to push up the price of services. The Banque de France estimates that negotiated pay rises will average 4.4% in 2023 (compared with 2.8% in 2022 and 1.4% in 2021), often supplemented by a one-off bonus. Salary increases are more pronounced in sectors where recruitment difficulties are greatest. As we expect the labour market to remain tight over the coming quarters despite the economic slowdown, wage increases are likely to strengthen further. However, given the lower price intentions and sluggish demand we expect in the coming quarters, it is likely that wage increases will not be fully passed on to selling prices, weighing on margins. Therefore, inflationary pressures, including in the services sector, should eventually subside. We expect CPI inflation to average 4.6% in 2023 (5.6% for the harmonised index) and 2.1% in 2024 (3.1% for the harmonised index).   The French economy in a nutshell (% YoY)

Returning Greece to investment grade an obvious target Looking ahead, an obvious priority for Mitsotakis will likely be to bring Greece back into the investment-grade domain. With a possible new normal characterised by higher rates and restored fiscal discipline, rating agencies might wait for more reassuring evidence about future debt sustainability before pulling the trigger. Developments in state sector accounts until May point to a primary surplus already this year; this is a good starting point, but the resumption of the reform path, temporarily set aside over the pandemic/energy crisis years, will likely be as important to the eyes of the agencies. In the parliamentary debate, which culminated in a positive vote of confidence for his government, Mitsotakis talked about the plan for the next four years as a multi- dimensional reform. Time will tell.   We expect Greece to remain a growth outperformer in the eurozone for at least a couple of years. For 2023, we project GDP growth of 1.7% year-on-year, with upside risks if the disinflation path proves faster than we are currently projecting.   The Greek economy in a nutshell (% YoY)    

Eurozone industrial production confirms no strong GDP bounce back for 2Q With more data coming in, it really seems to be a coin flip as to whether the eurozone technical recession continued into the second quarter. The May production data is consistent with industry stagnating at a relatively low level of activity.   Industrial production increased by 0.2% in May, which is the second small increase in a row after plummeting in March. Overall, this leaves the level of activity well below the average for where it was in 2022, in line with a weakening global growth environment in which demand for goods has moderated. In recent months, industrial production has stagnated. There are large differences by sector, which is due to the shocks that individual sectors have been influenced by in recent years. At the moment, the sectors most hurt by supply-chain problems are still contributing positively to annual industrial production growth. The sectors that profited a lot from the pandemic – think of pharma for example – are showing more volatile production performance at the moment and energy production and energy-intensive sectors are contributing negatively. For the months ahead, weakness continues to be in the cards as surveys point to a drying up of backlogged orders and new orders are weakening. Global demand is going through a weak patch and that is reflected by a subdued outlook for the manufacturing sector. For GDP growth in the second quarter, the impact is clear. Production will have needed a strong rebound in June to have an average production level similar to the first quarter. That seems unrealistic given the negative PMI and industrial sentiment data for the month. Another quarterly decline for industrial output is therefore in the making, which is also likely for retail sales. The goods part of the economy is therefore likely to have remained in recession and services – on which we have much less intermediate data – will have needed to perform well to eke out a positive growth figure. It’s likely that the eurozone economy has therefore continued to straddle the zero growth line in the second quarter, extending the current phase of stagnation in economic activity.

Recent macroeconomic readings, including wages, GDP, and industrial production, have provided valuable insights into the current state of the British economy. These key indicators have prompted discussions about the depth of the potential recession and the future actions of the Bank of England (BoE). To gain a better understanding of these developments, we turn to Antreas Themistokleous, an expert in the field. The release of major economic data from the UK this week shed light on the condition of the British economy. The unemployment rate for May saw a 0.2% increase, reaching 4%, and the number of unemployment claims surpassed expectations, indicating a higher demand for unemployment benefits. On the other hand, average earnings experienced a 0.2% growth, while year-over-year GDP showed a decline of -0.4%. Although the GDP figure was not as dire as anticipated, it still reflects a subpar performance compared to the same period last year. Industrial production also fell by 2.3%, aligning with market forecasts.     FXMAG.COM: What do this week's macroeconomic readings - wages, GDP, industrial production - tell us about the state of the British economy? Will the recession be deep? Will the BoE continue to raise rates?   Antreas Themistokleous:  This week we saw major economic data from the UK being released that could help in determining the state of the British economy. Unemployment rate for the month of May increased by 0.2% pushing the figure to 4% while the Claimants came out to be worse than expected, missing expectations of negative 22,000 claims to a positive 25,700. This means more people claimed for unemployment benefits in May and that was reflected in the official unemployment rate.  On the other hand average earnings have increased by 0.2% while the year over year GDP growth came out at -0.4%. Even though the GDP was expected to be worse , at -0.7% , it still shows that the British economy did not perform very well compared to the same month last year. Industrial production recorded a negative 2.3% perfectly aligned with market expectations.    Inflation rate for the month of June is expected to be published on the 19th where the market expects a further decline of around 0.4%. If this is confirmed it would be the yearly low and could potentially boost the quid against its pairs, especially USD and the Euro at least in the short term.    Even though inflation might be coming down, it does so at a very slow pace so the Bank of England could still have a hawkish stance at their next meeting on the 3rd of August. In June, the Bank of England increased interest rates for the 13th time in a row, by 50 basis points to 5% while some analysts argue that they could peak around 5.75% by the end of this year.    By paying attention to the labor market and the economic growth we will be able to gauge the consequences of the rate hikes by the central bank and how it could affect the overall economy. Recession fears are still hovering above the heads of the British since they are not “out of the woods” just yet but the stance of the central bank in regards to their monetary policy will be closely monitored by market participants.       

Asia Morning Bites The RBA is to get a new Governor, Michelle Bullock, in September. In the US, James Bullard will step down from the St Louis Fed. More disinflationary pressure from June PPI data helps stocks to rally and the USD and US treasury yields to slide.   Global Macro and Markets Global markets:  Further disinflationary signs from US PPI data yesterday helped US Treasury yields to drop sharply. 2Y yields fell 11.6bp to 4.63%, while 10Y yields fell 9.4bp to 3.763%. This probably helped to spur further USD weakness. At 1.1224, it does really look as if the long-awaited USD turn has arrived. We haven’t seen levels like this since March 2022.  The AUD also made solid gains against the USD, rising to 0.6890. Cable too has surged, rising to 1.3131, and the JPY has plunged below 140 to 137.96. All Asian currencies were stronger against the USD yesterday, and it looks like a fair bet that this will be the theme in trading this morning. US stocks also seemed to like the additional disinflationary message from the PPI numbers. The NASDAQ rose 1.58% while the S&P500 rose 0.85%. Chinese stocks were also positive. The Hang Seng rose a very solid 2.6% while the CSI 300 rose 1.43%.   G-7 macro: US PPI rose just 0.1% MoM in June for both the headline and core measures. This resulted in a final demand PPI inflation rate of just 0.1%YoY, though the ex-food-and-energy PPI inflation rate was 2.4%YoY, down from 2.6% in the prior month. Initial jobless claims were a little lower though, so we shouldn’t get too carried away with the disinflationary theme.  Today, the US releases import and export price data, which should also indicate falling pipeline prices The University of Michigan confidence publication will also throw some light on inflation expectations, which are forecast to come down slightly on a 1Y horizon. There is May trade data out of the Eurozone. In Fed news, James Bullard, one of the FOMC hawks, and in this author’s view, one of the most thought-provoking and consensus-challenging members of the FOMC, is to step down to pursue a career in academia. Shame.  Meanwhile, Christopher Waller has said the Fed will need two more hikes to contain inflation because the negative impact of the banking turmoil earlier in the year has faded. Markets don’t agree.     Australia:  According to a Bloomberg article, the Reserve Bank of Australia’s Governor, Philip Lowe, will not be reappointed when his 7-year term ends on September 17. This may not come as a massive surprise following an independent review of the central bank, which criticized some of the RBA’s forward guidance on rates during Covid and the pace of the response to higher inflation. Lowe will be replaced by Michele Bullock, who is currently Deputy Governor.   China:  June FDI data is due anytime between now and 18 July. The last reading for May showed utilized FDI running almost flat from a year ago. Given the run of recent data, it is conceivable that we see a small negative number for June, indicating net FDI outflows.   India: Trade data took a sharply negative turn in May, and today’s June numbers, while likely to show exports still falling from a year ago, may have moderated slightly from the -10.3%YoY rate of decline in May. The trade deficit could shrink slightly from the May $22.12bn figure.     Singapore: 2Q GDP surprised on the upside and settled at 0.7%YoY compared to 1Q GDP growth of 0.4%YoY.  The Market consensus had estimated growth at 0.5%YoY. Compared to the previous quarter, GDP was up 0.3% after a 0.4% contraction in 1Q23. The upside surprise to growth may have been delivered by retail sales, with department store sales and recreational services supported by the return of visitor arrivals. Services industries as a whole expanded 3%YoY, much faster than the 1.8% gain reported in 1Q.  The rest of the economy, however, continues to face challenges with manufacturing down 7.5%YoY, tracking a similar downturn faced by non-oil domestic exports as global demand remains soft.    What to look out for: China FDI, India trade and US University of Michigan sentiment China FDI (14 July) Japan industrial production (14 July) India trade (14 July) US import prices and University of Michigan sentiment (14 July)

Poland's current account surplus with net exports to support GDP growth Poland’s balance of payments data for May generally surprised on the positive side. The current account surplus exceeded consensus. Its balance on a 12-month rolling basis is approaching 0% of GDP as the country benefits from a sizeable improvement in terms of trade, in particular falling prices of energy commodities as compared with 2022.   The current account surplus widened to €1.4bn in May compared with €0.5bn in April and was clearly above consensus and our forecast (€0.6bn). On a 12-month basis, we estimate that the current account balance improved to -0.3% of GDP in May from -0.7% of GDP in April. At the same time, the merchandise trade surplus in May (€1.1bn) was noticeably higher than in April (€0.3bn) and improved on a 12-month basis to -1.2% of GDP from -1.6%of GDP in the previous month. In the current account structure, a traditional surplus in trade in services of €3.4bn outweighed a primary income deficit of €2.9bn, and the secondary income account deficit was €0.3bn. The merchandise trade data suggests that net exports is the key area of support for second quarter GDP against a backdrop of weak domestic demand. This is taking place despite stagnation in the eurozone and the German economy, which in the second quarter of 2023 may record its third consecutive quarterly decline in real GDP. This last happened during the 2008-09 financial crisis. According to the CSO's goods turnover data, 60% of Polish exports have gone to the eurozone so far this year, almost half of them to Germany. The exports growth (nominal) expressed in euro rebounded slightly to 3.3% year-on-year, albeit from a bottom in April, when growth was 2.6% YoY. At the same time, the 6.2% YoY fall in the value of imports was shallower than in April (-8.9% YoY). According to the National Bank of Poland (NBP), export prices are growing at a near-zero annual rate, while the YoY decline in import prices is deepening. May was the third consecutive month of decline in the value of imports. This was due to both a favourable decline in import prices (especially energy) and the weakness of domestic demand in the second quarter, as indicated by e.g. retail sales or real wages data. Poland – as a net importer of energy – benefits from normalisation on the European energy market in 2023. The NBP communiqué underlines an increase in exports of the automotive sector, including strong growth in sales of lithium-ion batteries and commercial vehicles. In imports, the value of five of the six main categories of goods fell, the strongest in intermediate goods, fuels and consumer goods. Only the value of imports of transport equipment increased. Today's data will support investors' generally positive sentiment towards the zloty and other regional currencies in recent months. Improving exporters' performance against weak imports will imply a positive contribution of net exports to economic growth in the second quarter and throughout 2023. For the year as a whole, we expect a 1.5% of GDP current account surplus after a 3.0% of GDP deficit in 2022. The main risk factors for the current account balance this year remain arms spending, the increase in which is mainly being met by purchases abroad following the start of the Russian war in Ukraine.

Further internal demand deterioration in China but PBoC refrains from cutting key interest rate Retail sales in China decelerated to 3.1% y/y in June from May’s 12.7% y/y, weakest growth rate since December 2022. Q2 GDP growth in China came in below expectations at 6.3% y/y vs. consensus estimates of 7.3% y/y. China’s central bank, PBoC left its one-year medium-term lending facility rate unchanged at 2.65% likely due to the risk of a “liquidity trap” scenario. China’s proxies stock benchmarks Hang Seng Index, Hang Seng TECH Index & Hang Seng China Enterprises Index outperformed intraday against the mainland “A” shares benchmark CSI 300.   China’s Q2 GDP growth came in below expectations at 6.3% year-on-year versus consensus estimates of 7.3% but above Q1 of 4.5%; 0.8% growth for Q2 on a quarter-on-quarter basis, below Q1’s 2.2% (q/q). Retail sales for June tumbled to single-digit growth of 3.1% year-on-year from 12.7% recorded in May, its steepest growth deceleration since December 2022, almost on par with expectations of 3.2%. On the other hand, industrial production rose to 4.4% year-on-year in June, above expectations of 2.7%, and May’s reading of 3.5%, its highest growth rate since October 2022. The labour market for youth has remained worrisome, the youth unemployment rate for 16 to 24 years old accelerated to 21.3% in June, a new high from 20.8% in May, that’s around four times the nationwide unemployment rate that remained steady at 5.2% in June. The growth deceleration in retail sales and continued uptick in youth unemployment have further reinforced the ongoing weak internal demand environment in China since March this year that dented consumer confidence and increased the risk of a deflationary spiral.     A liquidity trap scenario is likely to see less marginal benefits from interest rate cuts To negate weak internal demand and eroding consumer confidence, expansionary fiscal stimulus measures are likely to be more effective than more interest rate cuts, and accommodating monetary policy in a deflationary environment reduces the “marginal benefit” from an extra added effort of monetary policy stimulus; a “liquidity trap scenario”. Hence, it is not surprising for China’s central bank, PBoC to refrain from cutting its key one-year medium-term lending facility today and left it unchanged at 2.65% after a 10-basis point reduction in June, which in turn implies a likely similar no-cut scenario for its decision on the one-year (3.55%) and five-year loan prime rates (4.2%) out later this Thursday.   China “A” shares benchmark CSI 300 dragged down by financial stocks   Fig 1: CSI 300 sectors rolling 1-month performance as of 17 Jul 2023 (Source: TradingView, click to enlarge chart) Interestingly, the China proxies benchmark stock indices listed in Hong Kong do not suffer a steep sell-off; In contrast, the China mainland “A” shares benchmark stock index, CSI 300 shed -1.1% dragged down by the banks that underperformed intraday likely due to the fear of a “liquidity trap” scenario that led to slower loan growth, the CSI  300 Financials Index shed -1.44% intraday.    

NZD/USD in negative territory after jumping 2.58% last week US dollar was broadly lower last week on expectations that Fed rate-tightening almost over The New Zealand dollar has started the week with considerable losses. In the European session, NZD/USD is trading at 0.6338, down 0.51%. This follows a superb week for the New Zealand dollar, which soared 2.58%.   US dollar in trouble over Fed expectations It was a week to forget for the US dollar, which hit a 15-month low. The US dollar index fell by 2.52% last week, its worse weekly performance since November 2022. The New Zealand dollar made the most of the greenback’s woes and pummelled the US dollar even though the Reserve Bank of New Zealand took a pause last week for the first time in almost two years. The US dollar’s nosedive last week against the major currencies was exacerbated by the US inflation report, which was softer than expected. The headline and core rates both eased in June, raising market speculation that the Fed may finally wrap up its rate-tightening cycle after the July 26th meeting. The markets have priced in a July hike at 96% and a pause in September at 83%, according to the CME tool. The Fed has relied on interest rate hikes as its main tool to curb inflation, and an end to the cycle will result in investors looking elsewhere to park their funds. The US dollar is under pressure, but traders and investors should be careful before writing off the US currency. Earlier this year, the markets were too hasty in betting that the Fed would cut rates and the US dollar would fall. Instead, the Fed continued to raise rates as the US economy remained robust and the US dollar rebounded. Fed Chair Powell has signalled one more rate after the July meeting and Fed members have sounded hawkish, noting that inflation remains much higher than the 2% target. The markets may once again be getting ahead of themselves in assuming that inflation is won and the Fed is done. . NZD/USD Technical There is support at 0.6316 and 0.6221 0.6466 and 0.6561 are the next resistance lines    

Poland’s retail trade improves as goods inflation eases further The decline seen in Poland's retail sales moderated in June as the implied retail deflator subsided further. The domestic economy most likely reached the bottom in the first half of the year, and we should see some recovery in the second half. For 2023 as a whole, we continue to count on GDP growth of around 1%, with risks tilted to the downside.   Real retail sales of goods fell 4.7% year-on-year in June (consensus: -5.0%), following a 6.8% YoY decline in May. Seasonally adjusted data point to a 0.6% month-on-month increase in sales, following a decline of more than 1% in May. On an annual basis, the deepest decline was in the category of newspapers, books, other sale in specialised stores (-17.6% YoY). The only category where we did not observe a decline in sales volume was that of pharmaceuticals, cosmetics, orthopedic equipment (0.0% YoY). The implied retail sales deflator maintained a downward trend and fell to 7.1% YoY from 9.2% YoY in May. We've now seen almost a full set of monthly data for the second quarter of the year, with the year-on-year dynamic of industrial production, construction output and retail sales all coming in softer than seen in the first quarter. The annual pace of GDP in the second quarter was not significantly different from what we saw in the first. The scale of the decline in household consumption most likely deepened, and the consumption recession – along with falling energy commodity prices – is one of the factors currently driving disinflation. The domestic economy most likely reached the bottom of the current business cycle in the second quarter, and we should see some recovery in the second half of the year – albeit at a rather sluggish pace. A key element to note is the decline in inflation and the recovery of real household purchasing power. A narrowing foreign trade balance, which translates into a positive contribution of net exports to GDP, will continue supporting growth. It is much more difficult to assess the impact of changes in companies' inventory adjustments on activity. In 2022, this was a supporting factor for GDP (unblocking supply chains), but is now clearly weighing on economic growth. For 2023 as a whole, we continue to count on GDP growth of around 1%, with downside risks dominating.

Eurozone PMI suggests worsening economic conditions The eurozone PMI suggests contracting economic activity at the start of the third quarter. Overall, this fits a trend of weakening survey indicators over recent months and increases the recession risk for the bloc. The survey continues to suggest moderating price pressures, but the impact of wages on services will remain a concern for ECB hawks. Survey data became progressively bleaker during the second quarter and the July PMI continues that trend. The June composite PMI stood at 49.9, broadly signalling stagnation, but in July the PMI dropped to 48.9, indicating contraction. Demand in the eurozone is falling for both goods and services according to the survey, with services new orders dropping for the first time in seven months while the decline in new orders for manufacturing steepened further. France and Germany look particularly bleak with output PMIs signalling contraction, which is offset slightly by the rest of the eurozone. We don’t have more details yet, but this could be due to more tourism-dependent economies profiting from a somewhat stronger summer period. Still, the positive tourism effect doesn't seem strong enough to counter weakening in the economy elsewhere. We have previously argued that the eurozone economy has been in a stagnation-type environment, and the recent two quarters of minimal negative GDP growth should not be taken as a broad recession given the strength of the labour market. The July PMI suggests that recession risk has increased though. With expectations of output weakening further, the outlook for the coming months is sluggish at best. The inflation picture coming from the survey is very similar to recent months. Price pressures are cooling, but more so for goods manufacturers than services providers. Rising wages continue to keep price pressures elevated for services, resulting in a slower downward trend. Dropping input costs are helping to bring inflation expectations down much faster for goods at the moment. This confirms our view of a materially lower inflation rate towards the end of the year but keeps hawkish concerns about the effect of wages on inflation alive.

Goldilocks GDP feeds the US soft landing narrative GDP growth was a little stronger than expected in 2Q 2023, but inflation pressures continue to moderate, supporting the soft landing narrative. The Fed will leave the door open to further rate hikes, but the legacy of past rate hikes and tighter lending conditions will restrain activity and dampen price pressures, negating the need for further action.     Not too hot inflation, not too cold growth We’ve got a nice combination on the US data front this morning for risk assets. Second-quarter GDP growth is stronger than expected (2.4% vs 1.8% consensus), led by consumer spending and investment with inventories not being as important a growth driver as thought likely. Meanwhile, the core PCE price deflator slowed to 3.8% annualised from 4.9% (consensus 4%). So we’ve got decent growth with slowing inflation while jobless claims fell to 221k from 228k and continuing claims dropping to 1,690k from 1,749k, which have further helped to boost the soft landing narrative. At the same time June durable goods orders jumped 4.7% month-on-month thanks to strong Boeing orders boosting civilian aircraft orders by 69.4%. Non-defense capital goods orders ex aircraft remain subdued though at 0.2% MoM – a little better than expected, but there were downward revisions.   Contributions to US quarterly annualised GDP growth (%)   Focusing on GDP, the 1.6% gain in consumer spending was slower than the warm-weather-boosted 4.2% surge in the first quarter, but it was better than the 1% figure we expected to see and points to some upward revision to the monthly profile in tomorrow’s personal income and spending report. Fixed investment was also better than predicted, rising 4.9%, led by a 10.8% jump in equipment and software investment after a couple of negative quarters. Government expenditure was also robust, rising 2.6%. The main drags were inventories, which weren’t rebuilt as much as expected while net trade was disappointing, subtracting 0.12 percentage points from headline growth with exports plunging 10.8% and imports falling 7.8%.   GDP continues to run below pre-Covid trend   GDP below pre-Covid trend, suggesting inflation still largely a supply side story If we look at the levels of GDP we see that while today’s growth number was better than expected, output is still around 2 percentage points below where we would have been had the economy remained on its pre-pandemic track. This suggests that supply side constraints continue to have an important legacy impact on inflation and additional rate hikes to dampen growth and get inflation sustainably back to target are not necessary. This view gets some support from that lower-than-expected core PCE deflator which at 3.8% annualised is the slowest rate of price increase since the first quarter of 2021. The headline PCE deflator slowed to 2.6% annualised.   Leading indicators still point to downside risk for GDP growth   Recessions risks linger on In terms of the outlook, we remain concerned that the cumulative effect of tighter monetary policy plus tighter lending conditions will increasingly restrain economic activity and growth will slow and possibly contract from the fourth quarter. Certainly the leading economic indicator suggests that the risks are skewed to the downside for economic activity. This should result in weaker employment numbers through the second half of this year and into 2024, which will further dampen price pressures, As such, we continue to believe that while the Fed will leave the door open to further interest rate hikes, there is less urgency to do so and that yesterday’s rate hike to 5.25-5.5% will end up marking the peak for US interest rates.

German economy stagnated in the second quarter The flash estimate of German GDP growth shows that the eurozone's largest economy stagnated in the second quarter and seems to be stuck in the twilight zone between stagnation and recession. According to the flash estimate of the German statistical agency, the German economy stagnated in the second quarter. On the year, GDP growth was down by 0.6% or 0.2% if corrected for working days. We advise you to take these numbers with caution as over the last quarters, these flash estimates had been subject to significant revisions. Today, again, the last quarters were slightly revised upwards, without revising away the winter recession. Judging from available monthly data and the comments by the statistical office, it was mainly private consumption which helped the German economy to avoid an extension of the winter recession.   Stuck between stagnation and recession Looking ahead, recently released sentiment indicators do not bode well for economic activity in the coming months. In fact, weak purchasing power, thinned-out industrial order books, as well as the impact of the most aggressive monetary policy tightening in decades, and the expected slowdown of the US economy, all argue in favour of weak economic activity. On top of these cyclical factors, the ongoing war in Ukraine, demographic changes, and the current energy transition will structurally weigh on the German economy in the coming years. However, all is not bleak. The stuttering Chinese rebound could easily bring some temporary positive surprises as well. Also, the drop in headline inflation and the actual fall in energy and food prices combined with higher wages should support private consumption in the second half of the year. We continue to see the German economy being stuck in the twilight zone between stagnation and recession. Today’s German GDP data resembles this economist's favourite football club winning the last match of the season but still being delegated to the second division. It's a victory that does not give rise to celebration.

Eurozone economy returns to positive growth but underlying weakness remains GDP growth beat expectations at 0.3% quarter-on-quarter in 2Q, but underlying weakness remains significant. For the data-dependent European Central Bank, this GDP reading will not be a dovish argument at the September meeting, leaving a further hike on the table.   After GDP declined in the fourth quarter and stagnated in the first, it increased by 0.3% quarter-on-quarter in the second quarter. This was better than expected but also boosted by very strong Irish activity, which is known to be volatile on the back of multinational accounting activity. Without Ireland, growth would have been halved. Looking through the most volatile components, we argue that the economy has remained broadly stagnant. Still, for the ECB this will not be the main argument to pause in September.   The buoyant reopening phase is behind us and the effects of high inflation, weak global demand and monetary tightening are resulting in a phase of sluggish economic activity. While the labour market continues to perform very well, a recession is never far away in this type of environment and remains a clear downside risk for the quarters ahead. The differences between countries are large in terms of performance. The German and Italian economies continue to suffer, in part because their manufacturing sectors are larger and demand for goods remains in contraction. Germany saw flat GDP growth quarter-on-quarter after two quarters of negative growth, while Italy dipped back to -0.3%. On the other hand, France and Spain continued to perform well. French GDP growth accelerated from 0.1 to 0.5%. Spain saw growth decelerate from 0.5 to 0.4%. Judging by the survey data we have so far on the third quarter, the risks are to the downside for the coming quarters. Manufacturing performance continues to slump as new orders continue to weaken and strong services performance is waning as reopening effects from the pandemic fade. With monetary tightening still expected to have its most dampening effect on growth later, continued broad stagnation of economic activity remains the most likely outcome for the coming quarters.

Monitoring Hungary: Disinflation shifts into a higher gear In our latest update, we reassess our economic and market forecasts for Hungary, as we expect disinflation to shift into a higher gear due to a marked collapse in domestic demand. In contrast, we see the technical recession ending in the second quarter, while the monetary normalisation will continue unabated if market stability prevails.   Hungary: at a glance Economic activity has slowed significantly in all sectors, except one. The positive contribution of agriculture will lift the economy out of the technical recession in the second quarter of 2023. However, unsurprisingly, the lack of domestic demand is weighing on both retail sales and industrial output, with the latter currently being supported only by export sales. Real wage growth has been negative for nine months, but we expect to see a turnaround as early as September, as the disinflationary process picks up speed. Weakening economic activity lowers import demand, which combined with lower energy prices is helping the country’s external balances to improve faster than expected. The rapid deterioration in the pricing power of businesses has contributed to the strengthening disinflationary process, which we expect to markedly accelerate, especially in food items. The normalisation cycle of monetary policy should continue unabated in 100bp steps until the September merger. Beyond that, we expect a pause and then further 100bp cuts. Currently we see a 0.5-1.0% of GDP slippage in this year’s budget, but a revision by the Ministry of Finance will only come in September. We still believe in a turnaround in forint due to FX carry and support by the improving current account and a better gas price story. We see the market underestimating further normalisation in the next year or two, opening the door for more curve steepening.     Technical recession will end in the second quarter, but no change to full-year outlook Hungary has been in a technical recession for three quarters (3Q22-1Q23) as sky-high inflation has stifled economic activity. Consumption has slowed markedly, and investments have come to a standstill due to high interest rates and fiscal savings. While most sectors continue to struggle with weak domestic demand, agriculture stands out. This is due to a combination of base effects and favourable weather conditions. In our view, these factors will lead to a significant positive contribution from agriculture to overall growth, lifting the economy out of the technical recession in the second quarter. As we expect domestic demand to remain subdued for the rest of the year, we believe that agriculture could be the only silver lining for growth prospects this year. However, we maintain our full-year GDP growth forecast of 0.2% as we await the official second-quarter data.   Real GDP (% YoY) and contributions (ppt)     Industrial performance hinges on export activity Industrial production surprised on the upside in May, as production volumes rose by 1.6% month-on-month but fell by 4.6% year-on-year. At a sectoral level, the picture remains unchanged, with volumes expanding only in the electrical equipment and transport equipment sub-sectors (e.g. electrical vehicle batteries and cars). We believe this trend underlines our view that only those sub-sectors that are linked to the automotive sector, and thus largely dependent on export sales, are performing well. Nevertheless, the heavy reliance on export sales is understandable in the context of subdued domestic demand. However, with global leading indicators suggesting that recessionary forces are building globally, this could weaken export prospects and thus delay the turnaround in overall output growth in industry until next year.   Industrial production (IP) and Purchasing Managers' Index (PMI)   Retail sales continue to plunge as real wages deteriorate The retail sector continues to suffer from the cost-of-living crisis, as the volume of sales in May fell by 12.3% YoY, adjusted for calendar effects. Short-term dynamics further cloud the picture, as retail sales volume fell by 0.8% MoM, with no recovery in sight. At the component level, food retailing was virtually flat, while non-food retailing fell slightly on a monthly basis. However, the lack of domestic demand is most evident in the case of fuel, as the volume of fuel retailing fell despite lowering fuel prices. In our view, this phenomenon underlines our view that the deterioration in household purchasing power is having a significant negative impact on retail sales. In this respect, we expect this downward trend to continue at least until real wage growth turns positive, which we expect to happen as early as September.   Retail sales (RS) and consumer confidence   We expect a turnaround in real wages as early as September Average wage growth remained strong in May, rising by 17.9% YoY on the back of higher bonus payments. However, after adjusting for inflation, real wages fell by 3% YoY, extending the streak of negative real wage growth to nine months. The good news is that we expect real wage growth to return to positive territory as early as September, in line with the strengthening of the disinflation process. As for other labour metrics, the three-month unemployment rate remained at 3.9% in the April-June period, showing that the cost-of-living crisis is encouraging people to work. In addition, strong demand for seasonal workers pushed the participation rate to a record high in June. In this regard, even if the seasonal effects fade, we expect the unemployment rate to peak in the vicinity of 4%, as the labour market faces structural shortage problems.   Growth of real wages in Hungary (% YoY)   Import pressure eased by subdued domestic demand The combination of high inflation and high interest rates is weighing heavily on domestic demand, reducing the need for imports. In addition, as the energy issue appears to be easing this year, the pressure on the trade balance from the import side is easing significantly. Conversely, the export side has huge growth potential due to new EV battery plants, while carmakers are still dealing with backlogs. Taking all these factors into account, the staggering €1.1bn trade balance surplus in May hardly comes as a surprise. In our view, high-frequency data point to a balanced current account (CA) at the end of the year. However, a looming recession in the eurozone, coupled with a weaker-than-expected economic rebound in China, could significantly weaken the export outlook, and thus may limit the upside to the CA.   Trade balance (3-month moving average)    

The collapse in domestic demand strengthens disinflation Headline inflation eased to 20.1% YoY in June, mainly driven by the 0.4% MoM decline in food prices. Within this, the fall in processed food prices was the main driver, hence the sharp 2ppt deceleration in core inflation to 20.8% YoY. In our view, the rapid deterioration in firms' pricing power is evident, and will only accelerate going forward as competition among retail outlets for households' overall shrinking disposable income intensifies. Based on our high-frequency data collection, we expect disinflation to strengthen further going forward, driven mainly by food deflation. In this context, we expect average inflation to fall to single digits in the fourth quarter, while average inflation for the year as a whole is likely to be below, but close to 18%.    Inflation and policy rate   Rate cuts to continue in 100bp steps if market stability prevails At the July meeting, monetary policy normalisation continued as the National Bank of Hungary (NBH) lowered the effective interest rate by a further 100bp to 15%. The central bank emphasised cautiousness, graduality and predictability, so we expect same-sized cuts into the September merger of base and effective rates. After September, however, the NBH has several options to alter the interest rate complex. The central bank can either continue the easing cycle unabated in 100bp increments, setting the policy rate at 10% at the end of 2023. However, reducing the pace of cuts to 50bp seems to be another viable option, leaving the key rate at 11.5%. In our view, the NBH will cut both repo and deposit rates by 100bp in October, leaving room for market rates to adjust lower, but will only cut the base rate by 100bp in November and December. We, therefore, expect the policy rate to end the year at 11%.   Real rates (%)   VAT receipts hit hard by fall in domestic demand The Hungarian budget posted a deficit of HUF 132.7bn in June, bringing the year-to-date cash flow-based shortfall to 85% of the full-year target. The decline in domestic demand is weighing heavily on tax revenues. In this respect, VAT receipts in the first half of 2023 were only 2.2% higher than a year ago compared to the 24% average inflation during this period. Despite some ongoing adjustments (e.g. public investment cuts), we still see a slippage of 0.5-1% of GDP in this year's budget. A recent interview with the Finance Minister revealed that a revision could come as early as September, which in our view could lead to additional adjustments plus a minor increase in the 2023 EDP deficit target. From a cash-flow perspective, the fate of the EU funds remains a key issue, with the clock ticking (90 days) at the European Commission's table, as the government officially submitted the self-review on horizontal enabler (judiciary) reforms on 18 July.   Budget performance (year-to-date, HUFbn)   We still believe in a HUF turnaround Although we heard what we thought we would from the National Bank of Hungary – a cautious cut with a commitment to remain patient – market players were ignorant of the hawkish message. The NBH’s assurance that the cutting cycle will not be accelerated did not result in a turnaround in EUR/HUF as we expected. However, our market view remains unchanged. In case of further forint weakening, we expect the central bank to hit the wire and repeat some hawkish statements, trying to push against HUF underperformance versus Central and Eastern European peers. Moreover, we see some improvement in conditions at the global level, too. Last but not least, despite the whole EU fund issue being overly politicised, we still believe in a positive outcome before the year-end. Our ultimate argument would be that European politicians don’t want to bother with Hungarian issues when European Parliament elections are approaching (June 2024). On a local level, we think FX carry should continue to be the main positive driver for the HUF, supported by an improving current account, a record decline in gas prices, and despite cuts by a cautious central bank, overall pushing EUR/HUF closer to 370.   CEE FX performance vs EUR (30 December 2022 = 100%)   We continue to see further curve steepening In the rates space, we found the IRS curve a bit steeper again after the last NBH meeting and a steeper and lower curve remains our main view for the coming months. 2s10s spread has moved roughly 100bp since May, the first rate cut, and we still see room for further normalisation of the IRS curve, which remains by far the most inverted in the CEE universe. Market expectations for this year are more or less fair given that the September rate merge is a broad market consensus, however, NBH's next steps are unclear to the market, and we see the market underestimating further normalisation in the next year or two, opening the door for more curve steepening. On the other hand, the fall in core rates will slow the normalisation of the curve compared to previous months.   Hungarian sovereign yield curve   Hungarian government bonds (HGBs) eased in July and the rest of the region caught up with the swift rally. We therefore see current valuations of HGBs as more justifiable, which could attract new buyers. Despite the fiscal slippage risk, year-to-date issuance has reached 60% by our calculations, which we see as more than sufficient. Moreover, recent government measures supporting HGBs and the fastest disinflation in the region should be enough to sustain demand.

Eurozone core inflation surprises on the upside Eurozone GDP accelerates to 0.3% The euro is showing little movement on Monday. In the North American session, EUR/USD is trading at 1.1023, up 0.06%. It has been a wild ride for the euro over the past two weeks. On July 18th, EUR/USD hit its highest level since February 2022, but the same day, the euro began a slide which saw it drop almost 300 points. Interestingly, the euro had a muted reaction to Monday’s eurozone inflation and GDP reports. Eurozone inflation for June was within expectations. Headline CPI dropped from 5.5% to 5.3% y/y, matching the consensus estimate. Core CPI remained steady at 5.5%, a notch higher than the consensus of 5.4%. Core CPI, which is closely watched by the ECB, hasn’t improved much from the 5.7% gain in March, which marked a record high. The inflation report shows that inflation remains stubbornly high, and will provide support to ECB members who favor a rate hike at the September meeting. The ECB raised interest rates last week, which came as no surprise as the ECB had signalled that it would do so. What happens next is anyone’s guess. ECB Lagarde said at last week’s meeting that “the September meeting will be deliberately data-dependent”. This didn’t clear up any uncertainty or really say anything, as the ECB has abandoned forward guidance and made rate decisions based on key data, especially inflation and employment reports. The ECB could go either way in September – inflation remains well above the 2% target, which would support a hike, but the eurozone economy remains weak and some members may wish to pause in order to avoid a recession. There was a bright spot in Monday’s releases as eurozone GDP rose to 0.3% in the second quarter, up from 0.0% in Q1. We’ll get a look at German and eurozone Manufacturing PMIs on Tuesday. EUR/USD Technical EUR/USD is testing resistance at 1.1037. The next resistance line is 1.1130 There is support at 1.0924 and 1.0831    

EUR/USD Euro failed to approach the target range of 1.1068/92 yesterday, in part due to the large distance to cover and the technical resistance on lower timeframes. Key economic reports also came out rather weak, with Germany's retail sales for June showing a decrease of 0.8%. Meanwhile, the Chicago Business Activity Index for July increased from 41.5 to 42.8, collectively offsetting the eurozone's GDP growth for the 2nd quarter by 0.6% y/y (0.30% q/q).     The political factor also intervened, as China decided to reduce the export of unmanned aerial vehicles to the US, citing national security reasons. Furthermore, the forecasts for key economic indicators in the US came out optimistic. Currently, the price approaches the target level of 1.0924, along which the MACD line also converges. There may be a breakout around the speculative buying range of July 6-7, or a correction from the entire decline since July 18.   On the four-hour timeframe, the balance indicator line capped yesterday's growth, pushing the price below 1.1012. The Marlin oscillator also fell under zero, showing a downward trend.    

China is no 1990s Japan - but it could have been Talk of deflation for China is well wide of the mark, and obsessing over historical growth rates misses the point that 5% growth is sustainable and about the right pace of growth for an economy of China's stage of development.   5% growth from China - get used to it China will probably grow by about 5% this year. And for those for whom GDP growth is the only goal worth pursuing (it really isn’t) this sounds nothing short of disastrous. There have even been some media articles questioning whether China is entering a phase of stagnation similar to that experienced by Japan in the 1990s after its bubble burst. This has been spurred by Chinese CPI inflation figures that are hovering at around zero. The D-word (deflation) is being brushed off.  But let us be very clear, China is not on the brink of deflation, and the situation between Japan in 1990 and China today is very different. Indeed, there is a strong argument to support a slower, less debt-fuelled and in all senses more sustainable rate of Chinese economic growth over the coming years, than to provide an artificial jolt of stimulus, after which, will come the inevitable question…”What do we do when that stimulus runs out?” Japan’s answer was to do it again, only larger, and then again, and again. And that is why today, they have a government debt-to-GDP ratio of around 263%. For all the talk of stimulus plans that fills the newswires each week, there is nothing wrong with China sticking to its current path.    Recap of Japan's bubble and subsequent burst Let’s start with a recap of the Japan bubble. The received wisdom today is that this followed a period of over-accommodative monetary policy by the Bank of Japan (BoJ) following the Plaza Accord, after which the yen rallied, prompting the BoJ to keep rates much lower than they would otherwise have done, and which in turn, fed an aggressive property boom and then eventual bust.   Tokyo land prices 1980-2000

No bubble, no bust What is missing from the chart above is the sort of exponential growth that typically characterises a bubble, after which there is then a catastrophic drop as participants realise that the “Emperor” has no clothes after all. China has had occasional and short-lived periods of excessive property price growth in the past, that is all. What follows is likely to be a period of much slower property price growth or even some slight declines. From an aggregate point of view, that is neither particularly worrying nor all that undesirable.   Turning now to the equity markets. If we superimpose the recent price developments of the Shanghai composite index onto the Tokyo stock exchange in the period running up to the bubble, what we see is that China’s stock market has for some time been extremely average. There is no sense at all here of an excessive surge that requires a long period of dismal performance to compensate. That’s not to suggest a particularly bright future for Chinese stocks, but it beats a Japan-style collapse.   China's stock market performance has been moribund     Growth will be slower, but more sustainable without a construction boom Ruling out a deflationary collapse is clearly a positive standpoint. But we also don’t see Chinese growth at much more than 5% over the coming few years. And we have a tough time explaining to people why this is actually a perfectly reasonable growth rate which doesn’t require a panicked response. But here goes… In previous years, China’s GDP growth had taken a disproportionate boost from property development. Not only does construction provide a substantial direct boost to activity and labour demand, but it also requires a lot of inputs from industry: cement, steel, copper, aluminium, PVC etc. That also provides a big boost to things like energy demand. And new property sales also require furnishings, and that in turn pushes up this aspect of retail spending. But the amount of growth that construction was delivering to the economy had grown to totally unsustainable levels. In some years, in nominal terms, construction contributed up to almost three percentage points of total GDP growth, often about a third of the total.      Contribution to Chinese nominal GDP growth from construction   Disaster potentially averted... To try to highlight how anomalous this was, if you look at average Asian GDP growth rates pre-Covid relative to GDP per capita, China was a huge outlier, growing several percentage points faster than you would expect for an economy of its state of development. And that deviation can be largely put down to growth generated by excessive construction activity. This was essentially construction-driven GDP “bought” with debt and ultimately, unsustainable. Maintaining this sector at pre-Covid growth rates could have ended up in disaster. Maybe a Japan-style disaster. What the Chinese authorities have done, quite sensibly, is to nip this in the bud before this happens, though this of course is going to mean reversion to slower (more sustainable) growth rates that are more in line with an economy of China’s stage of economic development.    The property development sector is currently being kept on life support – allowed just enough access to credit to finish the vast stock of unfinished properties which they have sold in advance to a quite understandably nervous household sector. It is unlikely that they will embark on much in the way of new investment until this process is complete. And it is also not clear that Chinese household’s love for property as an investment asset will rapidly, or fully recover after this experience. So if we can no longer rely on construction to power the economy ahead, then growth will likely average something closer to 5% than the 6-8% China averaged pre-Covid. And in our view, that is surely superior to faster debt-fuelled property-led growth for a few years, followed by a Japan-style collapse. Because while China’s current situation is far from that of Japan in 1990, that is not to say that that future could not have happened if things had run on unchecked as before.     GDP per capita and average GDP growth rates for Asia

Bank of England hikes by 25bps, keeps options open for September By Michael Hewson (Chief Market Analyst at CMC Markets UK)     As expected, the Bank of England raised rates by 25bps to a new 15-year high of 5.25%. This was the baseline assumption given an expectation that we could see further sharp falls in the CPI headline rate in just under 2 weeks' time when we get July CPI numbers, and the lower energy price cap kicks in. There was a 3-way split on the voting with Catherine Mann and Jonathan Haskell voting for a 50bps move, while external MPC member Swati Dhingra maintained her no change stance. The bank also downgraded its expectation for GDP growth for this year to 0.5% from 0.75%. They also downgraded their end of year inflation forecast to below 5%. The pound had already been trading lower in the leadup to the decision and has remained weak as markets price in the prospect that the terminal rate could be lower. This has softened below 5.7%. New MPC member Megan Greene, who replaced dove Silvana Tenreyro adopted a more hawkish position, going with the majority of a 25bps move.     It was also noteworthy that the bank said that rates would need to stay sufficiently restrictive for longer to be able to return inflation to its 2% target, which reading between the lines suggests that rates could be close to their peak. Deputy Governor Ben Broadbent more or less admitted this with his comments that UK policy was restrictive already, and that UK rates are now likely above the neutral rate. Time will tell, but with another 2 CPI reports to come before the September meeting there is a chance that today's hike could well have been the final one of this cycle. UK gilt yields appear to be pricing that prospect already with 2-year yields below 4.9% and down 10bps on the day.     Today's decision by the central bank has prompted a modest rebound in housing and banking stocks off the lows of the day, as traders take the view that the Bank of England is close to calling a pause on further rate hikes. There are some important caveats to a possible pause, with the governor warning that services price inflation has been much more persistent, but with the long and variable lags that monetary policy operates in, the bank needs to be careful about pushing its luck when it comes to further rate hikes, given the fragile nature of the UK economy as well as the housing market. The central bank needs to look more carefully at PPI in terms of the likely direction of headline CPI where we have already seen negative readings in both output and input prices.  

German industrial ‘bad news show’ continues A further drop in German industrial production in June is another illustration of the country's ongoing stagnation.   The industrial bad news show continues. German industry continued its downward trend in June as industrial production dropped by 1.5% Month-on-Month, from -0.1% MoM in May. For the year, industrial production was down by 1.7%. Industrial production is still more than 5% below its pre-pandemic level, more than three years since the start of Covid-19. Production in energy-intensive sectors escaped the negative trend and increased by 1.1% MoM in June, still down by more than 12% over the year. The disappointing industrial production performance in June was mainly driven by the automotive industry (-3.5% MoM) and the construction sector (-2.8% MoM). With today’s numbers, the risk has increased that the flash estimate of stagnating GDP growth in the second quarter could still be revised downwards.   More industrial disappointments to come Today’s industrial production data will do little to change the current hangover mood in Germany. The country finally seems to have woken up to the reality that it's lost international competitiveness over the last decade on the back of too few investments and hardly any structural reform. The pandemic and the war in Ukraine have worsened the problems without being the root cause. It doesn’t come as a surprise that according to a recent survey, German companies have never been more pessimistic about the country’s international competitiveness than currently. With earlier investments and reforms, the economy could have mastered the current challenges better. As a result, economic stagnation is the new normal. And in this new normal, the ‘traditional’ growth drivers of the German economy, i.e. industry and exports, have actually become a drag on growth. Looking ahead, last week’s surge in industrial orders brightened the industrial outlook somewhat. However, up to now, the rebound in new orders in May and June has only offset the sharp drop earlier in the spring but is not yet the start of a new positive trend. In fact, ongoing high inventories and the order book deflation until springtime still suggest more industrial disappointments in the months ahead.

Australia: How to ride a bumpy disinflationary path Australia's growth outlook has cooled off, but the labour market remains too tight and the decline in inflation has been primarily due to base effects. We disagree with markets' expectations that we have seen the peak in RBA rates, and expect at least one more hike. This should help a recovery in the undervalued (in the short- and medium-term) Aussie dollar.   After two months of 'no-change', the market has decided that the Reserve Bank of Australia (RBA) has finished hiking rates. We disagree. There has been only a modest slowdown in the economy, and most of the decline in inflation so far owes to base effects which are turning less helpful, while the run-rate for month-on-month inflation remains much higher than is consistent with the RBA’s inflation target. We expect at least one more hike, possibly in September or maybe waiting for the quarterly inflation numbers which will be known by the November meeting, and quite possibly two. That would take the cash rate target to 4.35% with an upper risk of 4.6%. If we are right that the US Fed has finished tightening, then this could see some outperformance of the AUD into year-end. AUD’s sensitivity to pro-cyclical trades and the shape of the yield curve, as well as its pronounced undervaluation, put it in a good position to potentially outpace other G10 peers in a multi-quarter USD decline.   The macro picture: Labour market remains tight GDP growth in Australia has slowed every quarter since the third quarter of 2022, and looks set to deliver another weak quarter of growth in the second quarter of 2023. NowCasting estimates are pointing to only about a 0.2% quarter-on-quarter increase, and 1.5% year-on-year annual growth rate in the second quarter.   Australian GDP projections   This suggests that the RBA’s rate tightening is indeed working, on top of the external factors weighing on growth (weak China re-opening, US and EU slowdown). But on many measures, the Australian economy remains robust, and this remains a concern when we dig into the inflation data and see that on some measures (admittedly not all) inflation is still running quite strong. In particular, Australia’s labour market shows only limited signs of slowdown. At 3.5%, the unemployment rate is close to its all-time low of 3.4% in October last year. And almost all of the jobs that have been created over that time have been full-time jobs, with commensurately higher weekly earnings, benefits and security than part-time jobs. That means household spending power is being supported. The consequence of this is that wages growth, though only measured quarterly, and with long lags, remains, according to the RBA’s own anecdotes, on an upward path. And this will help keep service sector inflation higher than would ideally be the case.   Wages, unemployment and inflation in Australia  

UK manufacturing surge lifts second quarter growth A surprisingly large increase in manufacturing production has meant that second quarter GDP increased by more than we'd expected. For the Bank of England, next week's inflation and wage numbers matter much more.   Manufacturing surge boosts UK GDP growth The UK economy grew faster than expected in June, helped by a surge in manufacturing production. Monthly GDP rose by 0.5% on the month, though the 2.4% increase in manufacturing between May and June is extremely unusual (at least outside of the Covid-19 period). The result is that overall second-quarter economic growth came in at 0.2%, a bit higher than expected. The ONS puts this down to pharmaceuticals and car production. And while the latter can probably be partly explained by the ongoing improvement in supply conditions (production is up 15% since last summer’s low), it’s hard to explain why so much of this growth fell in June specifically. The impact of May’s bank holiday appears to have been fairly minimal in comparison to past royal events. Still, while much of the positive surprise can be explained by those manufacturing sectors, the rest of the economy looks fairly resilient too. That was helped by better weather in June which seems to have boosted the likes of hospitality and retail.   Third quarter looking better, but growth is likely to slow thereafter What next? Well, June’s large rebound means the starting level for the third quarter is pretty favourable. In other words, even if we get only very modest growth over the summer months, third quarter GDP is still likely to come in at roughly 0.4%. The gradual resolution of worker strikes also adds a bit of upside potential for some public industries, perhaps including transport. The circa 20% fall in household energy bills at the start of July should also offer a tailwind for consumption. Like many analysts, we are doubtful that this sort of growth figure will be repeated later in the year, as the mounting impact of higher interest rates weighs on the economy. So far, the average rate being paid on outstanding mortgages has risen from 2% to 2.9%, considerably less than the 6%+ rates being quoted on new lending. Around 85-90% of mortgages are fixed, albeit only for two or five years in the vast majority of cases. The impact of higher rates will therefore gradually increase over the next 12 months, although it’s worth remembering that a smaller share (less than 30%) of households now have a mortgage compared to the 1990s/2000s. A greater share of households own their home outright.   Services inflation and wage growth much more important Ultimately, today’s growth figures are of limited consequence for the Bank of England. That’s partly because they are only slightly above what it had expected (0.1% for the second quarter), and because its third-quarter forecast of 0.4% now looks reasonable, having looked a tad optimistic when it was released. But the Bank has also made it abundantly clear that it’s watching services inflation and wage growth much more closely. We’ll get fresh data on both of those next week, and on the former (services CPI), the Bank expects a slight uptick. We think the risks are tilted towards a flat or slightly lower reading, and if we’re right, that would boost the chances that a September rate hike will be the last such move.

There will be essential data releases in Poland next week with CPI expected to fall and GDP to decline for the second consecutive quarter. In Hungary, all eyes will be on the preliminary release of second-quarter GDP growth as it is expected to break a streak of three consecutive quarters of negative growth. Poland: CPI and Flash GDP to be released CPI (July): 10.8% YoY The StatOffice is expected to confirm its flash estimate of July CPI inflation at 10.8% year-on-year. According to preliminary estimates, the price of food and non-alcoholic beverages fell by 1.2% month-on-month, the price of energy sources for housing was unchanged vs. in June, while gasoline prices increased by 0.4%MoM. We estimate that core inflation moderated to 10.5%YoY from 11.1%YoY in the previous month. In August, annual inflation will be close to single-digit levels and will certainly fall below 10%YoY in September. Flash GDP (2Q23): -0.3% YoY According to our forecasts, the second quarter of 2023 was the second consecutive quarter of GDP declines in annual terms. We think the economy shrank at a similar scale as in the first quarter, with an even deeper annual decline in household consumption (close to -3%YoY), while fixed investment continued to expand. We judge the positive contribution of net exports was higher than the drag from a change in inventories. A more decisive improvement in economic activity is projected for the fourth quarter.  

Hungary: Second quarter GDP growth expected to turn positive The main event of the next week in Hungary is the preliminary release of second-quarter GDP growth. After being in a technical recession for three quarters, we see Hungary ending this streak with a boom. Our forecast shows quarter-on-quarter GDP growth of 0.8%, with the main drivers being agriculture and the services sector. The performance of the former will be helped by the exceptionally favourable weather conditions. Combine this with an awfully weak agricultural year in 2022, and the contribution of agriculture to the year-on-year growth could be close to a record high. In contrast, with domestic demand still struggling, we expect construction and industry to be a major drag on growth. As last year’s economic activity was spurred by government transfers during the first half of 2022, the base effect in general will be unfavourable. Against this backdrop, we see the GDP shrinking further on a yearly basis by 1.2% in the second quarter of 2023.   Key events in EMEA next week  

The week ahead features trade and inflation data from Japan, India and China. We'll also get a Philippine central bank decision and Australia’s unemployment data, which could influence India's move on rates later this month. Australia unemployment rate to increase slightly Australia’s unemployment rate came close to its all-time low of 3.4% last month, falling to 3.5%. Despite that, the Reserve Bank of Australia (RBA) kept rates unchanged last week as the inflation data was more favourable. Although labour data is an important input into the RBA’s reaction function, we think that the central bank will continue to be subordinate to the monthly inflation numbers, which must grapple with large electricity tariff hikes in July and then much less helpful base effects between August and October.     Japan to release GDP, trade and inflation data With modest improvement in net exports and a solid recovery in service activity, we expect second-quarter GDP growth to rise 0.6% quarter-on-quarter seasonally-adjusted (vs 0.7% in the first quarter). For inflation, we believe that private consumption has cooled moderately as the high prices in the second quarter put off consumption demand, though this is likely to be compensated by improved terms of trade as imports fell sharply due to falling global commodity prices. However, we should expect exports to record a contraction in July, particularly due to base effects. We believe Japan’s inflation should stay at the current level while core inflation is expected to accelerate further, as the previous Tokyo inflation outcome suggested. Philippine central bank to extend rate pause? The Philippines' central bank, Bangko Sentral ng Pilipinas (BSP), is likely to extend a pause, but persistent upside risks to the inflation outlook could give Governor Eli Remolona a reason to stay hawkish. Headline inflation has been trending lower and could be within target as early as September. This would be the main reason the BSP holds rates at 6.25%. However, with global grain and energy prices inching higher, a fresh round of upside risks to the inflation outlook has surfaced. Persistent upside risks will likely translate to the central bank remaining hawkish even if the BSP opts to extend its current pause. We expect the BSP to keep rates untouched but signal a strong willingness to tighten further should upside risks to the inflation outlook materialise. Inflation to surge in India India will release its July CPI next week, and we are expecting a steep climb to over 8%, breaching the upper end of the Reserve Bank of India's (RBI's) 2-6% target range. This is due to soaring food prices caused by the erratic monsoon rains: tomatoes experienced a whopping 200% month-on-month increase in July. But this should not bother the RBI too much as food price shocks like this come and go. The effect of food inflation has also spilled over to exports, where the Modi administration has announced an immediate ban on some non-basmati rice. As such, we are expecting a further decline in India’s export to -23.6%. Key data on industrial production and retail sales from China While China’s data has been disappointing lately, the summer season from July may usher in some better news. Data from China Railway show that there was a 14.2% increase in operating passenger trains compared to the same period in 2019. Flight numbers, on the other hand, experienced a slower recovery. They are currently running at about 48% relative to the same period in 2019, but this is still a 12% increase on a yearly and monthly basis. The rise in movement could provide a boost to consumption and strengthen retail sales. However, the effect is unlikely to spill over into industrial production, and we should continue to see weak growth here. Both the official and Caixin Manufacturing PMI released earlier this month showed that China’s recovery has yet to gain traction.   Key events in Asia next week    

In this interview, we sit down with Paweł Majtkowski to delve into the intricate web of macroeconomic data shaping the British economy. As a seasoned economic analyst, Mr. Majtkowski provides his expert insights on the latest series of economic indicators from the UK. From GDP growth and inflation figures to employment rates and trade balances, we explore the trends, challenges, and potential opportunities that lie ahead for the UK's economic landscape. Join us as we navigate through the numbers and uncover the narratives behind the data-driven journey of the British economy.   FXMAG.COM: Let me ask you to comment on the whole series of macroeconomic data from the British economy. However, will it enter a recession? What does this data say about further potential rate hikes in the UK? The UK continues to struggle with high inflation. In June, it stood at 7.3 per cent year-on-year. The British economy is therefore experiencing difficult times, not least because of 14 consecutive interest rate rises in a row. Domestically, there is economic stagnation. However, the GDP results - 0.5 % growth last month and 0.2 % in the second quarter - are better than analysts' expectations. With such modest growth, it is the details that count. Economic activity increased in June due to very good weather (the best since 1884), there were more working days in May than in previous years and this helped to offset the effects of ongoing strike action. The services sector, which dominates UK GDP, is benefiting from low (structural) unemployment and rising wages. This, in turn, is a cause for concern for the Bank of England and especially its hawkish representatives. Further rate rises cannot therefore be ruled out. The manufacturing sector and the real estate market, on the other hand, are performing worse. Not insignificant for the UK is the fact that its second largest trading partner, Germany, has already slipped into recession. This is a result of falling manufacturing and a very slow recovery in China.   Paweł Majtkowski, eToro Market Analyst

FX Daily: More volunteers to support the US dollar Data confirms the strength of the US economy and today's industrial production and FOMC minutes can only add fuel to the fire. The US dollar is the clear winner here and we are hardly looking for firepower in the eurozone to defend the euro. In the CEE region, Poland returns from holidays and the Czech koruna is the only one able to resist negative global factors.\   USD: FOMC minutes and a strong economy should offer further support Another nudge coming from the positive surprise in US retail sales did not last long and the US two-year yield slipped back down after touching the 5% level. This kept the US dollar index near 103.00, however, another hawkish test may come again today. Industrial production, after a 0.5% month-on-month drop in June, should show a return to 0.3% MoM growth in July in our view, in line with market expectations. Retail sales already indicate 3% GDP growth in the third quarter in our view and estimates for industrial production are also supportive of another positive surprise, confirming the strength of the US economy, which would be more positive news for the US dollar, of course. Later today, the July Federal Reserve minutes will come into play, which should reflect the FOMC's hawkish efforts to combat dovish expectations. This should be the last big event from the Fed until next week's Jackson Hole symposium. For now, this strategy is working perfectly. The implied policy rate has moved up roughly 50-60bp over almost the entire curve in the last month alone, with the exception of the super-short horizon. However, it is just a matter of time before the Fed uses up its ammunition and the market stops buying more hawkish news. For now though, we remain in this mode for at least the next few days, which combined with the positive surprises from the economy, should continue to support the US dollar. Thus, DXY should remain above 103.00 and test higher levels closer to 103.50 today as well.

Strong consumer keeps US on track for 3% GDP growth Retail sales provided another upside data surprise and indicates a 3% annualised GDP growth rate is possible for the third quarter. However, higher consumer borrowing costs, reduced credit availability, the exhausting of pandemic-era savings and the restart of student loan repayments pose major challenges for fourth quarter activity.   Retail sales lifted by Prime Day and eating out We have another US data upside surprise from the household sector with retail sales rising 0.7% month-on-month in July versus the 0.4% consensus. June's growth was also revised up 0.1 percentage point to 0.3% MoM. Importantly, the control groups which excludes volatile autos, gasoline, food service and building materials, rose 1% MoM versus 0.5% consensus, but here there was a 0.1pp downward revision to June's growth to 0.5% MoM. This category, historically, has a better correlation with broader consumer spending. Remember retail sales is only around 45% of consumer spending in total, with consumer services taking a greater share. Amazon Prime Day appears to have been the main driver with non-store sales up 1.9% MoM, but there was also strength in restaurants and bars (+1.4%) while sporting goods rose 1.5%, clothing was up 1% and grocery up 0.8%. Electronics (-1.3% MoM) and vehicles (-0.3%) and furniture (-1.8%) were the weak spots. All in it points to the US being on track to report 3% annualised GDP growth in the third quarter, which will keep the Fed's language hawkish even if they don't carry through with further rate hikes, as we expect.   Official retail sales growth versus weekly chain store sales growth (YoY%)   The challenges for spending are mounting Interestingly, there has been a bit of a breakdown in the relationship between official retail sales growth of the control group and the weekly Redbook chain store sales numbers, as can be seen in the chart above. Maybe this is the Prime day effect playing out and we see a reconvergence again in August. The Retail sales report is a good story for now, but we are expecting weakness to materialise in the fourth quarter. Higher market interest rates will add to upward pressure on what are already record high credit card borrowing rates and rising auto, mortgage and personal loan rates. With households also continuing to run down pandemic-related excess savings, as measured by Fed numbers on cash, checking and time savings deposits, this will act as a brake on growth.   US consumer borrowing costs (%)   Higher borrowing costs and reduced credit availability will hurt However, it is important to remember that reduced access to credit is just as important as the cost of credit in taking heat out of the economy. The latest Federal Reserve Senior Loan Officer Opinion Survey (SLOOS) underscores how the tightening of lending conditions will increasingly act as a headwind for activity and contribute to inflation sustainably returning to target. Banks are increasingly unwilling to make consumer loans and as the chart below shows, this has historically pointed to an outright contraction in consumer credit outstanding.   Fed's Senior Loan Officer Opinion Survey points to negative consumer credit growth (YoY%)   Fed to keep rates on hold Add in the squeeze on household finances from the restart of student loan repayments for millions of households and it means further weakness in retail sales and broader consumer spending remains has to remain our base case. The concern is that it will also heighten the chances of recession, which we believe will discourage the Fed from any further interest rate increases. Instead, we expect interest rate cuts from March 2024 onwards as monetary policy is relaxed to a more neutral footing.  

EUR: Lack of strong support EUR/USD appears stuck in a relatively low volatility environment, despite feeling some pressure. The swings in the 2-year swap rate differential are not proving dramatically impactful on the pair, but the retightening of the spread from the 140bp area to the 134bp is probably offering a bit of support. Eurozone data continued to do very little to help a rapid turnaround in the euro’s softish momentum, though. Yesterday, 2Q GDP growth was confirmed at 0.3% QoQ and employment figures at 0.2% QoQ. With forward-looking indicators pointing at an economic slowdown in key parts of the euro area, a EUR/USD rally later this year (which is still our base case) should rely primarily on a decreasing attractiveness of the dollar rather than on an idiosyncratic EUR boom. It may be yet another rather quiet day in FX today, and barring a major surprise on the US data side – and considering the eurozone calendar is quite light – EUR/USD should keep hovering around 1.0850/1.0900.

US Treasury yields continue to rise, with 2-year bonds exceeding 2% for the first time since 2009, the 10-year rate at its highest since 2007, and 30-year T-bonds setting a record.   On the one hand, the increase in Treasury yields indicates a decrease in risks, as a sell-off in bonds means a sell-off in risky assets. On the other hand, the burden on the US budget increases, and inflation expectations can grow again at any time. The risks on the path of inflation moving to the target level remain high.   The main threat to New Zealand and Australia is China's economic slowdown. Financial stress is increasing, and there are signs that China is heading towards a full-blown financial-economic crisis. The Chinese authorities have tools to prevent such an outcome, but a slowdown in GDP growth is almost inevitable, resulting in a decrease in foreign trade volumes. NZD/USD As expected, the Reserve Bank of New Zealand left the rate at 5.5% at the meeting that ended last week. The tone of the accompanying statement unexpectedly gained an additional hawkish tilt due to a slight increase in the rate forecast (by 9bps). The GDP and inflation forecasts changed little, but the updated OCR track from 0.25% indicates that the RBNZ does not consider the current level as sufficiently restrictive as it did three months ago.     The risks for the New Zealand economy are diverse and to some extent offset each other, but in some cases, they intensify. High net migration is a good thing for the labor market, as the increase in labor supply will raise the unemployment rate but simultaneously allow wage growth to be contained, an essential criterion in the fight against inflation. At the same time, domestic demand is getting weaker, despite the influx of migrants. Exports fell by 14% YoY in July, while a decrease of only 4% was expected.   Imports fell by 15% (forecast 8%), partly due to lower global commodity and goods prices. On Thursday, a quarterly retail trade report will be published, which will serve as the basis for the forecasts for consumer demand. The net short position in the NZD increased by $123 million during the reporting week to -$145 million. Market positioning remains neutral with a slight bearish bias. The price is certainly falling, with no signs of a reversal.   A week earlier, we identified the support zone of 0.5870/5900 as a target, the pair has reached this target, and from a technical perspective, a bullish correction is possible. The nearest target is 0.5975, followed by 0.6010. At the same time, the primary trend remains bearish, so in the long term, after the corrective phase has ended, we expect another wave of sales, with the target being the support zone of 0.5830/50.     AUD/USD Australia's economic calendar for the week is calm, with no significant economic reports to take note of. The next week will be much more saturated - on August 29, Reserve Bank of Australia Deputy Governor Michele Bullock will speak, and we can look forward to several reports, including the monthly Consumer Price Index for July, retail sales, and investment dynamics for the 2nd quarter, which will allow a preliminary assessment of GDP growth rates. The RBA rate forecast assumes another increase in November, as the RBA will likely respond to rising business costs, rent, and energy prices. Inflation is declining more slowly than in the United States. The net short position in the AUD increased by an impressive $620 million over the reporting week and reached -$3.45 billion, with market positioning firmly bearish. The price is below the long-term average but has lost momentum, suggesting an attempt at a corrective phase.  

Canadian retail sales post weak 0.1% gain Markets eye Jackson Hole Symposium as tightening cycles near end The Canadian dollar remains under pressure on Wednesday. In the North American session, USD/CAD is trading at 1.3554, up 0.04%. Earlier, the Canadian dollar fell below the 1.36 line for the first time since May 31st.   Canada’s retail sales stagnant in June Canada’s retail sales for June barely moved, with a gain of just 0.1% m/m. This was unchanged from the May reading, which was downwardly revised from 0.2%, and just above the consensus estimate of zero. On a yearly basis, retail sales slipped 0.8% in June, compared to a gain of 0.2% (revised downwards from 0.5%) and shy of the estimate of 0.3%. The data indicates that consumer consumption is cooling down as higher interest rates continue to filter through the economy. Canada’s GDP in the first quarter was solid at 3.1%, but second-quarter growth is expected to be much more modest, at around 1%. Consumer spending has been a key factor in the Bank of Canada’s rate decisions. Earlier in the year, stronger-than-expected consumer spending resulted in the BoC raising interest rates in June and July. Today’s soft retail sales figures will provide support for the central bank to take a pause at the September 6th meeting, with GDP the final key release ahead of that meeting.   Markets await Jackson Hole There has been a whole lot happening this week and investors will be hoping for some interesting comments from central bankers who are meeting this week in Jackson Hole, Wyoming. Many of the major central banks, including the Federal Reserve, are winding up their rate-tightening cycles and Jackson Hole has often served as a venue for announcing shifts in policy. That said, Fed Chair Powell has insisted that the fight against inflation is not done, although the dark days of high inflation appear to be over. There is talk in the markets of the Fed trimming rates next year, but I doubt that Powell will mention any cuts to rates, when he is yet to acknowledge that the Fed is done tightening.   USD/CAD Technical USD/CAD put strong pressure on the resistance at 1.3606 earlier. Above, there is resistance at 1.3660 1.3522 and 1.3468 are providing support    

German stagnation in the second quarter confirmed The second estimate of second-quarter GDP growth confirms the stagnation of Europe's largest economy and will do very little to end the 'sick man of Europe' debate.   Finally, a quarter without any statistical revision. The just-released second estimate of German GDP growth in the second quarter confirmed the economy's stagnation. The second estimate doesn't show the German economy in a better state and does little to shut down the current debate about Germany once again being the "sick man of Europe". According to the just-released data, the German economy stagnated in the second quarter, after two quarters of contraction. On the year, GDP growth was down by 0.6% or 0.2% if corrected for working days. The question remains whether technically speaking a stagnation after two quarters of contraction is actually the end of a technical recession or a prolongation. What is new in today’s data are the GDP components. While private consumption stagnated and public consumption increased marginally (+0.1% quarter-on-quarter), net exports were a drag on growth. The positive growth contribution from inventories reflects the ongoing inventory build-up, which doesn't bode well for the coming quarters.   Stagnation remains our base case Both the short-term and the longer-term outlook for Germany looks anything but rosy. Recently released sentiment indicators do not bode well for economic activity in the coming months. Weak purchasing power, thinned-out industrial order books, the ongoing weakness of the Chinese economy as well as the impact of the most aggressive monetary policy tightening in decades, and the expected slowdown of the US economy, all argue in favour of weak economic activity. On top of these cyclical factors, the ongoing war in Ukraine, demographic changes, the current energy transition as well as the lack of new investment in digitalisation, infrastructure and education will structurally weigh on the German economy in the coming years. However, all is not bleak. The drop in headline inflation and the actual fall in energy and food prices, combined with higher wages, should support private consumption in the second half of the year. We continue to see the German economy being stuck in the twilight zone between stagnation and recession.

In a world where economic indicators and market movements can shift with the blink of an eye, staying updated on the latest offerings and promotions within the financial sector is crucial. Today, we delve into one such noteworthy development that has emerged on the horizon, enticing individuals to explore a blend of banking and insurance services. As markets ebb and flow, being vigilant about trends and opportunities can lead to financial benefits. Let's explore this exciting promotion that brings together the worlds of banking and insurance to offer a unique proposition for consumers.     By Michael Hewson (Chief Market Analyst at CMC Markets UK) US non-farm payrolls (Aug) – 01/09 – the July jobs report saw another modest slowdown in jobs growth, as well as providing downward revisions to previous months. 187k jobs were added, just slightly above March's revised 165k, although the unemployment rate fell to 3.5%, from 3.6%. While the official BLS numbers have been showing signs of slowing the ADP report has looked much more resilient, adding 324k in July on top of the 455k in June. This resilience is also coming against a backdrop of sticky wages, which in the private sector are over double headline CPI, while on the BLS measure average hourly earnings remained steady at 4.4%. This week's August payrolls are set to see paint another picture of a resilient but slowing jobs market with expectations of 160k jobs added, with unemployment remaining steady at 3.5%. It's also worth keeping an eye on vacancy rates and the job opening numbers which fell to just below 9.6m in June. These have consistently remained well above the pre-Covid levels of 7.5m and have remained so since the start of 2021. This perhaps explain why the US central bank is keen not to rule out further rate hikes, lest inflation starts to become more embedded.                          US Core PCE Deflator (Jul) – 31/08 – while the odds continue to favour a Fed pause when the central bank meets in September, markets are still concerned that we might still see another rate hike later in the year. The stickiness of core inflation does appear to be causing some concern that we might see US rates go higher with a notable movement in longer term rates, which are now causing the US yield curve to steepen further. The June Core PCE Deflator numbers did see a sharp fall from 4.6% in May to 4.1% in June, while the deflator fell to 3% from 3.8%. This week's July inflation numbers could prompt further concern about sticky inflation if we get sizeable ticks higher in the monthly as well as annual headline numbers. When we got the CPI numbers earlier in August, we saw evidence that prices might struggle to move much lower, after headline CPI edged higher to 3.2%. We can expect to see a similar move in this week's numbers with a move to 3.3% in the deflator and to 4.3% in the core deflator.       US Q2 GDP – 30/08 – the second iteration of US Q2 GDP is expected to underline the resilience of the US economy in the second quarter with a modest improvement to 2.5% from 2.4%, despite a slowdown in personal consumption from 4.2% in Q1 to 1.6%. More importantly the core PCE price index saw quarterly prices slow from 4.9% in Q1 to 3.8%. The resilience in the Q2 numbers was driven by a rebuilding of inventory levels which declined in Q1. Private domestic investment also rose 5.7%, while an increase in defence spending saw a rise of 2.5%.             UK Mortgage Approvals/ Consumer Credit (Jul) – 30/08 – while we have started to see evidence of a pickup in mortgage approvals after June approvals rose to 54.7k, this resilience may well be down to a rush to lock in fixed rates before they go even higher. Net consumer credit was also resilient in June, jumping to £1.7bn and a 5 year high, raising concerns that consumers were going further into debt to fund lifestyles more suited to a low interest rate environment. While unemployment remains close to historically low levels this shouldn't be too much of a concern, however if it starts to edge higher, we could start to see slowdown in both, as previous interest rate increases start to bite in earnest.            EU flash CPI (Aug) – 31/08 – due to increasing concerns over deflationary pressures, recent thinking on further ECB rate hikes has been shifting to a possible pause when the central bank next meets in September. Since the start of the year the ECB has doubled rates to 4%, however anxiety is growing given the performance of the German economy which is on the cusp of three consecutive negative quarters. On the PPI measure the economy is in deflation, while manufacturing activity has fallen off a cliff. Despite this headline CPI is still at 5.3%, while core prices are higher at 5.5%, just below their record highs of 5.7%. This week's August CPI may well not be the best guide for further weakness in price trends given that Europe tends to vacation during August, however concerns are increasing that the ECB is going too fast and a pause might be a useful exercise.     Best Buy Q2 24 – 29/08 – we generally hear a lot about the strength of otherwise of the US consumer through the prism of Target or Walmart, electronics retailer Best Buy also offers a useful insight into the US consumer's psyche, and since its May Q1 numbers the shares have performed reasonably well. In May the retailer posted Q1 earnings of $1.15c a share, modestly beating forecasts even as revenues fell slightly short at $9.47bn. Despite the revenue miss the retailer reiterated its full year forecast of revenues of $43.8bn and $45.2bn. For Q2 revenues are expected to come in at $9.52bn, with same store sales expected to see a decline of -6.35%, as consumers rein in spending on bigger ticket items like domestic appliances and consumer electronics. The company has been cutting headcount, laying off hundreds in April as it looks to maintain and improve its margins. Profits are expected to come in at $1.08c a share.        HP Q3 23 – 29/08 – when HP reported its Q2 numbers the shares saw some modest selling, however the declines didn't last long, with the shares briefly pushing up to 11-month highs in July. When the company reported in Q1, they projected revenues of $13.03bn, well below the levels of the same period in 2022. Yesterday's numbers saw a 22% decline to $12.91bn with a drop in PC sales accounting for the bulk of the drop, declining 29% to $8.18bn. Profits, on the other hand did beat forecasts, at $0.80c a share, while adjusted operating margins also came in ahead of target. HP went on to narrow its full year EPS profit forecast by 10c either side, to between $3.30c and $3.50c a share. For Q3 revenues are expected to fall to $13.36bn, with PC revenue expected to slip back to $8.79bn. Profits are expected to fall 20% to $0.84c a share.         Salesforce Q2 24 – 30/08 – Salesforce shares have been on a slow road to recovery after hitting their lowest levels since March 2020, back in December last year, with the shares coming close to retracing 60% of the decline from the record highs of 2021. When the company reported back in June, the shares initially slipped back after full year guidance was left unchanged. When the company reported in Q4, the outlook for Q1 revenues was estimated at $8.16bn to $8.18bn, which was comfortably achieved with $8.25bn, while profits also beat, coming in at $1.69c a share. For Q2 the company raised its revenue outlook to $8.51bn to $8.53bn, however they decided to keep full year revenue guidance unchanged at a minimum of $34.5bn. This was a decent increase from 2023's $31.35bn, but was greeted rather underwhelmingly, however got an additional lift in July when the company said it was raising prices. Profits are expected to come in at $1.90c a share. Since June, market consensus on full year revenues has shifted higher to $34.66bn. Under normal circumstances this should prompt a similar upgrade from senior management.   Broadcom Q3 23 – 31/08 – just prior to publishing its Q2 numbers Broadcom shares hit record highs after announcing a multibillion-dollar deal with Apple for 5G radio frequency components for the iPhone. The shares have continued to make progress since that announcement on expectations that it will be able to benefit on the move towards AI. Q2 revenues rose almost 8% to $8.73bn, while profits came in at $10.32c a share, both of which were in line with expectations. For Q3 the company expects to see revenues of $8.85bn, while market consensus on profits is expected to match the numbers for Q2, helping to lift the shares higher on the day. It still has to complete the deal with VMWare which is currently facing regulatory scrutiny, and which has now been approved by the UK's CMA.

Rates Spark: Losing buoyancy Weaker data is eroding the US narrative that has helped push yields higher over the past week. A lower landing zone for the Fed also means a lower floor to long-end rates. There is still more data and volatility in store this week, with the US jobs data looming large. EUR markets will look to the inflation data key input for the upcoming ECB meeting.   The Fed discount is eroding and so is the floor for the 10Y yield Recent data is eroding the narrative of US resilience that had supported the rise of 10Y yields to above 4.3% over the past weeks. Poor job openings data and dipping consumer confidence yesterday saw the 10y falling through 4.2% and then briefly further towards 4.1% overnight. Interestingly the move was largely in real rates, and it reversed all of the gains that they had managed after dipping on the weaker PMIs last week.   We had suspected that an elevated Fed discount would draw a floor under longer rates. But just as data had shifted this floor higher, data is now hacking away at that discount. The curve bull-steepened with 2Y SOFR swap rates dropping more than 12bp while the 10Y still dropped close to 10bp. Data this week holds more candidates to push yields around, especially with US jobs data out on Friday. The consensus is already looking for further cooling with the payroll increase decelerating to 170K, but the unemployment rate is seen steady at 3.5%. Keep in mind that the Federal Reserve itself – in comments and its June projections – has pointed to an unemployment rate of 4% and above as being necessary to cool inflation towards the target rate. The indications it got yesterday are going in the right direction.   A pause in September is widely seen as the base case, with markets firming their view as the discounted probability of a pause moves towards 90%. One final hike is still possible this year, but the discounted chances for that to happen have slipped from close to 70% to a coin toss. Our economist believes the Fed has already reached its peak.   Assessing the Fed's landing zone remains crucial to overall rates   Aiding the ECB decision process, first August CPI indicators from Spain and Germany European Central Bank President Lagarde did not provide any further guidance in Jackson Hole with regard to the upcoming meeting in September. From recent comments, it is clear that the hawks on the governing council would still like to see higher rates. Austria’s Holzmann had been quite explicit, saying he saw the case for a hike if there were negative surprises until then. Latvia’s Martins Kazaks also wants to err on the side of raising rates, while Bundesbank’s Joachim Nagel also says it is too early to consider a pause. In later comments, he seemed to soften his tone, suggesting to wait for the data. Following the dip in the wake of the PMIs, the market has slowly priced the probability of a hike back into the forwards, but still just below 50%. But further out, markets are back to seeing a 75% chance that a 25bp rate hike comes before the end of the year to take the ECB’s depo rate to 4%. We would focus more on the upcoming meeting, however. We also think a September hike at this stage could be more of a coin toss, but more importantly, we sense that the hawks will see it as a last chance to hike one final time. If there is no hike in September, rates will probably not rise any further. One key input to arrive at a final assessment is the inflation data this week, starting today with the preliminary readings from Spain and Germany.   Today's events and market view It appears that the tide has turned again for rates now that data is eroding the resilience narrative. The latest auction metrics, such as the strong 7Y UST sale last night, also suggest that levels had been pushed sufficiently high to attract demand again. But the key remains in the data, with the US jobs report looming large on Friday. Today, we will get the ADP payrolls estimate, with a consensus for a weaker 195K after 324K last month. The value of the ADP as a predictor for the official data is questionable, however, as was also evidenced early this month – a large upside surprise in the ADP was followed by a disappointing official payrolls figure. But today’s data and anecdotal evidence from the release can still offer insight into the health of the labour market where more signs of cooling have come to light. In other US data today, we will get the pending home sales and the second reading of second-quarter GDP growth. The main highlight for the EUR markets will be Spanish and German regional CPI data. The consensus is for Spanish headline inflation to tick higher from 2.1% to 2.4% year-on-year. For Germany, the headline is seen falling somewhat from 6.5% to 6.3% year-on-year, but the state of NRW numbers already came in slightly hotter this morning. Yesterday, supply had initially helped push yields higher before the US data turned the market. Today, we will see Germany tapping a 4Y green OBL for €1.5bn. Italy’s bond sales today include a new 10Y benchmark and will amount to up to €10bn in total.    

Italian business confidence falls in August The deterioration in confidence is more marked in industry and construction, but services are not immune either. Consumers remain relatively upbeat, possibly helped by a resilient labour market. This all points to a stagnating economic environment.   Consumers remain relatively upbeat Consumer confidence only slightly edged down to 106.5 in August (from 106.7 in July). The deterioration in the perception of the current and future economic climate contrasts with the improvement in personal circumstances. We believe this has to do with the combination of declining inflation and a very resilient labour market. Indeed, the unemployment expectation component of the survey slowed down on the month. When matching this with an increase in the current opportunity to save sub-index, we sense that a possible stabilisation in the savings ratio might be in the making, limiting the scope for a strong pick-up in private consumption, at least in the short term.   Manufacturing confidence softens further On the business front, confidence unsurprisingly declined again among manufacturers to 97.8 (from 99.1 in July), the lowest level since January 2021. Here, softer orders coupled with a stable inventory component resulted in a decline in the production expectation component. Softer demand in key export destination countries such as Germany and, to a smaller extent, China, is apparently taking its toll, with the domestic component unable to compensate. Interestingly, the investment goods segment seems less affected, suggesting that some demand linked to the implementation of the Recovery and Resilience Facility might still be in place.   Construction confidence fall suggests that the effect of tax incentives is fading The six-point decline in the construction confidence index to 160.2 (from 166.5 in July) sends a warning signal. While the index remains close to its historical highs, the push coming from the residential component is gradually fading as generous tax incentives come to an end. While the existing backlog of orders related to incentives looks set to keep the sector afloat into year-end, the exceptionally high contribution of construction investment to GDP growth looks set to vanish in 2024.   Services only marginally down, with tourism relatively weak Confidence in market services fell to 103.6 in August, from 105.5 the previous month. The decline affected all big aggregates, except information and communication. Interestingly, it also affects tourism services, where an improvement in the current affairs component contrasts with declining order expectations. This broadly fits with other evidence available pointing to a good summer tourism season.      Modest GDP growth in the second quarter still possible All in all, today’s confidence data suggest that conditions are still ripe for the continuation of a soft economic environment. After the disappointing 0.3% GDP contraction in the second quarter (we will get the full details for this on Friday), a very small rebound still looks possible in the third quarter. Whether this will materialise or not will depend on whether services are strong enough to compensate for industrial weakness. We still hold average Italian GDP growth of 1% in 2023 as our base case.

Poland set to cut interest rates in September despite double-digit inflation Even though latest figures show Poland's inflation is still in double digits, we think the country's central bank will start its easing cycle in September. CPI fell to 10.1% in August from 10.8% in July, Year-on-Year. It reflects lower food and energy prices. Core inflation's drop came in third place; we estimate that fell to 10% from 10.6%.   Polish headline CPI inflation fell from 10.8% YoY to 10.1% YoY in August, marginally above expectations (ING 10.0% YoY and consensus 9.9% YoY; the forecast range was 9.7 to 10.6%). Food price dynamics subtracted 0.8pp from the CPI, energy carriers 0.3pp and core inflation only 0.3pp. In contrast, fuel prices rose in August and added 0.6pp to the headline figure. The release of double-digit CPI means that one of the conditions for easing, which the National Bank of Poland Governor mentioned, has not been met. However, we still believe the MPC will cut rates in September. Here's why:  We are on the path to single-digit inflation in September; the data will be published after the September MPC meeting. The CPI path in 2H23 should be either close to or slightly lower than the NBP's July projection. The MPC should consider this as a disinflation scenario materialising.  The pace of GDP growth in 2Q23 was lower than the NBP's projection, and data on economic activity in Poland and Europe suggests pushing back the economic rebound instead to 4Q23, so the state of the economy in the second half of this year will still be weak. In the short term, monetary easing is supported by strong disinflationary trends in global supply chains, resulting in a large drop in companies' inflation expectations, and these trends are still stronger than the rebound in oil and wheat prices. So, we expect the NBP to cut rates by 50-75 basis points this year, and the easing cycle may well continue into 2024. However, the inflation picture in Poland is not unequivocally positive. Poland's core inflation rate is declining significantly slower than elsewhere in the region; a roughly 20% increase in the minimum wage is expected in 2024, and a sizeable fiscal loosening is planned. Once the favourable impact of falling external prices ends, it's going to be difficult to bring inflation back to target on a sustained basis. 

The US confounded 2023 expectations that it would fall into recession as households used pandemic-era savings and their credit cards to maintain lifestyles amidst a cost-of-living crisis. But with loan delinquencies on the rise, savings being exhausted, credit access curtailed and student loan repayments restarting, financial stress will increas.   Robust resilience in the face of rate hikes At the beginning of the year, economists broadly thought the US economy would likely experience a recession as the fastest and most aggressive increase in interest rates inevitably took its toll on activity. Instead, the US has confounded expectations and is on course to see GDP growth of 3%+ in the current quarter with full-year growth likely to come in somewhere between 2% and 2.5%. What makes this even more surprising is that this has been achieved in the face of banks significantly tightening lending conditions while other major economies, such as China, are stuttering and even entering recessions, such as in the eurozone.   Consumers still happy to spend with the jobs market looking so strong So why is the US continuing to perform so strongly? Well, the robust jobs market certainly provides a strong base, even if wage growth has been tracking below the rate of inflation. Maybe that confidence in job security has encouraged households to seek to maintain their lifestyles amidst a cost-of-living crisis by running down savings accrued during the pandemic and supplementing this with credit card borrowing. The housing market was another source of concern at the start of the year, but even with mortgage rates at 20-year highs and mortgage applications having halved, prices have stabilised and are now rising again nationally. Home supply has fallen just as sharply, with those homeowners locked in at 2.5-3.5% mortgage rates reluctant to sell and give up that cheap financing when moving to a different home and renting remains so expensive. This has helped lift new home construction at a time when infrastructure projects under the umbrella of the Inflation Reduction Act are supporting non-residential construction activity.   But lending is stalling and savings have been run down The Federal Reserve admits monetary policy is now restrictive, and while it could raise interest rates further, there is no immediate pressure to do so. With inflation showing encouraging signs of slowing nicely, this is fueling talk of a soft landing for the economy. With less chance of an imminent recession, financial markets have scaled back the pricing of potential interest rate cuts in 2024, with the resiliency of the US economy prompting a growing belief that the equilibrium level of interest rates has shifted structurally higher. This resulted in longer-dated Treasury yields hitting 15-year highs earlier this month.   Outstanding commercial bank lending ($bn)   Nonetheless, the threat of a downturn has not disappeared. We estimate that around $1.3tn of the $2.2tn of pandemic-era accumulated savings has been exhausted and at the current run rate all will be gone before the end of the second quarter of 2024. At the same time, banks are increasingly reluctant to lend to the consumer with the stock of outstanding bank lending flat lining since the banking stresses in March, having increased nearly $1.5tn from late 2021. We suspect that financial stresses have seen middle and lower income households accumulate the bulk of the additional consumer debt and have run down a greater proportion of their savings vis-à-vis higher income households so a financial squeeze for the majority is likely to materialise well before the second quarter of 2024.   Rising delinquencies will accelerate as student loan repayments resume Indeed, consumer loan delinquencies are on the rise, particularly for credit card and vehicle loans with the chart below showing data up until the second quarter of this year. Since then the situation has deteriorated further based on anecdotal evidence with Macy’s CFO expressing surprise at the speed and scale of the rise in delinquencies experienced through June and July on their own branded credit card (Citibank partnered). With credit card interest rates at their highest level since 1972 and with household finances set to become more stressed with the imminent restart of student loan repayments, something is likely to give. We see the risk of a further increase in delinquencies, which will hurt banks and lead to even further retrenchment on lending, together with slower consumer spending growth and potentially even a contraction.   Percent of loans 30+ days delinquent   Downturn delayed, not averted The manufacturing sector is already struggling and we see the potential for consumer services to come under increasing pressure too. On top of this there are the lingering worries about the demand for office space and the impact this will have on commercial real estate prices in an environment where there is around $1.5tn of loans needing to be refinanced within the next 18 months. With small banks the largest holder of these loans, we fear we could see a return to banking concerns over the next 12 months. Consequently, we are in the camp believing that it's more likely that the downturn has been delayed rather than averted. Fortunately, we think inflation will continue to slow rapidly given the housing rent dynamics, falling used car prices and softening corporate pricing power and this will give the Federal Reserve the flexibility to respond swiftly to this challenging environment. We continue to forecast the Federal Reserve will not carry through with the final threatened interest rate rise and instead will switch to policy loosening from late first quarter 2024 onwards.  

The third quarter may still be saved by tourism in the eurozone, but the latest data points to a more pronounced slowdown in the coming months. Inflation is falling, but a last interest rate hike in September is not yet off the table. The European Central Bank will be hesitant to loosen significantly in 2024, limiting the scope for a bond market rally.   Business sentiment in contraction territory In spite of heatwaves and wildfires, the tourist season seems to have been strong in Europe. It has continued to support growth in the third quarter following a better-than-expected growth figure in the second quarter. However, with the end of the summer in sight, we're now beginning to see a more sobering economic outlook emerge. The composite PMI survey for August was certainly a cold shower, falling to the lowest level in 33 months at 47 points. While the figure has already been in contraction territory in industry for some time, it has now fallen below the boom-or-bust level in the services sector. Deteriorating order books weighed on confidence in both the manufacturing and the services sector, which also explains why there were job losses in manufacturing while hiring plans in the services sector were put on a slow burner. This will probably stop the decline in unemployment in the eurozone. Disappointing external demand A softer labour market might lead to higher savings rates, thereby countering the positive impact on consumption of rising purchasing power. At the same time, the much-anticipated export boost is unlikely to materialise as the US economy eventually starts to cool while the Chinese recovery continues to disappoint. Finally, with a rapidly cooling housing market on the back of tighter monetary policy, the construction sector is also likely to see a slowdown. All of this explains why we still don’t buy the European Central Bank's story that economic recovery will strengthen on the back of falling inflation, rising incomes and improving supply conditions. We expect the winter quarters to see close to 0% growth, resulting in 0.6% annual GDP growth for both this year and next year.   Cooling housing market is likely to weigh on construction activity   Inflation is coming down, slowly While inflation is clearly trending down, the pace might still leave the ECB uncomfortable. Industrial goods prices have started to fall, but services prices are still growing monthly above 4% in annualised terms. Negotiated wage growth seems to have reached a plateau just below 4.5%. Still, given the slow productivity growth (with the decline in hours worked as one of the important drags), final demand will have to be very weak to prevent higher wages from feeding into higher prices. We expect headline inflation to hit 2% by the end of 2024, but over the coming months, core inflation remains likely to hover around 5%. As the recent trend in underlying inflation is one of the key determinants of monetary policy, this would lead to an additional rate hike.   Loan growth is close to stalling The ECB's job is almost done With credit growth now close to a standstill and money growth negative, there remains little doubt that monetary policy is already sufficiently restrictive and that the monetary transmission mechanism is working. On top of that, the median consumer inflation expectation for the period three years ahead fell back to 2.3% in June. So, it looks as though the job is nearly done. For now, we're still pencilling in a final 25 basis point hike for the ECB's September meeting – but it's a very close call. A pause would likely mean the end of the tightening cycle, as the faltering recovery will make it harder to continue raising rates afterwards. While we see the first rate cut by the summer of 2024, we can't imagine the central bank loosening aggressively next year. In her speech at Jackson Hole, President Christine Lagarde mentioned a number of structural changes that make the medium-term inflation outlook more uncertain, and we think that the ECB will keep short rates relatively high for some time to come. That will probably limit the potential for the bond market to rally strongly in the wake of the expected economic stagnation later this year.    

US spending surges, but it’s not sustainable US consumer spending is on track to drive third quarter GDP growth of perhaps 3-3.5%. However, this is not sustainable. American consumers are running down savings and using their credit cards to finance a large proportion of this. With financial stresses becoming more apparent and student loan repayments restarting, a correction is coming.   Inflation pressures are moderating Today’s main data release is the July personal income and spending report and it contains plenty of interesting and highly useful information. Firstly, it includes the Federal Reserve’s favoured measure of inflation, the core Personal  Consumer Expenditure deflator, which is a broader measure of  prices than the CPI measure that is more widely known. It rose 0.2% month-on-month for the second consecutive month, which is what we want to see as, over time, that sort of figure will get annual inflation trending down to 2% quite happily.   Services PCE deflator (YoY%)   The slight negative is the core services ex housing, which the Fed is watching carefully due to if being more influenced by labour input costs. It posted a 0.46% MoM increase after a 0.3% gain in June so we are not seeing much of a slowdown in the year-on-year rate yet as the chart above shows. With unemployment at just 3.5% a tight jobs market could keep wage pressures elevated and mean inflation stays higher for longer so we could hear some hawkishness from some Fed officials on the back of this. Nonetheless, the market is seemingly shrugging this off right now given signs of slackening in the labour market from the latest job openings data and the Challenger job lay-off series.

US ISM reports remain consistent with GDP slowdown despite the construction boom Construction spending is performing strongly, but the ISM reports shows manufacturing has contracted for 10 consecutive months while next week's ISM services index is expected to post a headline reading consistent with the economy growing at a rate closer to 1% year-on-year rather than the 2.5% rate recorded in the second quarter.   ISM manufacturing index signals 10 months of contraction US ISM manufacturing index rose more than expected in August to stand at 47.6 versus 46.4 in July (consensus 47.0), but this is the tenth consecutive month it has come in below the break-even 50 level i.e. indicating contraction. The ISM surveys asks companies a range of questions on employment levels, orders, output, supplier delivery times and price pressures in order to come up with a broader picture of the state of the sector rather than measuring output alone such as in the industrial production report. The output index improved to 50 from 48.3, but new orders slipped back to 46.8. Prices paid moved higher to 48.4 from 42.6 but because this is below 50 it merely means that the rate of price declines are slowing rather than prices are moving higher. As such inflation pressures emanating from the manufacturing sector remain minimal and are consistent with goods consumer price inflation slowing closer to zero.     ISM reports suggest the economy is weaker than the GDP report has been signalling   Construction boom is a clear positive Meanwhile, construction spending rose 0.7% month-on-month versus the 0.5% consensus with June’s growth rate revised up to 0.6% from 0.5%. The housing market was a source of concern at the start of the year, but even with mortgage rates at 20-year highs and mortgage applications having halved, prices have stabilised and are now rising again nationally. Home supply has fallen just as sharply, with those homeowners locked in at 2.5-3.5% mortgage rates reluctant to sell and give up that cheap financing when moving to a different home and renting remains so expensive. This rise in property prices has boosted builder sentiment and lifted new home construction with residential construction rising 1.4% MoM in July after gains of 1.5% in June and 3.5% in May. Meanwhile, infrastructure projects under the umbrella of the Inflation Reduction Act are supporting non-residential construction activity, which posted the 14th consecutive monthly gain to stand 16.5% higher than 12 months ago.   Slower GDP growth ahead Construction is the stand out performer in the US right now, but next week's service sector ISM is predicted to slow to 52.4 from 52.7 and the combination of the two ISM series has historically been consistent with US GDP growth of 0-1% YoY, rather than the 2.5% the US posted in the second quarter (see chart). Just as the jobs report did earlier today, the ISM indices suggest little need for any further interest rate rises from the Federal Reserve.    

Labour shortages are mainly being driven by lower average hours worked Despite the fact that the eurozone economy has broadly stagnated, job creation remains strong and the eurozone labour market seems to be tighter than ever. The good news is that the unemployment rate has fallen to a historic low of 6.4% on the back of this. At the same time, eurozone enterprises now see labour as the largest supply-side problem hindering their business, and the ECB worries that the tight labour market will keep inflation above target for longer. Clearly, the labour market is one of the most important parts of the economy to watch at the moment. Strong economic recovery and ageing populations are often cited as the key reasons for labour shortages. What is often overlooked is the lower number of average hours worked per person that has occurred since the pandemic. While the ECB has previously written about it and President Christine Lagarde mentioned it in her Jackson Hole speech, the extent of the impact of this is very large. The average number of hours worked per person was fairly stable between 2013 and 2019. It experienced a large drop during the pandemic – which was mainly caused by the massive take-up of furlough schemes – but has never fully recovered since. While the recovery is still ongoing, the trend has slowed substantially. This means that more people are needed to do a similar amount of work. At the moment, this equates to 3.8 million more people employed than if everyone was working the average amount of hours they did in the years before the pandemic   The gap in average hours worked amounts to 3.8 million more people in work   This excess of 3.8 million workers equates to about two percentage points of unemployment, adding to a substantial easing of labour shortages. Of course, a lot of people would not have been looking for work in an environment that was not this exceptionally tight, however even using the Abel and Bernanke (2005) Okun’s Law estimate, we find that recent GDP growth should roughly correlate with an unemployment rate of 7.5%. This is by no means high, but it is high enough to not generate meaningful wage pressures, according to the European Commission’s natural unemployment rate estimate. So, the argument that the current economy is so strong that it causes labour shortages does not really hold up, especially given the fact that total hours worked have only just breached pre-pandemic levels. Ageing populations – which are expected to cause the active population to shrink over time – are also not a reason for current shortages, as the number of people at work and looking for work has never been higher than it is now. The main cause for shortages seems to lie in lower average hours worked.   An Okun's law estimate would currently put eurozone unemployment at 7.5%

Two different outcomes are possible, both with significant implications Since we don’t fully understand the workings of this, it’s hard to say what comes next. But both a recovery to the previous level of average hours worked per person and a stabilisation at the current level have serious implications for the eurozone economy, businesses and the European Central Bank. If it turns out that the recovery in average hours worked per person regains speed, the coming years will probably see easing labour shortages, but also higher trending unemployment as fewer people will be needed to reach the same hours worked. This would relieve wage pressures substantially. In turn, this would dampen overall household income and consumption, but it would not necessarily be triggered by any regular cyclical development. It means that the labour market would become less tight without a macroeconomic event causing it. If a recovery in average hours worked were to happen, it is very likely that most forecasters are underestimating this as it is something that models do not pick up on. That makes it likely that the ECB staff's macro projections – currently expecting a further drop in unemployment over the coming years – do not take these possible developments into account. If the average hours worked per person do not recover meaningfully from here, this means that there has been a permanent shift lower in total labour supply. This results in more permanent labour shortages and quicker wage pressures – like we are already seeing now – and therefore means that monetary policy should remain tighter compared to a situation where average hours worked are higher. Overall, the average output per worker being reduced means that potential output will be driven down at a time when demographic forces will start shrinking the labour force. A prospect that lowers GDP growth expectations for the medium term. Both possible outcomes will have profound implications for understanding the post-pandemic eurozone economy. It is therefore imperative that we gain a better understanding of what drives the downturn in average hours worked per person more precisely.

The previous trading week was filled with important events and reports. When looking at the range and movements of both instruments, one might wonder: why was it so subdued? It was reasonable to expect stronger movements and market reactions. To briefly recap, key reports from the United States turned out weaker than market expectations. Even the stronger ones left a peculiar impression. GDP grew by 2.1% in the second quarter, not the expected 2.4%. The ADP report showed fewer new jobs than expected. Nonfarm Payrolls reported more jobs, but the previous month's figure was revised downward. The ISM Manufacturing Index increased but remained below the 50.0 mark. The unemployment rate rose to 3.8%, which few had anticipated.     Based on all these reports, one might have assumed that it was time to build a corrective upward wave, but on Thursday and Friday, the market raised demand for the US dollar, so both instruments ended the week near their recent lows. So what can we expect this week?   On Monday, the most interesting event will be European Central Bank President Christine Lagarde's speech. On Tuesday, another speech by Lagarde, as well as Services PMIs of the European Union, Germany, and the United Kingdom. We can also expect speeches by other members of the ECB Governing Council. I advise you to monitor the information related to Lagarde's speeches. If she softens her stance, it can have a negative impact on the euro's positions. Wednesday will begin with a report on retail trade in the EU and end with the US ISM Services PMI. We can consider the ISM report as the main item of the week, although the ISM Manufacturing PMI that was released on Friday did not stir much market reaction. It is likely that the index will remain above the 52.7 mark, which is unlikely to trigger a market reaction. On Thursday, you should pay attention to the final estimate of GDP in the second quarter for the European Union. If it comes in below 0.3% quarter-on-quarter, the market may reduce demand for the euro. The US will release its weekly report on initial jobless claims. On Friday, Germany will publish its inflation report for August, and that's about it. There are hardly any important events and reports this week. Based on the conducted analysis, I came to the conclusion that the upward wave pattern is complete. I still believe that targets in the 1.0500-1.0600 range are feasible, and I recommend selling the instrument with these targets in mind. I will continue to sell the instrument with targets located near the levels of 1.0637 and 1.0483. A successful attempt to break through the 1.0788 level will indicate the market's readiness to sell further, and then we can expect the aforementioned targets, which I have been talking about for several weeks and months.     The wave pattern of the GBP/USD pair suggests a decline within the downtrend. There is a risk of completing the current downward wave if it is d, and not wave 1. In this case, the construction of wave 5 might begin from the current marks. But in my opinion, we are currently witnessing the construction of the first wave of a new segment. Therefore, the most that we can expect from this is the construction of wave "2" or "b". I still recommend selling with targets located near the level of 1.2442, which corresponds to 100.0% according to Fibonacci  

US service sector’s strong summer boosted by concerts and movies The US service sector ISM surprised to the upside in August and while not at very high levels is consistent with US growth accelerating in the third quarter. There are doubts as to how sustainable this will be, but the rise in the inflation component will keep hawks wary even if they do indeed go with the majority and vote for a pause on rate hikes in two weeks.   Entertainment drives a strong summer for services The US ISM services index was surprisingly strong in August, rising to 54.5 from 52.7. This is well ahead of the 52.5 consensus expectation and in fact above every single forecast submitted by economists, leaving the index at a six-month high. Activity improved to 57.3 from 57.1, new orders jumped to 57.5 from 55.0 while employment rose to 54.7 from 50.7, indicating broad-based strength throughout the report. It may well be that the summer entertainment boon has been a big factor with concerts and cinemas pulling in record revenues and ancilliary businesses feeling the benefits too. Nonetheless, as the chart shows, the headline reading is still at levels that would historically point to lower YoY GDP growth than the 2.5% recorded in the second quarter.   US ISM indices and US GDP growth (YoY%)   Inflation concerns to keep the hawks wary amid data uncertainty The prices paid component rising to 58.9 from 56.8 is a concern though and is likely to keep the hawks wary even if there does seem to be a consensus amongst Federal Reserve officials that it can afford to pause in September and assess the situation again in November. Interestingly S&P's PMI measure for services, also released this morning, told a very different story. The headline index dropped sharply to 50.5 from 52.3, indicating barely any growth with its employment measure weakening and its prices measure recording their lowest reading since February. Just shows you how tricky it is to get a clear reading of what is going on in the economy right now and reinforces the view that a pause at the September FOMC makes sense.

Rates Spark: Service sector oomph We continue to view the dominant market tilt as one point towards upward pressure on market rates. Resilience is the simplest explainer. It will give eventually, but has not done so as of yet. The latest US ISM services report pushes in the same direction.   Another ratchet up in US Treasury yields, and for good reason Another leg higher in US Treasury yields, this time driven by ISM services. New orders and prices paid in the high 50s were the standout contributors. An interesting outcome was the re-inversion of the curve as the front end began to raise the discount for one more 25bp rate hike. It’s still priced for no further hikes but has moved closer to a balanced probability. A more neutral to downbeat Beige Book later in the day tempered enthusiasm, but not by enough to materially take yields off their highs. It still appears to us that the marketplace is not getting a green light to re-test lower, and we continue to read the path of least resistance as pointing higher for market yields. The market discount for the funds rate is now up to 4.3% for January 2025. Remember that was at 2.5% when Silicon Valley Bank went down in March this year. The market continues to discount rate cuts, but nowhere near to the extent they once were. The US 10yr Treasury yield is also at 4.3% and does not look wrong there. There is still a greater likelihood that it heads to the 4.5% area than the 4% one in the weeks ahead. Ultimately there is much more room to the downside for yields when something actually breaks, but for now, things are very much holding together – or at least there is enough constructiveness in the service sector to support ongoing elevation in official rates and market yields.   Resilience keeps the Fed discount elevated   Today's events and market views The goldilocks scenario is a narrow path; things can easily break precipitating a sharper downturn, or stay too hot and keep inflation elevated. The services ISM moved the needle a little to the latter scenario, bear flattening the curve as markets also pushed the implied probability for a Federal Reserve hike before year-end to 50%. The Fed Beige Book however was more downbeat, arguing for a Fed pause this month. Today’s calendar features the weekly initial jobless claims data, a more contemporaneous read of job market conditions than the payrolls data. Markets will also be confronted with another busy slate of Fed speakers.     In Europe, we will get the final reading for second quarter GDP growth. The list of scheduled European Central Bank speakers is long, but the black-out period has started. Yesterday Klaas Knot suggested markets were underestimating the chances for a hike this month, nudging rates higher to now discount a one-in-three chance.   A greater focus will be on the Bank of England publishing the results of the decision-maker panel survey on price expectations. Yesterday Governor Andrew Bailey remarked the Bank was probably “near the top of the cycle”, causing markets to pare their hike expectations. Two more hikes are fully priced, but we think chances still are we get one less.   In government bond primary markets, France and Spain will be active with auctions. Source: Refinitiv, ING

French industrial output rebounds in July French industrial production rebounded in July, almost wiping out June's decline. Looking ahead, the outlook for French industry remains very weak, against a backdrop of a sharp slowdown in demand. Very weak GDP growth is expected over the next few quarters.   Rebound in July, erasing June's decline French industrial production rebounded in July, increasing by 0.8% over the month, following a 0.9% fall in June. Manufacturing output rose by 0.7%, compared with -1.1% in June. Output is therefore back to its May level, thanks to a rebound in production in the pharmaceuticals, wood, wood and paper industries, as well as in mining and quarrying. Energy-intensive industries therefore seem to be seeing their output stabilise, thanks to lower gas prices, albeit at a low level. These sectors are still producing much less than they did a year ago (-40% for steel, -20% for paper and cardboard and -10% for basic chemicals). Still benefiting from a catch-up effect following the normalisation of the situation in supply chains, automotive manufacturing continues to recover (+2.8% over the month). Conversely, the manufacture of capital goods is suffering from the global economic slowdown in the manufacturing sector (-0.6% in July after -1.8% in June).   Pessimism among manufacturers Looking ahead, the outlook for French industry remains poor. The August business climate survey points to greater pessimism among French manufacturers, who see the outlook for production deteriorating and order books shrinking. Lack of demand has once again become the most important production constraint for manufacturers, ahead of supply problems and labour shortages. While certain catch-up effects could continue to have a small positive impact on French industrial production over the coming months, industry is nevertheless likely to continue to suffer from the global slowdown.     Several quarters of very weak growth expected As far as France's economic outlook is concerned, the rebound in industrial production in July is good news for third-quarter GDP. Household consumption of goods also rose over the month, so the third quarter has got off to a good start. Added to this is the very good tourist season in France this summer, which should boost growth. Today's data therefore suggests that French GDP will not contract in the third quarter. Nevertheless, the confidence indicators for August were disappointing, so the activity data is likely to be weak. This means that strong growth over the quarter is unlikely. With interest rates high, inflation only slowly coming down and the global economic slowdown, the following quarters are likely to be synonymous with virtual stagnation. Ultimately, we are expecting average GDP growth of 0.8% in 2023 and 0.6% in 2024. This figure is much lower than the very optimistic assumption on which the government based its 2024 budget (+1.4% for GDP in 2024), which heralds some complicated budget discussions ahead.

Instead of declining, the US ISM Services PMI rose to 54.5 in August from 52.7 in July. The report recorded growth in all key parameters – employment, new orders, and even prices. Apparently, increased levels of consumer spending had become the main reason for the rise, but the question of whether consumer activity will remain high in the coming months remains debatable. The US ISM data contrasts with the rest of the world, as similar gauges in China, the eurozone, and the UK, showed a decline, and the market interprets the results in favor of the US dollar.   Take note that the final reading from S&P Global Business on the US services sector PMI was slightly lower than the preliminary one - 50.5 vs. 51.0, which sharply contradicts the ISM readings. This imbalance will be resolved next month. The Federal Reserve's Beige Book showed that economic and labor market growth slowed in July and August, while many businesses expect wage growth to slow down in the near future. Here, too, we see a discrepancy with the ISM assessment, especially in light of the Fed's policy of restraining consumer demand as one of the key factors in inflation.   The GDPNow model estimate for real GDP growth by the Federal Reserve Bank of Atlanta in the third quarter of 2023 is 5.6 percent on September 6. Take note that this is a very high figure.   In summary, the general fundamental story suggests that the US is still a bit stronger compared to the rest of the world, and this will be the catalyst for the dollar strength, which remains the primary favorite in the currency market.   USD/CAD As anticipated, the Bank of Canada held its key overnight interest rate unchanged at 5%. Therefore, changes in policy are deferred to the next meeting on October 26, where, among other things, forecasts will be updated. In the accompanying statement for the July 12 meeting, it was stated that the rate was raised due to accumulation of evidence that excess demand and elevated core inflation have proved to be persistent. This time, the wording has been changed to a more neutral tone: "With recent evidence that excess demand in the economy is easing, and given the lagging effects of monetary policy...". This implies that the BoC believes that the measures taken earlier are yielding results and no changes are needed. Only time will tell whether this is really the case, but one thing is clear – the Canadian dollar has become more susceptible to further weakness. At least, concern about the persistently high core inflation was specifically emphasized. At the moment, the probability of a rate hike in October is estimated at 25%, which is too little for a bullish revision of CAD forecasts. The net short CAD position increased by 0.3 billion to -1.2 billion over the reporting week, indicating bearish positioning. The price is significantly above the long-term average, and there are no signs of a reversal. USD/CAD continues to gradually rise. The pair has reached the nearest target that we mentioned in the previous review, and it appears that it will eventually test the upper band of the 1.3700/20 channel. It is likely for the pair to break above the channel, with 1.3857 as the medium-term target. From a technical perspective, after testing the upper band of the channel, we can expect a retracement towards the channel's midpoint. However, fundamental indicators suggest further growth.      

Higher-than-expected Romanian inflation is not as bad as it looks At 9.4%, August inflation came in higher than expected but can be largely blamed on one item: drug prices. These increased by a whopping 20.8% versus the previous month. On the bright side, core inflation dropped by 1.1pp versus July, to 12.1%, and looks on track to reach single digits this year. August inflation in Romania was higher than anticipated, as we expected the headline print to be 8.70%. The forecast error on our side came almost entirely from a single item – drug prices – which advanced by 20.8% versus July and added 0.82pp to the headline figure, versus an assumption of flat prices. This has pushed the non-food items to increase by 2.43% compared to the previous month, the strongest acceleration in the last 16 months. Assuming flat drug prices, the increase would have been 0.89% – still the highest in 2023, due to the recent increase in fuel prices. Otherwise, price dynamics in the other sectors largely matched our expectations. Food prices dropped by almost 2pp versus July on seasonal items and the effect of the government ordinance which caps the mark-ups on basic food products. The latter is scheduled to expire in November, although talks about it being prolonged are already underway. Service inflation decelerated to 0.44% month-on-month, the lowest increase in the last 12 months.] Headline and core inflation converge in 2024   At 12.1%, the core inflation print confirms our view that it will reach single digits this year, most likely in November and could even dip below 9.0% in December. The outlook for 2024 remains largely unchanged, as the core is likely to stay above the headline, though the spread will get narrower and could reach zero around mid-2024.   Today's data are not as bad as the headline number suggests. Capping the mark-ups on basic food items seems to be working, services inflation looks to be softening, and even wage growth appears to be moderating slightly. Moreover, the economy is clearly decelerating, and we have recently re-confirmed our below-consensus GDP growth forecast of 1.5% in 2023. We maintain our forecast for inflation to reach 6.9% in December 2023 and 4.0% in December 2024. From a monetary policy perspective, we still believe that rate cuts can be excluded this year. The start of the easing cycle should come in the first quarter of next year, with a total of 150bp cuts by the year-end. This might be done alongside the gradual restriction on liquidity conditions in the interbank market, as the current surplus is likely not giving a lot of comfort to the National Bank of Romania. We therefore still expect that pressure on the EUR/RON will be used as an opportunity to mop up some of the excess liquidity, hence the upside room for EUR/RON still looks limited in the short term.

ECB hikes by 25bp and signals end to hiking cycle Another rate hike of 25bp from the European Central Bank, but a clear signal that the current hiking cycle has come to an end. These are the main takeaways from today’s meeting The fear of not getting inflation fully under control and the risk of stopping too early must have outweighed concerns around the rising recession risk in the eurozone, motivating the European Central Bank to hike interest rates for the tenth consecutive time since July 2022. After a total of 450bp rate hikes, the ECB’s deposit rate is now at a record high.   ECB's staff projections point to too high inflation and lower growth The ECB remains highly concerned about inflation, not only actual inflation but also future inflation. The newest ECB staff projections show headline inflation coming in at 3.2% in 2024 and 2.1% in 2025. However, the upward revision for 2024 is mainly the result of higher energy prices. The inflation forecast for 2025 was revised downwards. The ECB’s core inflation forecasts were slightly revised downwards to 2.9% in 2024 and 2.2% in 2025. Still, in the eyes of the ECB, both headline and core inflation above 2% in 2025 is not compatible with its own definition of price stability. It was not so much the direction of the revisions but rather the absolute levels and the long period of deviating from the target which motivated the ECB’s decision today. The ECB’s staff projections for eurozone GDP growth were also revised downward to 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025. However, the downward revision for 2024 is purely the result of carry-over effects and the quarterly profile for 2024 remained unchanged, showing a return to potential growth from the second quarter of 2024 onwards. The ECB is still sticking to the view of a temporary slowdown and not of more structural growth weakness.   Dovish rate hike as a compromise The staff projections have probably increased the ECB’s dilemma: inflation, while coming down, remains too high but the growth outlook continues to deteriorate. With this macro backdrop, both a rate hike and a pause would have been plausible. This time, the ECB decided to compromise: a dovish hike, mainly aimed at strengthening credibility and probably bridging growing divergences between ECB hawks and doves. In this regard, one remark in the official communication is key: “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target”. Given the imprecision of the ECB’s own models over the last few years, it is questionable how the ECB has now come to the conclusion that the current level is enough. Why not 25bp less? Why not 25bp more? During the press conference, ECB President Christine Lagarde hinted at different views within the Governing Council. According to Lagarde, today’s decision was taken with a “solid” majority. A dovish hike as compromise to balance between credibility, inflation, growth and team spirit.   The final hike Looking ahead, the ECB would be crazy to completely rule out further rate hikes. Inflation has simply taken too many unexpected turns and the ECB has been wrong too often in the past. This is why today’s meeting still leaves the possibility of picking up hiking at a future stage. However, such a scenario is highly unlikely. A further weakening of the economy and more traction in a disinflationary trend will make it very hard to find arguments for additional rate hikes any time soon. For now, the ECB is determined to keep rates where they currently are, waiting for the 450bp of total rate hikes to filter through to the economy. The next discussion will be on how long the new “high for longer” can be sustained. Even if the door to future rate hikes remains open, today’s rate hike will soon be remembered as the final hike of the ECB’s most aggressive rate hike cycle in history.

US housing feels the squeeze from high mortgage rates A tripling of US mortgage rates constrained both the demand and supply of housing, leaving existing home sales at post-GFC lows. Mortgage rates will rise further in the wake of the market's reaction to yesterday's Fed forecasts, further constraining activity.   Market acknowledges the risk of a final hike, but it will depend on the data The Fed's messaging of higher for longer interest rates has been taken on board by financial markets, with the dollar strengthening and the yield curve shifting higher in the wake of yesterday's decision. Nonetheless, the market remains somewhat sceptical on the prospect of the final 25bp interest rate rise that the Fed's forecasts signalled for this year, with the pricing for November's FOMC meeting only being 8bp with 13bp priced by the time of the December meeting. The jobs market remains tight, as highlighted by low jobless claims numbers today, but we continue to believe that core inflation pressures will slow meaningfully, the economic outlook will soften, and the Fed won't end up carrying through. The jobs market is always the last thing to turn lower in a downturn and there are areas of more obvious weakness.  For example, US existing home sales fell 0.7% MoM in August to a level of 4.04mn rather than rising the 0.7% MoM as the market expected. This is due not only to weakness in demand but also a complete collapse in properties available for purchase. The affordability issue is front and centre here, with prices having risen nearly 50% nationally during the pandemic, but demand has obviously been crushed by the fact that mortgage rates have tripled since the Federal Reserve started hiking interest rates. But this surge in borrowing costs is constraining the supply of homes for sale as well - people who are locked in at 2.5-3.5% mortgage rates cannot afford to give them up. They can't take the mortgage with them when they move home, so even if you downsize to a smaller, cheaper property, you are, in all likelihood, going to end up paying a higher monthly dollar mortgage payment.   We're in a crazy-sounding position Consequently, we are in a crazy-sounding position whereby the number of housing transactions is on a par with the lows seen during the global financial crisis, yet home prices are rising. This should be a boon for home builders, but note the big drop in sentiment and housing starts seen earlier in the week. The drop-off in prospective buyer traffic is making builders cautious. Mortgage rates at 7%+ will obviously do that over time, but it may be another sign of the household sector starting to pull back at the margin now that the Fed believes pandemic-era savings are close to being exhausted.   Existing homes sales transactions and home prices   Leading index still indicates recession can't be ruled out Meanwhile, the US leading economic indicator, which combines a range of other numbers, including jobless claims, orders, average work week, the yield curve and credit conditions, posted its 17th straight monthly decline. As the chart below shows, the index at these sorts of levels has been a clear recession indicator in the past, but for now, GDP growth is strong.   Leading index versus GDP (YoY%)   Our view remains that this strength in activity has been caused primarily by households running down pandemic-era accrued savings aggressively and borrowing more on credit cards. But with savings obviously being finite - note the Fed's Beige Book citing evidence of the "exhaustion" of these savings - and consumer credit harder to come by and certainly less affordable than it was, the cashflow required to finance ongoing increases in spending will have to increasingly come from rising real income growth. Rising gasoline prices will erode spending power while student loan repayments, strikes and the prospect of a government shutdown will add to the financial stresses on millions of households, so we will need to see substantial wage increases for everyone - not just auto workers - to keep this growth engine firing.  Given this situation, we not only think the Fed will leave rates at their current levels, we also see the potential for more rate cuts next year than the 50bp currently being signalled by the Federal Reserve.

Why India is bucking the global slowdown trend India is the fastest-growing major economy this year. While others in the region look to be struggling, there are few clouds on the horizon for India. Inflation is high, but falling, and the rupee is one of the strongest currencies in the region, which will be further helped as Indian government bonds are set to be included in global indices next year.   Economic growth - firming, not stalling In the second quarter, India recorded a growth rate of 7.8% YoY, which was a marked increase over the 6.1% rate of growth recorded for the first quarter. This makes India the fastest-growing major economy in the world and leaves growth on track to achieve 7% for the full year. India’s growth momentum is in stark contrast to the rest of the Asia Pacific region, where economic growth is generally slowing – a response to the slowdown in the West, and more importantly in recent months, to the slowdown in China, topped off with weakness in the global semiconductor industry, which is an important driver for many regional economies. Growth is coming mainly from domestic demand and is spearheaded by capital investment. This bodes well for future growth too, with investment likely to raise India’s non-inflationary growth potential. Net exports aren’t helping much, but weaker imports have helped offset falling exports.   Contribution to GDP growth (pp)   Household consumption is also holding up well too, helped by improvements in the labour market, falling unemployment, rising labour participation, and falling inflation. Government spending is not directly adding anything to growth, but as we shall shortly explain, indirectly, targeted spending is helping.   India unemployment rate and labour force

French growth slows sharply despite a rebound in domestic demand French GDP growth slowed markedly in the third quarter, coming in at 0.1% quarter-on-quarter, compared with +0.6% in the second quarter. The details of the figures are solid, with domestic demand rebounding strongly. Nevertheless, the French economy is facing a significant economic slowdown that is likely to persist over the coming quarters.   Weak growth In line with expectations, French GDP growth slowed sharply in the third quarter to 0.1% quarter-on-quarter, following an upwardly revised 0.6% rise in the second quarter. Despite the sharp deceleration in growth, the details of the figures are fairly solid, with domestic demand accelerating and making a very positive contribution to GDP growth (+0.7 points compared with +0.2 points in the second quarter). Household consumption grew by 0.7% over the quarter, after stagnating in the previous quarter, thanks to a rebound in the consumption of capital goods, transport equipment and food. Consumption of services slowed. Investment also accelerated sharply in the third quarter (+1.0% compared with +0.5% in the second quarter), particularly in manufactured goods and information and communication services. However, construction investment stagnated over the quarter. The weak growth in GDP in the third quarter can be attributed to foreign trade, which made a strongly negative contribution (-0.3 points) due to a fall in exports that was greater than that of imports. While inventories were the main contributor to growth in the second quarter (+0.5 points), the situation has reversed, and they are now making a very negative contribution to economic activity (-0.3 points). In short, while the details are fairly good, they do not alter the reality that the French economy is facing a major economic slowdown, and this is likely to continue.    The slowdown is likely to continue The construction sector, for its part, is likely to see its activity continue to weaken due to higher interest rates which are having an increasing impact on demand for credit. The dynamism of household consumption is also likely to moderate over the coming months. While nominal wages have risen, allowing households to regain some purchasing power, the labour market is beginning to show the first signs of weakening, consumer confidence remains low and inflation remains rather sticky. Recent rises in oil prices linked to geopolitical tensions will keep energy inflation buoyant in France until the end of the year and into 2024, which will weigh on purchasing power and limit consumer spending. Retail and services are therefore likely to face weak demand. Ultimately, the French economy is likely to slow further in the fourth quarter. We expect GDP to stagnate over the quarter, which would bring average growth for 2023 to 0.8%. We believe that the recovery in 2024 will be slow, weighed down by a sharp global economic slowdown and by monetary policy that remains very restrictive. Given the low starting point for the year, average growth in 2024 is likely to be weak, and well below the government's forecast of 1.4%. Our forecast for average French GDP growth in 2024 is 0.6%.

Rates Spark: Don’t dismiss the remaining yield upside just yet The US borrowing estimate and the BoJ were not the drivers of another leg higher in rates as many had feared. While it's unlikely to be the end of the supply story and we still await the quarterly refunding announcement, markets will also focus on the data and the Fed meeting again. After all, economic resilience was the other factor of higher rates.   The long end took its cues from lower US borrowing and more cautious tweaks from the BoJ Long-end rates took their cues for yesterday’s trading from the somewhat lower-than-expected US Treasury borrowing estimate as well as the Bank of Japan (BoJ) decision to only slightly adjust its yield curve control policy. In essence, two of the factors that many, including us, had seen as potential drivers of a renewed attempt at taking on the 5% threshold in 10Y UST yields proved to be duds. The UST curve kicked off with a bull flatteneing which also spilled over into other rates markets.   However, especially with a view on supply it is unlikely to be the end of the story. Markets are still awaiting the quarterly refunding announcement and the maturity split of the upcoming issuance today. Some had flagged the possibility of a more cautious approach focusing any increase on shorter-dated issues. But following the lower borrowing requirement, the US Treasury might feel less pressed on this topic. More importantly, the overarching concerns surrounding the medium- to long-term trajectory of the US deficit have not been addressed.   US economic resilience remains an important factor in keeping rates elevated as well Yesterday’s quarterly employment cost index rising to 1.1% should also remind us that the other important driver of higher long-end rates was the resilience of the economy and the job market in particular. It was in fact the faster wage growth figure managed to turn around the bullish dynamic yesterday and point yields higher again. The Federal Reserve has guided markets to firmly expect a hold at tonight’s FOMC meeting despite the more benign inflation backdrop, third-quarter GDP growth coming in hot, the jobs market remaining tight and inflation remaining well above the 2% target. But it has done so by pointing out that the higher long-end rates are now doing part of its job. That said, European rates markets were confronted with a more dovish data set as the eurozone flash CPI slipped below 3% and 3Q GDP growth came in with a negative sign. Yesterday's bull flattening was probably still more inspired by the overall direction given US and Asian events rather than the domestic data. That said, European Central Bank (ECB) officials are still attempting to anchor front-end rates by emphasising the outlook of keeping rates high for longer.     The US yield increase is stalling, but curves remain steeper   Today's events and market view The BoJ and US borrowing announcements have proved more benign for rates than anticipated with the 10Y UST yield dropping towards 4.8% before moves were reversed in month-end flows. Especially on the supply side, it is unlikely to be the end of the story with the refunding announcement coming today. But economic resilience should also not be dismissed as a potential driver of another leg higher in rates. To that end, we will get the  ADP payrolls estimate today ahead of the key jobs data on Friday. Also on today’s agenda are JOLTs jobs opening numbers as well as the ISM manufacturing. The key event for the day is the FOMC meeting tonight, although a hold has been well-flagged. The Fed is still likely to keep its bias for further tightening in place.  All Saints Day is observed in large parts of Europe. In today’s government bond primary markets, Germany will tap its 7Y bond for €3bn

German industrial production disappoints once again Another disappointing data release not only suggests that third-quarter GDP growth could be revised downwards, but also that the country is likely to end the year in a technical recession. Germany’s macro horror show continues, and we are almost getting to the point where kids ask their parents where they were the last time Germany produced a series of positive macro data. Today’s industrial production data is unfortunately no exception to the longer-lasting trend. German industrial production dropped once again in September for the fifth consecutive month. On the month, it was down by 1.4% from -0.1% month-on-month in August. For the year, industrial production was down by 3.7%. The drop in industrial activity was spread across all main sectors. Industrial production is now more than 7% below its pre-pandemic level, more than three years since the start of Covid-19. Production in energy-intensive sectors was more than 8% down compared with September last year.   Risk of ending the year in technical recession remains high Looking ahead, leading indicators in October don't bode well for future production. After a first stabilisation in September, production expectations and survey-based order book assessments weakened again in October. Inventories have started to come down somewhat but remain too high. Yesterday’s industrial orders data for September confirmed the weak outlook. It all looks as if German industrial production will continue moving sideways rather than gaining momentum anytime soon. With today’s data, industrial production would have to increase by at least 2% MoM in the coming months to bring production back into positive territory in the fourth quarter. Even though there isn’t any hard data for the fourth quarter yet, recent developments have clearly increased the risk that the German economy will end the year in recession.

China’s trade surplus shrinks in October A continuation of weak exports could weigh on the contribution of trade to GDP growth in the fourth quarter, though there could be a more positive story emerging about domestic demand buried in the import data. At this stage, it is too difficult to draw firm conclusions and more data is needed.   Trade figures raise more questions than they answer China's October trade surplus shrank to CNY405.47bn from CNY558.74bn in September. The cause was a combination of weaker exports (-3.1% year-on-year in Chinese yuan terms, down from -6.2% in September) and stronger imports (+6.4%, swinging up from -0.8% in September).  Ordinarily, the weaker export figure would not bode too well for the contribution to GDP from net exports, and it certainly indicates that overseas demand for China's exports remains weak.  Conversely, the import figure suggests that domestic demand may not be as weak as indicated by, for example, the recent run of PMI numbers. Though this raises the question, which data do you put more weight on?    China commodity imports (YoY YTD %)   Data distortions make interpretation difficult It is tempting to try to dissect these trade figures to try to figure out what is actually going on. But even using year-on-year cumulative figures runs the risk of distortions caused by lockdowns at the end of last year in China, and our best advice at this stage is to reserve judgment on what is happening and wait to see what next month's data bring before conjuring up some fanciful explanation for what happened this month. Even looking at the figures in terms of volume levels runs risks as these numbers are also highly seasonal.  For those who are prepared to stomach these problems, the chart below of imports of crude materials suggests that in fact, this month, nothing particularly exciting took place.   In year-on-year year-to-date terms, the chart shows that imports of iron and copper ores and concentrates, together with crude oil and natural gas are all growing, though not trending particularly strongly.  Earlier inventory building for crude may account for some of the current strength in oil, and the same is also probably true for natural gas as we head into the colder winter months.   Imports of copper and iron ore and concentrates have held fairly steady in these terms at about 8.5% YoY YTD in recent months, which is probably a bit more than the state of manufacturing or construction would indicate, so there may be a more positive story brewing here. However, we think it is too soon to draw any firm conclusions in the face of such conflicting numbers, and this month's figures aren't really out of the ordinary compared to recent months either.  Not shown here are imports of refined petroleum, which are running at a 95% rate of growth, though mainly due to increases in export quotas for similar products, and coal imports are also running strongly, though the rate of increase looks to be slowing.    No change to our GDP forecasts for now Until we get a better idea of what is happening here, we are not going to be revising our GDP figures for the year, which we recently revised higher to 5.4% for full year 2023. Whether there are the beginnings of a trade-off building between a weaker external environment and a firming domestic economy is an appealing hypothesis, but one that does not have enough support for now to run as a central forecast. Further data is needed.

The French labour market weakens still further France's unemployment rate rose in the third quarter to 7.4% of the active population, confirming the weakening of the labour market. And that weakening is set to continue in the coming months due to weak growth and the rise in the active population.   Unemployment rate up more than expected France's unemployment rate rose slightly more than expected in the third quarter to 7.4% of the active population. This represents an increase of 0.2 points over the quarter, or 64,000 more unemployed people. The unemployment rate nevertheless remains well below its pre-pandemic level (8.2%). The employment rate also fell slightly over the quarter, by 0.2%, to 68.3% of people aged 15 to 64. The decline was most marked in the 50-64 age group. This data confirms that the labour market is indeed weakening in France and that the weakening is even happening a little faster than expected. This is probably a turning point. For two years, employment growth in France had been much more dynamic than economic growth. Now, weak growth (French GDP rose by 0.1% in the third quarter) and a gloomy outlook appear to be leading to a weakening of the labour market. What's more, the leading indicators suggest that this is only the beginning of a rise in unemployment, which is likely to continue over the coming quarters. Payroll employment in the private sector fell in the third quarter, and hiring intentions are down in most sectors, signalling that the decline in the workforce could continue. Temporary employment, generally considered to be a good leading indicator of the labour market as a whole, fell sharply and is now back below its pre-pandemic level. In addition, the lack of labour is much less of a constraint on production for companies in all sectors than it was a few quarters ago. Added to this is the expected impact of pension reform on the active population. With the increase in the retirement age, older people will be working longer than before, and a marked increase in the active population is therefore expected in 2023 and 2024 (the effect of the reform on the active population being estimated at 0.2 points in 2023 and 0.4 points in 2024). There would have to be a very strong dynamic of job creation for such an increase in the active population not to lead to an increase in the unemployment rate. However, under current conditions, job destruction is more likely in the coming quarters.   Unemployment will continue to rise, limiting the rebound in consumption in 2024 Ultimately, the unemployment rate will probably continue to rise in France. We are forecasting an unemployment rate of 7.6% at the end of 2023 and 7.9% at the end of 2024, which would be a significant step away from the government's target of 5% for 2027. Although significant, the scale of the expected rise in the unemployment rate remains limited given the economic slowdown, and unemployment should remain below its pre-pandemic level. In terms of growth prospects, the weakening of the labour market is likely to weigh on household purchasing power, but this impact will probably be offset by the expected rise in real wages in the context of lower inflation. The downward impact on household consumption should, therefore, be limited. Nevertheless, the weakening labour market will probably prevent a dynamic rebound in consumption in 2024. We expect GDP to grow by 0.9% in 2023 and 0.6% in 2024.  

China: People’s Bank of China (PBoC) injects more cash to support the weak economy Despite leaving the one-year medium-term lending facility (1Y MLF) at 2.5%, the PBoC injected a net CNY600bn (over and above amounts falling due) to help support stimulus spending, raising thoughts that perhaps they may also tap other policy tools such as required reserves in due course.   More funding will help activity to recover Ahead of the monthly deluge of activity data, the PBOC already provided markets with a positive surprise. Despite leaving the 1-year medium-term lending facility (1Y MLF) rate at 2.5%, the PBoC provided CNY1.45tr in funding, a net CNY600bn more than that which was falling due for rollover. The MLF is the conduit through which the PBoC lends funds to big commercial banks, who in turn, finance the rest of the economy. Short-term market interest rates have risen since September, as the CNY has weakened in the face of a stronger USD, and the PBOC has kept short-term funding costs high to deter CNY selling. However, this has also resulted in a bit of a liquidity squeeze, and it now looks as if the PBoC is looking to sidestep the unhelpful rate environment and alleviate liquidity issues by turning to volume lending instead.  In so doing, it raises thoughts that similar liquidity-enhancing policies, such as the rate of required reserves (RRR), might also be tapped in the coming weeks and months, as the government looks to support economic activity, without resorting to large direct fiscal stimulus measures, or to rate cuts, which could send the CNY weaker. The last cut in the RRR was back in September when the rate for banks was cut by 0.25%.    Activity data - mostly stronger except for anything property related The run of activity data again suggested further modest progress in China's recovery, though once again, there was a divergence between general activity, which moved forward, and anything property-related, which continued to flounder.  The year-on-year growth rate for retail sales moved from 5.5% to 7.6% YoY, and well above the 7.0% rate expected. But year-to-date year-on-year measures, which may be less whipped around by last-year's pandemic-related distortions, showed a smaller improvement from 6.8% to 6.9%.  Industrial production also showed gains, rising to 4.6%YoY (from 4.5%) and 4.1% YoY ytd (from 4.0%).  There was less good news for fixed asset investments, which slowed to 2.9% YoY ytd, from 3.1%. And property investment declined at a faster pace of 9.3% (from -9.1%) while residential property sales also fell slightly faster (-3.7% down from -3.2%).  The surveyed unemployment rate remained 5.0%, though we don't know what is happening to youth unemployment since the figures stopped being published. It most likely remains extremely high.    The economy is still struggling Taking all of the data together, the general sense is that things are moving slowly in a more positive direction, but that the economy still needs the liquidity support that the PBoC seems to be starting to provide, and the slightly more helpful fiscal stance that the central government is taking. We don't expect the external environment to improve meaningfully.  The US may be weathering high interest rates for now, but we suspect that won't last. And Europe is skirting recession, with little prospect of an upturn.  Moreover, while the property sector continues to struggle, which we expect will be the case for some considerable time, the spillover effects to the rest of the economy are likely to keep overall growth rates tepid. The government's 5.0% GDP growth target is not under threat any more. But it was always a very unambitious target.   

Pipeline pressures support the US soft landing view After yesterday’s big reaction to the benign CPI data, which saw risk assets rally hard and the dollar come off as interest rate expectations fell sharply, it is the turn of retail sales and producer price inflation today. It once again feeds the soft landing narrative with subdued price pressures and resilience in activity. Last month, US retail sales surprised to the upside, rising 0.7% month-on-month despite credit card transaction numbers looking weak and we get a repeat of that for today’s October report. Headline retail sales fell 0.1% MoM, but this was better than the 0.3% drop expected, while September’s 0.7% initial print has been revised up to 0.9% MoM growth. The details show motor vehicle sales fell 1%, which tallies with the drop in unit sales reported by manufacturers while furniture sales dropped 2% MoM – the fourth consecutive monthly decline, which is consistent with the collapse in housing transactions on the basis that when you move home buyers tend to also buy a few new items. Gasoline station sales fell only 0.3% MoM despite the price of gasoline plunging while department stores and miscellaneous stores had a tough month with sales down more than 1% MoM. On the positive side it was a good month for health & personal care (+1.1%) while groceries and electronic both rose 0.6% MoM. Clothing was flat on the month and non-store (internet) rose 0.2%. Therefore the control group, which better matches the trends of broader consumer spending via removing volatile items such as autos, gasoline, building materials and eating out, came in at +0.2% MoM as expected. This indicates decent resilience and supports our view that fourth quarter GDP growth may not be as weak as the consensus is currently predicting – consensus is currently predicting 0.7% annualised 4Q GDP growth while we are forecasting 1.5% GDP growth.   WoW change in credit card spending   There will no doubt be some scepticism of the resilience in retail sales given the credit card spending numbers have been so soft over the past couple of months – are we all really returning to cash? But this is the life of an economist at the moment – data inconsistencies everywhere.   PPI shows weak pipeline price pressures Meanwhile, pipeline inflation pressures as measured by PPI are very soft with headline producer prices falling 0.5% MoM versus +0.1% consensus while core (ex food & energy) was flat on the month (0.3% consensus). This means that the annual rate of producer price inflation has slowed to 1.3% year-on-year from 2.2% while core is at 2.4% versus 2.7% previously. With wage growth looking more subdued amidst rising productivity growth, it reinforces our view that we will start consistently getting 2% CPI YoY prints at some point in the second quarter of  2024, giving the Federal Reserve the ability to respond to any eventual economic weakness with interest rates cuts.   Import prices, PPI and CPI (YoY%)

Retail sales and construction point to signs of recovery in Poland Retail sales showed the first signs of annual growth since January, rising by 2.3% YoY. Construction output also expanded by 9.8% YoY, pointing to a solid start to the fourth quarter for the Polish economy. This recovery should continue on the back of reviving private and public consumption, and in 2024, GDP could grow by around 3%.   A solid start to the fourth quarter for retail sets the stage for consumption bounce back Retail sales of goods rose by 2.8% year-on-year in October (versus our expectations of 2.3% and the consensus view of 1.4%) after shrinking by 0.3% YoY a month earlier. This was the first increase in goods sales in real terms since the turn of 2022/23. The seasonally adjusted data showed the fifth consecutive month of sales growth. The highest double-digit increases were recorded in fuel sales (16.7% YoY) and car sales (12.3% YoY). Weakness persisted in sales of durable goods other than auto. Double-digit declines were recorded in the furniture, consumer electronics, and household appliances category (-10.9% YoY) and in the group comprising newspapers, books and other sales in non-specialised shops (-11.1% YoY).   Retail sales turned positive again after months of declines Retail sales of goods, %YoY   The start of the fourth quarter of this year is encouraging for the retail trade. The recovery of real household disposable income is continuing. In October, real wages in the corporate sector increased by nearly 6% YoY. Consumer sentiment – including willingness to make major purchases – has been steadily improving since the beginning of the year. We expect the fourth quarter to see a year-on-year increase in household consumption, with a further rebound continuing into 2024. Next year, economic growth should reach 3%, driven mainly by private and public consumption growth. Private consumption would be supported by an increase in real disposable income due to lower inflation, while public consumption would benefit from high valorisation of social benefits (with more than 800 pensions) and planned salary increases in public services and administration.   Construction output growth still close to double-digits Construction output jumped up by 9.8% YoY in October after 11.5% in September, slightly below the market consensus of 10.5%. The annual growth was supported by a higher number of working days (22 vs. 21 a year earlier) and favourable weather conditions for construction activity (the average air temperature was 10.9˚C, 2.1 ˚C higher than the multi-year average for that month). On a monthly basis, output rose by 2.5% MoM after 11.4% in September, although on a seasonally adjusted basis, it fell by 1.1% MoM.   Almost double-digit growth in construction Construction output, %YoY

Eurozone is likely in a shallow technical recession The November PMI does not provide much evidence that eurozone GDP growth will turn positive in the fourth quarter, but the good news is that the downturn is not deepening. We’re currently likely in a very shallow technical recession. The eurozone composite PMI ticked up from 46.5 to 47.1 in November, which still indicates a contraction in business activity. New orders continue to fall as backlogs of work are being depleted. This is more so the case for manufacturing, where the downturn is deeper than for services. Still, new orders fell slightly less in November than in October. This confirms the view that the downturn is not worsening at the moment, but there is little evidence of recovery either. Overall, it looks like this is a shallow technical recession. The employment outlook continues to deteriorate. Services job growth had kept overall employment growing up till now but the survey suggests that employment in this sector is now growing at a snail’s pace. With manufacturing shedding jobs, this is resulting in a marginal downturn. To us, this fits into the bigger picture of a labour market weakening on the back of a few quarters of negative growth. Inflation is on a solid downward trend, but the PMI indicates that input cost pressures remain and that selling price inflation ticked up in November compared to last month. This is mainly coming from services as prices in manufacturing continue to fall. This serves as a warning that inflation pressures are not over yet, even though inflation does continue to move in the right direction with demand having weakened materially.

Poland: Solid labour market supports bounce back in spending A rebound in real wages and relatively stable employment are great starting points for a recovery in household spending. Economic growth in 2024 may reach around 3% on the back of both private and public consumption. The pro-inflationary structure of GDP may encourage the MPC to keep rates unchanged in 2024. Average wages and salaries in the enterprise sector rose by 12.8% year-on-year in October (ING: 13.0%; consensus: 11.7%), following an increase of 10.3% YoY in September. Higher annual wage growth than the previous month was a consequence of a more favourable pattern of working days and bonus payments. Average paid employment was slightly lower (-0.1%) in October than in the corresponding month of 2022 (ING and consensus: 0.0% YoY). Compared to September, the number of posts was down by 2,000 and this was the third month of decline in employment levels, albeit still on a modest scale. In real terms (after adjusting for the rise in consumer prices), average wages increased by 5.8% YoY showing the strongest increase since February 2019. Elevated wage pressure will be visible in the medium term amid an increase in the minimum wage, record-low unemployment levels and a reviving economy. Slightly lower inflation may act to moderate wage expectations. The recovery of real disposable income with relatively stable employment provides a good springboard for a rebound in consumption, which will be the main growth engine of the Polish economy in 2024. GDP growth in 2024 could be close to 3%.   Real wages and salaries in enterprises, %YoY Rebound in real wages to support consumption   The recovery and relatively pro-inflationary structure of GDP growth in 2024, with consumer demand dominating, may be an argument for the Monetary Policy Council to keep interest rates unchanged in the coming months. Unless the National Bank of Poland's March projection signals a faster return of inflation to target, interest rates may remain at the current level (the main policy rate at 5.75%) until the end of 2024.

Recent price actions of the Nikkei 225 are still trading above its 20-day moving average despite the latest official downbeat assessment of Japan’s economy. Significant correlation flip between USD/JPY and Nikkei 225 may persist as a weaker JPY may not be a main driver to drive up the price actions of Nikkei 225. A strengthening JPY may see the outperformance of consumer-oriented TOPIX equities sectors such as Retail Sales and IT & Services. A new medium-term uptrend may have kickstarted in Nikkei 225, watch the 32,090 key medium-term support. Japan’s government on this Wednesday, 22 November downgraded its assessment for the first time in ten months, citing economic growth in Japan has recovered moderately but appeared to be pausing due to weak domestic demand. The benchmark Nikkei 225 has continued to trade above its upward-sloping 20-day moving average since the start of this month, November, and rallied by +11% from its key swing low area of 30,530 printed on 4 and 24 October 2024. The latest official downbeat economic assessment has not derailed the current bullish tone of the Nikkei 225 as it has managed to remain above the “gapped up” support of 32,820 formed on last Wednesday, 15 November; the effect in a global risk-on herding behaviour reinforced by the softer than expected US CPI print for October that was released on last Tuesday, 14 November (current level of Nikkei 225 is at 33,452 as of 22 November).   Significant correlation flip between Nikkei 225 & USD/JPY   Fig 1: Correlation trends between Nikkei 225, USD/JPY & S&P 500 as of 22 Nov 2023 (Source: TradingView, click to enlarge chart) Interestingly, the previous long-term traditional high direct correlation between the movements of the Nikkei and USD/JPY has broken down based on its latest 20-day rolling correlation coefficient reading of -0.15. From a fundamental standpoint, a persistently weaker JPY (where the JPY has depreciated by as much as 15.9% against the US dollar since the start of 2023) is likely to have a more detrimental effect now on Japan’s economy due to the risk of higher imported inflation which in turn drives up imported energy costs for resources-scare Japan. Moreover, oil prices are likely to remain sticky on the upside in the medium term as OPEC+ leading member, Saudi Arabia seems to be still in favour of extending current oil supply cuts into 2024. Therefore, a stronger JPY is much needed for Japan at this juncture to negate the risk of elevated imported inflation that can dent business and consumer confidence which in turn dampens internal domestic spending. Hence, this latest narrative explains the current “correlation flip” between USD/JPY and Nikkei 225.   Consumer-oriented TOPIX equities sectors may benefit from a stronger JPY   Fig 2: 1-month rolling performance of the 17 TOPIX sectors as of 22 Nov 2023 (Source: TradingView, click to enlarge chart)   In the past week, the JPY has started to strengthen against the US dollar driven by more of an increasing expectation of a dovish tilt from the US Federal Reserve rather than a hawkish Bank of Japan’s modus operandi. The JPY has been appreciated by as much as around +3% against the US dollar since last Monday, 13 November and it has started to translate to an uptick in bullish sentiment seen in the Japanese equities sectors that are tied to business and consumer confidence and domestic spending. Based on the one-month rolling performance of the 17 TOPIX sectors as of 22 November 2023, Retail Trade (+7.59%) and IT & Services (+7.13%) have started to show outperformance against the broader TOPIX index (+5.98%).   Potential start of new medium-term uptrend for Nikkei 225   Fig 3: Nikkei 225 medium-term trend as of 22 Nov 2023 (Source: TradingView, click to enlarge chart) In the lens of technical analysis, the recent bullish momentum seen in the Japanese stock market is likely to trigger the potential start of a medium-term (multi-week to multi-month) uptrend phase in the Nikkei 225 after the -9.5% corrective decline seen from 16 June to 24 October 2023. The current price action of the Nikkei 225 as of 22 November is retesting a 33-year swing high of 33,770 after an initial pull-back seen on Monday to Tuesday. Meanwhile, the daily RSI momentum indicator has continued to exhibit positive momentum readings after its earlier bullish momentum breakout and retest on 7 November 2023. If the 32,090 key medium-term pivotal support holds, a clearance above 33,770 is likely to see the next medium-term resistance coming in at 36,600. However, a break below 32,090 sees another round of corrective decline to retest the 200-day moving average that also confluences closely with swing low areas of 4/24 October 2023, acting as a support at 30,530.    

Contraction of German economy in the third quarter confirmed The German economy remains stagnant - the recent fiscal turmoil will do little to change this any time soon. The second estimate of German GDP growth in the third quarter confirmed the minor drop in economic activity and came in at -0.1% quarter-on-quarter, from +0.1% QoQ in the second quarter. On the year, the German economy shrank by 0.4%. The German economy remains stagnant. In fact, since the war in Ukraine started, the German economy has grown in only two out of the last six quarters. What's even worse is that the economy currently remains barely above its pre-pandemic level more than three years later. While private consumption was a drag on growth in the third quarter (-0.3% QoQ), government consumption (+0.2% QoQ) and investments (+1.1% QoQ) supported economic activity.   Ongoing stagnation Today’s data will do very little to end the debate on whether or not the German economy is again the sick man of Europe. In any case, the German economy has become one of the growth laggards of the eurozone. This weak growth performance has a long list of explanations: there is the cyclical headwind stemming from inflation, still elevated energy prices and energy uncertainty, higher interest rates and China’s changing role from being a flourishing export destination to being a rival that needs fewer German products. But there are also well-known structural challenges, ranging from demographics to energy transition and not enough investment. The recent ruling of Germany’s Constitutional Court has exposed two new risk factors for the German economy: fiscal austerity and political uncertainty. Together with the well-known cyclical and structural headwinds, the ongoing pass-through of the European Central Bank's monetary policy tightening, still no reversal of the inventory cycle and new geopolitical uncertainties, it is hard to see Germany’s economic stagnation ending any time soon.

Next week in the US, we will be closely following the ISM manufacturing index and the Fed's favoured measure of inflation. All eyes will be on CPI releases in the eurozone, where we expect continued improvement and the core rate falling to 4%. Elsewhere, we expect to see positive third-quarter GDP releases in Hungary and Poland.   US: Closely following the ISM manufacturing index for any signs of a rebound Markets have firmly bought into the view that the Federal Reserve won’t hike interest rates any further and that 2024 will see a series of interest rate cuts from the second quarter onwards. Around 90bp of cuts are currently priced, whereas we're forecasting 150bp for next year on the basis that consumer weakness is likely to be a key theme given subdued real household disposable income growth, fewer savings resources, and less borrowing as interest rates continue rising. This should allow inflation to slow more quickly, giving the Federal Reserve greater scope to loosen monetary policy. Next week’s data flow includes the Fed’s favoured measure of inflation, which we expect to show a 0.2% month-on-month rate of price increases. This is broadly in line with what the central bank wants to see and, if repeated over time, would bring the annual rate of inflation as measured by the core personal consumer expenditure deflator back to 2%. We also get more housing numbers, which should signal healthy new home sales, but this is due to the lack of availability of existing homes for sale. Prices should continue rising in this environment, but with home builder sentiment having plunged in recent months, cracks are starting to form as the legacy of high borrowing costs bites more and more harshly. We will also be closely following the ISM manufacturing index for any signs of a rebound after having been in contraction territory for the past 12 months. Eurozone: Core inflation to continue improving to 4% Next week, we'll see new inflation numbers for the eurozone. Inflation dropped more than expected in September and October, and the question now is whether the low inflation trend will continue. We expect some continued improvement, with core inflation falling to 4% and headline inflation dropping to 2.7%. Still, there are signs of continued inflation pressures that shouldn’t be ignored after a few encouraging data releases. The November PMI showed that businesses still see increased input costs, resulting in more survey respondents indicating that selling price inflation ticked up. Thursday will tell us whether inflation has continued its rapid normalisation. Poland: We forecast a further decline in core inflation Flash CPI (Nov): 6.7% YoY Our forecasts suggest that in November, CPI inflation inched up to 6.7% year-on-year from 6.6% YoY in October, marking the first increase since it peaked in February. We expect a further decline in core inflation, but it will be accompanied by less favourable developments in energy prices as gasoline prices bounced back after two months of declines. GDP (3Q23): 0.4% YoY We expect the flash estimate of 0.4% YoY to be confirmed by the final data. We will also learn the composition of third-quarter GDP. According to our forecasts, household consumption declined slightly (-0.2% YoY), while fixed investments continued expanding at a solid rate (7.5% YoY). At the same time, we project a smaller drag from a change in inventories and a lower contribution of net exports than observed in recent months. Monthly data suggests that economic recovery continued at the beginning of the fourth quarter as annual change in industrial output and retail sales turned positive in October. Hungary: Novembers manufacturing PMI expected to remain in positive territory The Statistical Office will release the details behind Hungary's strong GDP growth in the third quarter next week. We see positive contributions from industry, construction and agriculture. On the expenditure side, we think net exports were the main driver of the improvement, along with some early positive signs on consumption. November's manufacturing PMI could remain in positive territory, with export capacity still in good shape, reinforcing our view that year-on-year GDP growth could also return to positive territory in the fourth quarter. Key events in developed markets next week Key events in EMEA next week    

Hungary’s labour market cools slight The cost of living crisis has not gone completely unnoticed in employment statistics, with labour metrics cooling slightly in the autumn. However, the labour market still remains tight, which also puts upward pressure on wage growth.   There has been a slight increase in the unemployment rate According to the latest unemployment statistics published by the Hungarian Central Statistical Office (HCSO), there was little change in the labour market in October. The model estimate for the tenth month of the year showed a slight deterioration in the unemployment rate (4.1%). Meanwhile, the official three-month moving average of this labour metric (based on a survey) rose by a similar 0.2ppt to 4.3%. Against this backdrop, the number of people out of work has once again risen meaningfully above 200,000, a level not seen since March 2021. Looking at the longer-term trend, the cost of living crisis has not gone completely unnoticed in the labour market. Apart from a (seasonal) improvement this summer, there has been a slow, trend-like deterioration in the unemployment rate since spring 2022. However, it is important to note that both the activity rate and the employment rate in the labour market have increased significantly over the same period. In other words, more and more people want to work as a result of the impact of the crisis on their livelihoods, and they have been absorbed to a significant extent, but not entirely, by the labour market.   Historical trends in the Hungarian labour market (%, 3m moving average) Looking at the monthly data, perhaps the most important change is that the number of people in employment rose by around 10,000, while the number of people unemployed rose by 11,000 and the number of people without a job by just under 2,000. On the one hand, these changes are within the margin of error, i.e. they are not significant. On the other hand, they suggest that more people are entering the labour market as the year draws to a close, but that finding a job is not as easy as it was a year ago. Compared to the beginning of 2023, there has been a significant increase in the proportion of people who have been unemployed for 0-3 months (i.e. either recently lost their job or recently returned to the job search), although there has also been an increase in the number of long-term unemployed who have been out of work for more than a year. The hiring propensity of companies thus appears to be easing significantly in the overall economy. Nevertheless, considering the cost of living crisis, we can conclude that the Hungarian labour market remains in good shape and labour shortages remain significant.   Unemployment by job search duration   Going forward, we do not calculate for any structural changes in the labour market for the rest of the year. The vast majority of companies will continue to insist on retaining staff, having learned from the shocks of recent years that it is quite difficult to expand the workforce in a recovery period in an economy with a structural shortage of labour. In this regard, judging by the latest third-quarter GDP data, the Hungarian economy is on the verge of recovery. The structural labour shortage can raise workers’ bargaining power and therefore support wage increases, especially in light of the recent minimum wage agreement. Positive real wages may support the economic recovery, but they also carry reflationary risks. For the time being, we believe that the corporate costs of the expected real wage increase can be covered by expected revenue growth and efficiency gains, so that while the risk of a price-wage spiral remains, we see a good chance that it can be avoided.   Slowdown in average gross earnings on the back of base effects According to the latest wage statistics published by the HCSO, the pace of year-on-year (YoY) average wage growth in Hungary slowed slightly in September. On the one hand, the 14.1% YoY average wage growth (for the full range of employers) can still be considered very strong. On the other, the slowdown in wage dynamics compared with the pace observed in recent months is due to a strong base effect, as salaries of professional members of law enforcement agencies increased significantly in September.   Nominal and real wage growth (% YoY)   Meanwhile, regular earnings in September were 14.9% higher than a year earlier, which means that the increase in total earnings (including bonuses and one-off payments) is higher than the increase in average earnings. This also means that one-off payments and bonuses were lower in September this year than a year ago. Again, this should come as no surprise, as at the end of last year, with inflationary pressures rising, many companies decided to give their employees one-off payments. The aim was to improve the financial situation of workers without imposing a long-term increase in wage costs on firms. It is therefore likely that, for the same reasons, the increase in regular earnings in the coming months will be higher than total average earnings. The impact of bonuses can also be seen from the fact that the increase in median gross earnings (14.1% YoY) was exactly the same as the increase in average gross earnings.   Wage dynamics (three-month moving average, % YoY)   The detailed data also shows that the base effect of last September's pay settlement for law enforcement officers influenced the change in average wage growth in the whole economy. In the public sector, the pace of wage growth slowed considerably, from almost 15% to just under 12% YoY. Meanwhile, wage growth in the private sector has also slowed, although this is mainly due to a decline in the level of one-off payments.  Looking at the individual branches of the economy in general, the pace of wage growth has slowed significantly almost everywhere, but there are a few exceptions, like scientific and technical activity, and education. As inflation continued to slow in September, the 12-month negative real wage growth on an annual basis has come to an end, despite the slowdown in average wage growth. The purchasing power of average wages was 1.7% higher in September 2023 than it was a year earlier, which is a significant change, but at the same time needs to be taken with a pinch of salt. In general, this simply means that the purchasing power of the population has started to increase again compared with the previous year.   The level of average and median real wages (1990 CPI adjusted HUF)   The problem might be that this is only one month of positive data, and it looks at the growth compared to the same period of the previous year. However, if we look at the level of monthly real wages at 1990 prices (i.e. we are not looking at a percentage change), our calculation shows that the level of real wages was 28,784 forints (around US$83). This compares with an average monthly wage of around 31,000 forints (US$89) in the last three months of 2021, calculated at 1990 price levels. This shows that the current positive year-on-year change basically marks the beginning of a recovery and that there is still a long way to go before the purchasing power of wages catches up with the decline caused by the inflation shock and the living standards crisis. The purchasing power of average wages is currently around the average in 2020, so we have managed to invent the time machine and get back to the 2020 standard of living in terms of wages. None of this suggests that households are going to start consuming a lot just because a statistic has gone from negative to positive. The recovery in domestic demand will therefore be a slow and gradual process, in our view.

Romanian growth figures reinforce signs of resilience The release of detailed data for third-quarter GDP growth, alongside a rather hefty upward adjustment of the flash print, points to a pretty resilient growth picture in Romania. We marginally raise our full-year growth forecast from 1.5% to 1.7%, with the risk balance still tilting upwards.   As the initial 0.2% annual growth in the third quarter has now been revised to 1.1%, the overall picture of Romania's economy certainly looks brighter for the full year. The quarterly growth has also been revised from 0.4% to 0.9%. Assuming no further data revisions (a difficult assumption to make), it would now take only a meagre 0.1% quarterly expansion in the fourth quarter to reach our initial 1.5% annual growth forecast. On the supply side, our assumption that agriculture can offer a positive surprise in the third quarter materialised, as the sector added 0.8pp to the 1.1% overall annual expansion. Boosted by the strong momentum in public infrastructure investments, the construction sector added 0.4pp. Industry remains a laggard, subtracting 0.4pp and marking the fifth consecutive quarter of negative contribution to the GDP growth.   Real GDP (YoY%) and contributions (ppt) - supply side   Demand side, there was a rather large negative contribution coming from inventories (included in “others” in the chart below) which subtracted 4.8pp from the 1.1% growth rate. Otherwise, the main engine of the economy right now remains fixed investments, which contributed with 3.7pp – the highest contribution since the third quarter of 2019. Net exports have also contributed positively again by 2.1pp. This is the third consecutive quarter of positive contribution from net exports, a rather unusual situation for the Romanian economy over the last 10 years or so.     Real GDP (YoY%) and contributions (ppt) - demand side   The few pieces of high-frequency data that we got for the fourth quarter so far are pointing towards a robust expansion, with retail sales starting the quarter on a rather strong footing and confidence data marginally improving as well. For 2024, we are likely to see a rebalancing of the growth drivers from investments towards consumption, though the former should still hold on close to double-digit growth. However, with public wages likely to stay well within double-digit growth and pensions due to be increased by 13.8% starting January 2024 and approximately 22.0% starting September 2024, the private consumption story is likely to show marked improvement. The above picture could complicate the National Bank of Romania's decision-making process, as the rising demand could slow the descent of an already sticky inflation profile, with many other uncertainties on the horizon. Again, this increases the likelihood of the rate-cutting cycle starting later and/or being shorter than our current 150bp estimate

2024 set to be the year that the hike cycle is felt The ECB hike cycle seems over, but the shockwaves of tightening will still shape the eurozone economy in 2024. Traditional lags in transmission are now accompanied by longer ones in average interest burden increases, potentially extending the impact of tightening. For the ECB, the risk of being behind the curve for the second time in one cycle is growing. The end of the hike cycle is most likely here. The ECB has raised interest rates aggressively - from -0.5% to 4% in just over a year. With inflation coming down quickly and the economy stagnating, it is hard to see how the ECB could continue hiking rates, either this week or in the coming months. Instead, the focus is shifting towards possible first rate cuts. This makes it an excellent moment to focus on how fast monetary transmission is happening and what to expect from the impact of this in 2024.   The initial impact of tightening was significant In March, we concluded that the early signs of a rapid impact on transmission channels were significant. Since then the pace has moderated a bit, depending on the channel. As back in March, we follow the ECB’s own categories of transmission channel. At the end of 2023, broad money supply is still contracting quickly, currently at an annual pace only seen in 2009. Bank rates for loans for households and businesses are still rising rapidly and the euro has broadly appreciated against the currencies of major trade partners since late summer - it is now slightly above levels seen at the start of ECB’s rate hikes. Asset prices have also corrected, but with very different results across asset classes.   Flow chart of how monetary policy impacts the economy, according to the ECB Moving on from the channels to the real impact of monetary tightening so far, the impact on bank lending has slowed. Most importantly, the bank lending impact was strong at the start of the tightening cycle - lending growth to non-financial corporates has slowed from around 1% month-on-month in the summer of 2022 to 0% in November and has stabilized around 0% since. This also seems related to a working capital and inventories-related lending surge in summer, the need for which faded when supply chain problems eased. Lending to households slowed from 0.4% month-on-month in May 2022 to 0% in April 2023, since when it has also stabilized around 0%. Overall, the lending correction is not dramatic, but has a significant impact on future investment. Don’t forget that there is likely more to come - the ECB Bank Lending Survey suggests continued weakness in lending ahead. In short, the impact of monetary policy tightening on lending and consequently on the real economy is unfolding like every textbook model would suggest.   At face value, monetary transmission is working quickly   Not every aspect of tightening works quickly, quite some of the burden is still to come While at face value the transmission of monetary policy tightening is working as planned, looking slightly deeper reveals more complexity and more sluggishness. Coming from a long period of negative rates is having a big impact on how fast interest payments are rising. Looking at net interest payments from corporates, we see that these have increased disproportionally slowly so far (chart 4). The same holds for households, where the average mortgage rate paid by households in the eurozone has only increased by 0.8% while new mortgage loan rates are up by 2.7%. For governments, the same is true. Interest rate payments are increasing but remain at relatively low levels. Low locked in-rates have caused a relatively small increase in debt burdens so far.   Average interest payments have started to move up only slowly   This means three things: First of all, costs have not increased materially so far, which would be an additional tightening effect. Higher costs force cuts in spending or investment elsewhere, which results in weaker activity. While the relationship between interest rates for new loans and average debt burden was more synchronized in previous hike cycles, the initial effect on debt burdens has been relatively limited. Secondly, this means that the impact of the hike cycle is likely more spread out this time. Over the course of next year, loans will have to be refinanced at higher rates, which will continue to increase average debt burdens. So, while the initial impact of ECB tightening has already been forceful, it is reasonable to expect that the effect will not fade quickly in 2024 as more businesses, households and governments adjust to a new reality of higher rates. Lastly, since there is now such a discrepancy between the current interest rate and the average interest rate paid in the economy, the ECB could cut rates but average interest payments could still be increasing. So, if the ECB were to start the process of decreasing interest rates, part of the tightening effect would still be coming through the pipeline. This would dampen the effect on monetary easing.   Important moderating effects have kept the impact on GDP mild so far Much to the chagrin of the ECB, governments have continued to provide ample fiscal support to the economy. As chart 6 shows, the fiscal stance is falling moderately, but continues to be generally supportive of economic activity. It is not the first time that fiscal and monetary stances are at odds with each other - think back of the 2010s when fiscal austerity countered ECB efforts to bring inflation up to 2%. Now this is working the other way, as fiscal support boosts economic activity and therefore counters the ECB’s efforts to reduce underlying inflation.   As in the 2010s, monetary and fiscal policy are working in different directions   The labour market is also moderating the impact of tightening; at least for now. The weaker economic environment since late 2022 has not yet translated into a weaker labour market. While a relatively simple Okun’s Law would suggest that the labour market should be cooling slightly, it remains red hot. This supports economic activity and maintains wage pressures for the moment. Tightening efforts in the labour market remain relatively invisible for now. Finally, investment has continued to be supported by the supply-side problems from 2021 and 2022. While new orders have fallen, production has been kept up by the large amount of so far unfulfilled orders brought forward. The size of eurozone order books has fallen rapidly since late 2022, which has boosted activity and masked weakness in drying up orders when it comes to total economic activity. These factors have so far suppressed the impact of tightening on the economy, but we expect them to be less supportive of growth in 2024. While the fiscal stance is set to remain expansionary, with the exception of Germany, it will likely be less so in 2024 than in 2023. The labour market has recently shown more serious signs of weakening, which leads us to expect that unemployment will finally start to slowly increase over the course of next year. Backlogs of work have largely been depleted, meaning that the full effect of monetary tightening will likely be felt more strongly next year as mitigating factors fade.   Unemployment is lower than you would expect on the basis of current economic activity   The landing has been very soft so far, but gets bumpier in 2024 Inflation has come down very quickly over the course of 2023. Peaking at 10.6% YoY in October, it has fallen to 2.4% in November. This has been achieved with economic activity stagnating but not falling and the labour market continuing to go from strength to strength. The monetary stance has moved from an interest rate of -0.5% and QE to a 4% interest rate and QT. Can we really move from a broadly accommodative stance to a very restrictive stance and not notice any economic pain? That seems unlikely: much of the impact of the higher rate environment is likely to be felt next year because of the usual lag of monetary policy, because some effects of tighter policy are now more lagged than in previous cycles, and because mitigating factors are set to fade. Milton Friedman’s famous quote that monetary policy has ‘long and variable lags’ seems to be an understatement in the current complex monetary environment. That does mean that the restrictive impact of monetary policy on the economy is set to increase while inflation already looks to be solidly under control. The month-on-month core inflation rate in November was negative and the trend has been sharply down. Disinflation in 2023 was mainly the result of base effects due to ending supply shocks and not so much to monetary policy tightening. Disinflation in 2024, however, will be mainly the result of the further unfolding of monetary policy tightening. While there are clear uncertainties about the inflation outlook - including how wage growth will develop and whether new spikes in energy prices could emerge - there is a high risk that the ECB is getting behind the curve for the second time in one cycle. It was late in responding to inflation on the way up and could well be late in responding on the way down as well. Expectations of rate cuts have moved forward and have grown a lot recently. Given the wrong assessment of inflation dynamics on their way up and concerns about possibly more persistent inflationary drivers, we think the ECB will be very hesitant to simply reverse the rate hiking cycle. Instead, we expect the ECB to wait for additional wage growth data for the first quarter and then start cutting in June - but rather gradually, with three cuts of 25bp every quarter. That would still leave monetary policy restrictive and keep average interest rate payments going up as society adjusts to higher interest rates. It would also make new investments slightly more attractive again. The hike cycle may have so far seemed like an easy adjustment to swallow, but ironically the pain of tightening will likely be felt most when the ECB already starts to ease.

Cautious tone of Polish MPC Governor press conference The NBP president's conference was short and cautious in its tone. The NBP may be heading in the direction of the conservative Czech National Bank. In our view, rates will remain unchanged until at least March 2024   Weak global economy, signs of recovery at home During his press conference, the NBP Governor Adam Glapinski assessed that the data received since the previous MPC meeting does not fundamentally change the assessment of the economic situation and its outlook. The external environment remains weak. The Eurozone is in stagnation and activity in Germany is declining. In Poland, economic activity remains subdued, but there are increasing signs of recovery. After declines in 1H23, 3Q23 saw GDP growth of 0.5% YoY. According to. Glapinski, the economy is beginning to improve. Global inflation is subsiding but still remains elevated. Major central banks, including the Fed and ECB, are keeping interest rates unchanged.   The NBP expects continued CPI decline, but at a slower pace President Glapinski reiterated that inflation in Poland is falling and is on a path to the NBP target, which it should reach within two years. Glapinski reiterated how much inflation has fallen (it is almost three times lower than at the February peak), adding that the core is falling as well and is around 5pp down from the peak. He noted that the decline in inflation has slowed and will also be slower in the coming quarters. In the Council's view, inflation will continue to fall due to reduced economic activity (negative output gap) and earlier monetary tightening, which cooled activity in the credit market. Also favourable for the inflation outlook is the strengthening of the PLN by about 20% against the US$ and about 10% vs. the €. Professor Glapinski was very neutral on the PLN exchange rate.   Uncertainty prompts MPC to adopt wait-and-see stance The Governor’s statements indicate that the MPC is adopting a wait-and-see stance, but definitely not a hawkish one. The MPC is waiting for decisions on electricity and gas prices, as well as VAT on food, the reinstatement of which could bump up inflation by about 0.9ppt. Therefore, the Council should take a closer look at inflation prospects on the occasion of the NBP's March projection, when the aforementioned uncertainty factors should be resolved. The Council's subsequent decisions will depend on incoming data.   Bottom line A communications revolution at the NBP took place. Yesterday's decision was made earlier than usual, i.e. at 2:29 CET  and the Governor’s conference lasted only 27 minutes. Could it be that the NBP is heading in the direction of the (conservative) Czech National Bank? During his speech, Glapiński declared willingness to cooperate with the new government and flagged cautious rate decisions in the future. In our view, a more disinflationary external environment, a stronger PLN and a more cautious NBP suggest that the risk that inflation will remain above target for a long time has moderated somewhat. Rates should remain unchanged until the end of 2024 as there is still no shortage of inflationary factors. For instance, we expect further fiscal expansion, increased wage dynamics (i.e. due to a 20% increase in the minimum wage in 2024), large inflows of EU funds and foreign direct investment. But rate cuts cannot be completely ruled out either. The space for interest rate changes could emerge in March, should global disinflation prove rapid and sustained and the zloty continue to gain. Our baseline scenario assumes that interest rates will remain unchanged, but the distribution of risks is skewed toward potentially lower inflation and the chances of earlier interest rate cuts than in 2025.

Rates Spark: Does the Fed know something we dont? The surprise from the FOMC was partly the extra 25bp implied cut added to 2024, but it was more the lack of pushback from Chair Powell on the 2024 rate cut narrative. He almost endorsed it, which leads us to question whether he knows something of significance that we don't. Today's focus is on the ECB and BoE policy meetings.   Chair Powell validates the move from 5% to 4% on the 10yr yield Such was Federal Reserve Chair Jerome Powell's phraseology at the press conference that one must suspect that he knows more than we know. And its not about the macro data. We can see that. It's more about what the Fed might be seeing under the hood. Perhaps in commercial real estate, or single family residential rentals or private credit, or another other area of the system that might find itself overexposed to rate hikes delivered, under water and vulnerable to breaking. We don't know of course, but a Fed chair that stands up asserts that he understands the dangers they run by keeping rates too high for too long is one that looks like he's ringing alarm bells. Along with the Fed, the market too has added an additional 25bp rate cut for 2024, now at 150bp cumulative. The entire curve has shifter lower, led by real rates. The 2/10yr curve has gapped steeper too. This is a meaningful outcome. The question now is whether the 2yr can really break free and head lower as a driver of the yield curve, steepening it out from the front end. That traditionally happens on a three month run in ahead of an actual rate cut. We’re on the cusp if this, but not quite there just yet. It’s been a remarkable ongoing market move, especially as it has been interlaced with some tailed auctions, indicative of resistance to the falling market rates narrative (in the long end). But there’s been little from Chair Powell and the FOMC to stand in the way of this. Recent data has not really validated the dramatic fall in yields. But today the Fed has helped to do so. A far more hawkish Fed had been anticipated. The question ahead is where is fair value for the 10yr. We think it’s 4%. It’s premised off the view that the funds rate gets to 3% and we are adding a 100bp curve to that. We are about to sail below 4% though as a theme for 2024, with 3.5% the target. But the move below 4% towards 3.5% will be an overshoot process. If something breaks, we fast track all of that and jump to a new environment. That has not happened as of yet, but we think the stakes have risen.   ECB to push back against early cut expectations With a first rate cut more than fully discounted by April and on overall anticipated easing of 135bp over 2024, the market’s expectations of European Central Bank policy stand in stark contrast to the official line of rates having to remain high for longer. But since the last meeting in particular the inflation data has surprised to the downside, which even influential ECB officials like Isabel Schnabel had to acknowledge. The prospect of further hikes is clearly off the table, but she warned that central banks will have to be more cautious. That also meant that the ECB should be more careful with regards to making statements about what will happen in the next six months. The ECB’s new growth and inflation forecasts will have to be lowered, the crucial question is just by how much. Also taking it from Schnabel, the ECB is unlikely to give any longer rate guidance, which would only mean a truer meeting-by-meeting and data dependent approach. Still, the ECB is unlikely to endorse the aggressive market pricing, especially that of cuts already early in the year. So far the communication has been that one is particularly concerned about the development of upcoming wage negotiations which makes pricing for March rate cuts look premature. But how can the ECB still convey a hawkish tilt? One possibility is using communication about plans to shrink the balance sheet. We do not think there will be concrete decisions yet, but the ECB could state that it has begun discussing to potentially end PEPP reinvestments earlier than planned.   BoE likely reiterate rates will stay restrictive for an extended period Expectations of policy easing have further deepened ahead of today’s Bank of England monetary policy committee meeting. A first rate cut is now fully discounted by June with an overall expected easing of close to 100bp over 2024. One reason for growing expectations was a downside surprise in wage growth which saw private sector regular pay growth fall to 7.3% year-on-year from 7.8% YoY. Another trigger was yesterday’s disappointing GDP growth for October which means we are potentially on track for a fractionally negative overall fourth quarter figure. The BoE is likely to reiterate the guidance from November, where it said it expected rates to stay restrictive for “an extended period.  A hold is also widely anticipated by the market, but the recent data could convince some of the three MPC’s hawks who had still voted for a hike in November to back down from that position toward a ‘no change’.    Today's events and market view The central bank meetings are clearly the focus today given how far market expectations of policy easing have come. There may well be some disappointment in store for pricing of rate cuts as early as March. But further out we must acknowledge that the shift lower in rates is also driven by a drop in inflation expectations. The 10Y EUR inflation swap for instance has come down all the way from levels closer to 2.6% in October to currently 2.15%. Even central banks themselves have become more positive about the disinflationary tendencies taking hold. On the heels of the FOMC meeting rates markets in the US will look out for the initial jobless claims as well as retail sales data today. we will also get import and export prices.

Grim outlook for the European staffing sector in 2024 After two years of above-average volume growth for the European temporary employment sector, that growth turned to contraction last year. For 2024, we expect the freeze on hiring temp workers to continue. Sluggish economic growth and staff shortages are the main challenges for the sector this year.   Slowdown in economic growth in most European economies Economic and geopolitical uncertainties, combined with higher interest rates, are likely to soften economic growth in Europe this year. Both companies and consumers are taking it easier with investments and spending due to those higher rates and persistently high inflation. As a result, GDP growth in most European economies will contract slightly or grow only modestly in 2024. Modest economic growth in most European economies in 2024 GDP growth, year-on-year   The European labour market remains tight Despite an economic slowdown and a cooling of the labour market, unemployment will remain relatively high in most European economies in 2024. While vacancy rates will be slightly lower in 2024, many European economies continue to struggle with a tight labour market. This is not only due to an ageing population, but also because the average number of hours worked per person is still lower than before the pandemic.  Staff shortages could slow market volume growth in the temporary employment sector, as temp agencies experience more difficulties recruiting new employees. Based on the job vacancy rate, the labour market is tightest in Belgium and the Netherlands, with 5% of unfilled vacancies in the third quarter of 2023.    The labour market is tightest in Belgium and the Netherlands Job vacancy rate, third quarter 2023, seasonally adjusted

Strongest hiring plans in the Netherlands While the economic environment is deteriorating, most employers still have modest hiring intentions as we begin 2024. In fact, most employers in the Netherlands, Belgium and Germany are more optimistic about their hiring plans at the start of this year than they were at the end of 2023. In France, Switzerland and Sweden, hiring plans are weaker for the first quarter of 2024 compared to the end of 2023.    Employers in the Netherlands, Belgium and Germany are more optimistic about their hiring plans in 2024 Percentage of employers planning to hire minus the percentage of employers expecting a reduction in staffing levels     Less demand for temporary workers 2024 will be another challenging year for the temporary employment sector. Economic growth forecasts for most European economies remain weak for 2024, ranging from a mild contraction in Sweden and Germany to a lingering 0.7% GDP growth in Belgium and the Netherlands. As a result, unemployment could rise slightly.  The sluggish economic outlook also has consequences for the employment services industry. Companies are reluctant to invest now that the market remains highly uncertain. This softens the demand for temporary agency workers. That's particularly true for the manufacturing sector, an important industry for temp workers, where new orders continue to decline, as does capacity utilisation. But employment prospects for temp workers are also deteriorating in the services sector. Taken together, market volumes in the employment services sector are expected to decline in most European economies next year.   Staffing sector forecast: volumes are likely to decline in most European economies Volume output (value added) employment services industry, year-on-year, indices (2019=100)     Belgium - Shorter duration of temporary work GDP growth in Belgium is expected to be relatively high at 0.7% in 2024, compared to other European economies. This is mainly due to automatic wage indexation, which means that income increases with the inflation rate (excluding alcohol, tobacco and fuels). Higher purchasing power stimulates consumer spending and, thus, economic growth. Nevertheless, higher hourly labour costs will negatively impact labour demand, including the demand for temporary agency workers. We, therefore, expect a decline in market volumes in the temporary employment sector in 2024. Despite a slow economic growth, Belgium's labour market remains very solid. This is largely due to the country's tight labour market. One of the consequences of talent scarcity is that the duration of temporary work is becoming shorter because temp workers are more often hired on a permanent basis.    France - Hiring plans on hold Economic growth is expected to slow further, from 0.9% in 2023 to 0.6% in 2024. The outlook for both the French services and manufacturing sectors remains bleak. Both sectors are facing lower demand, high inflation and greater uncertainty. In addition, the French labour market is showing the first signs of cooling down, resulting in a rise in unemployment in 2024. The deterioration of the employment climate is mainly due to the services sector. Because almost half of the temps actually work in the service sector, this will also have a negative impact on the demand for temporary agency workers and the number of hours worked. We, therefore, expect a further contraction in employment activities in 2024.    Germany - Hiring freeze over recession fears Weaker global demand, high interest rates, energy uncertainty and persistently high inflation are hitting the German economy this year. This will have consequences for the demand for temporary agency workers. Adverse macroeconomic developments are putting pressure on the German automotive industry, an important sector for employment agencies. In addition, production is also declining substantially in other subsectors of the manufacturing industry. Another factor negatively affecting the temporary employment sector is the shortage of temp workers due to demographic developments. Overall, we expect a further decline in the volume of employment activities in 2024.    The Netherlands - Self-employment is an attractive alternative As a result of a weakening economy, the number of temporary employment hours in the Netherlands is expected to decrease further in 2024. We anticipate a decrease in the number of temporary agency hours by approximately 5% by 2024, mainly due to continued relatively low economic growth. In manufacturing, temp workers are the first to be laid off due to a rapid decline in production and the number of orders.  A major challenge for the staffing industry in the Netherlands is the impact of stricter regulations, which make agency workers more expensive and less flexible. As a result, other forms of employment contracts become more attractive for hiring companies, such as self-employed professionals.    More self-employed people, less flexible employment in the Netherlands in 2023 Share of labour position in the labour force in the Netherlands, third quarter    Sweden - The job market is cooling down Sweden is among the European economies expected to enter a recession in 2023, mainly due to high inflation and higher interest rates. We expect economic activity to stagnate this year. There are already signs that the job market is cooling down. As a result, consumer and business confidence remains low. The economic situation is likely to weaken demand for temp workers, especially in the construction and manufacturing sectors. Overall, we expect market volumes for the temporary employment sector to decline again in 2024.    Switzerland - Another year of negative volume growth in employment activities Like many other European countries, the Swiss economy became more challenging in 2023 due to high inflation, higher interest rates and weakening global demand. GDP growth is expected to slow from 2.2% in 2022 to around 0.6% in 2023 and 2024. The Swiss manufacturing industry, with a relatively large weight of the cyclical chemical and pharmaceutical sectors, is shrinking. The staffing market is also negatively affected by staff shortages, making it difficult to find suitable candidates. In short, we expect another year of negative volume growth in employment activities in Switzerland in 2024.    Manufacturing and construction are the most important sectors for the Swiss staffing industry Percentage of industries that used temporary agency work in Switzerland in 2022   The United Kingdom - Weak outlook for the employment activities sector Economic activity in the UK is expected to grow only modestly in 2024, similar to most other European economies. The sluggish economy will lead to a decrease in the number of vacancies and an increase in the unemployment rate. However, given the ongoing staff shortages, this increase is expected to be limited. Nevertheless, we expect the demand for temporary agency workers to weaken further in 2024. 

Sticky US inflation reduces chances of an early Fed rate cut In the wake of the Federal Reserve's dovish shift in December, financial markets had moved to price an interest rate cut as soon as March. However, the tight jobs market and today's firmer-than-expected inflation numbers suggest this is unlikely, barring an economic or financial system shock. We continue to think the Fed will prefer to wait until May.   CPI comes in above expectations December US CPI has come in at 0.3% month-on-month/3.4%year-on-year and core 0.3%/3.9% versus the 0.2/3.2% expectation for headline and 0.3/3.8% for core. So, it is a little disappointing, but not a huge miss. Meanwhile, initial jobless claims and continuing claims both came in lower than expected with continuing claims dropping to 1834k from 1868k – the lowest since late October. The combination of the two – slightly firmer inflation and good jobs numbers really brings into doubt the market expectation of a March rate cut from the Federal Reserve. We continue to see May as the most likely start point.   Core CPI measured in MoM, 3M annualised and YoY terms   This means that the annual rate of headline inflation has actually risen to 3.4% from 3.1% in November while the core rate (ex food and energy) has only fallen a tenth of a percentage point, so we appear to have plateaued after a strong disinflationary trend through the first nine months of 2023. The details show housing remains firm, with the key rent components continuing to post 0.4/0.5% MoM gains while used cars also rose 0.5% and airline fares increased 1% while medical care is also still running pretty hot at 0.6%. Motor vehicle insurance is especially strong, rising another 1.5% MoM, meaning costs are up more than 20%YoY. The so called “super-core” measure (core services CPI ex housing), which the Fed has been emphasising due to it reflecting tightness in the labour market given high wage cost inputs, posted another 0.4% MoM increase. This backdrop remains too hot for the Fed to want to cut rates imminently, especially with the economy likely posting 2-2.5% GDP growth in the fourth quarter of last year and the labour market remaining as tight as it is.   But this is just one measure and the outlook remains encouraging Nonetheless, the CPI report isn’t the only inflation measure the Fed looks at. In fact the preferred measure – the core personal consumer expenditure deflator – has shown much better performance. To get to 2% YoY we need to see the MoM% change averaging 0.17%. 0.31% MoM for core CPI is near enough double what we want to see, but for the core PCE deflator we have seen it come in below 0.17% MoM in five of the past six months. The reasons for the divergence are slight methodological differences in the calculations, with weights for key components such as housing and cars, being very different.   Observed rents still point to a sharp slowdown in housing inflation   Nonetheless, the prospects for consumer price inflation returning to 2% YoY remain good. We have to remember that cars and housing have a 50% weighting within the core CPI basket and we have pretty good visibility for both components. Observed private sector rents point to a clear slowdown in the housing components, while declines in Manheim car auction prices point to used car prices falling outright over the next two months. Also note that the NFIB small business survey showed only 25% of businesses are raising prices right now versus 50% in the fourth quarter of 2022. In fact, the last time we saw fewer businesses raising prices was January 2021. So, while today's report wasn't as good as it could have been, there are still reasons for optimism on sustained lower inflation rates in 2024. We still see a good chance headline and core CPI to be in the 2-2.5% YoY range by late second quarter.

New inefficiencies but trade unlikely to be derailed Global trade has entered a phase of low growth following economic headwinds, geopolitical tensions and increasing protectionism. Trade growth may even lag global GDP growth for longer than expected. Trade patterns have also been disrupted over the last two years following sanctions on Russia, which led to big shifts in imports and exports of commodities and vessels sailing longer routes, especially in tanker shipping. Current detours add to already historically long routes in trade and introduce new inefficiencies. Falling container rates have long been positive for trade since 2022, and current increases reverse some of that, but as mentioned previously rates and ocean timelines for shipments are nowhere near peak levels. Shippers are looking into options for shift sourcing and nearshoring to reduce risk, but we’ve also seen that (underlying) interdependencies remain strong and companies continue to trade if potential benefits surpass costs. All in all, we stick to our forecast that merchant trade will grow 2.5% year-on-year in 2024 compared to the low competitive base of 2023.  

Elsewhere  The People's Bank of China (PBoC) held its policy rate steady this Monday - defying the expectation of a 10bp cut - while pumping more cash into the financial system to reverse the selloff and boost asset prices, and eventually growth. But in vain. The Chinese CSI 300 index barely reacted to the news after China posted a third negative CPI read on a yearly basis. China is still expected to hit its official 5% target this year, but the confidence crisis and the slump in property prices are not going to reverse overnight. Outlook for Chinese equities is not bright.   Taiwan's stock exchange, on the other hand, which diverged positively from the mainland stocks last year, had a cheery start to the week after the ruling DPP's Lai – who is pointed at as a 'separatist' by Beijing - won presidency and his party lost its legislative majority. The latter was seen as a good compromise for relations between China and Taiwan – as the outcome was clearly not over-provocative for Beijing. The Japanese Nikkei 225, on the other hand, hit the 36K mark on the back of a softer yen, and waning expectations that the BoJ will be normalizing at a decent speed this year.   In the FX, the US dollar kicks off the week on a slightly negative note, the AUDUSD struggles to find buyers near the lower bound of its October to now ascending channel, as the PBoC could've been more supportive. The EURUSD couldn't clear the 1.10 resistance last week, and the failure to break above the crucial psychological could weaken the euro bulls' hands this week. Across the Channel, Cable remains cautiously bid after Friday's GDP printed a better-than-expected growth number. The UK will release its latest inflation report on Wednesday. UK inflation is expected to have further eased from 3.9% to 3.8% in December, and core inflation is seen slipping below the 5% mark. A softer-than-expected set of inflation figures could prevent Cable from making a sustainable move above the 1.28 level.   

The Chinese yuan remained under pressure last week and ended it slightly lower against the broadly stronger US dollar. Data confirmed that China experienced the longest deflationary period since 2009, registering three months of declining consumer prices in a row. In December, the CPI index fell by 0.3%. The fact that this was a smaller decline than the month previous (-0.5%), and slightly more limited than expected (-0.4%), has not allayed concerns about domestic demand. Most other releases, including PPI inflation and financial data, also failed to provide optimism, although trade activity did, at least, pick up at the end of the year. Amid concerns about the economy's weak performance, the PBoC injected CNY 216 billion in fresh medium-term funds into the banking system today, but contrary to expectations it did not lower the 1-year MLF rate. Looking ahead, attention will be on the year-end data package to be released on Wednesday. GDP growth is particularly worth watching, as it could set the tone for sentiment toward China in 2024.  

Rates Spark: Near-term balance of risks still tilted towards higher rates Markets are geared for dovish outcomes this week, not just in rates where still notable probabilities are discounted for first cuts as early as March, but also across wider risk markets. This sets up markets for disppointments if they don't get exactly what they want. Data is a wild card, but the ECB will have this in mind if it is earnest about pushback.   Near-term balance of risks still tilted towards higher rates The thought of a soft landing actually materialising against all odds are supporting risk assets in all corners of the market. The S&P 500 closed at new record levels on Friday and also on Monday the equities rally pushed on through. In rates the pricing in of a soft landing has pushed down rates along the curve at the start of the week, supported by the idea that inflation is coming down as markets are eyeing this week’s PCE data. But markets are starting to fine-tune their expectations more in line with our thinking, even if we see more scope for correction in this direction: pricing for a March Fed cut is now down to 10bp, even though overall pricing for cuts this year has even deepened somewhat again to 134bp. Even though we also see inflation coming down steadily, we warrant caution about markets still getting ahead of themselves – especially in EUR rates. The European Central Bank will meet on Thursday and we expect a reiteration of their data-dependent path towards policy normalisation. Last week yields came down the day that Lagarde hinted at rate cuts in the summer. The best that markets can hope for is a reiteration of that comment, but given the guarded fashion of Lagarde’s statements we can see a scenario where she does not repeat this dovish message in the context of the policy meeting this week. We therefore see a chance that EUR 2Y rates will recalibrate higher again in response to the press conference when markets don’t get exactly what they are looking for. In the US there is also no guarantee that the nudge lower in rates we saw at the start of this week will extend. Markets have their eyes on a 2.0% core PCE inflation, in line with the Fed’s mandate that will be published on Thursday, which, if met, would keep the market pricing of a March rate cut as a realistic scenario. If, on the other hand, the actual number were to exceed 2.0%, even by a bit, we could imagine the market reacting more sensitively to such a disappointment. Similarly, we would expect an asymmetric reaction to the GDP growth figures, which our economist expects to come in firm on Thursday. On balance, if data come in as expected the further downside is moderate, but at least near term the potential could still be larger.   Tuesday's events and market views Japan will kick-off this week's central bank meetings but no change of the policy rate is expected. In terms of economic data releases Tuesday will be another light day. The EU Commission will publish the consumer confidence index and the ECB will release results of its bank lending survey. In the US we a few business indicators from regional Feds. It is the rest of the week will be of more interest, with eurozone PMIs on Wednesday, the ECB meeting and US GDP data on Thursday followed by the PCE on Friday. In primary markets Germany will sell 4Y and 30Y green bonds while the Netherlands taps a 15Y bond. The US Treasury sells new 2Y notes. In SSAs the EU has mandated syndicated taps of existing 7Y and 30Y bonds, which should also be Tuesday’s business.

Eurozone PMIs show very tentative signs of bottoming out The eurozone economy continues to trend around 0% growth and there are no signs of any imminent recovery. Price pressures are still increasing for the service sector, which provides another argument for the ECB not to hike before June. How you read today’s PMI release for the eurozone reveals whether you’re an optimist or a pessimist. The increase from 47.6 to 47.9 in the composite PMI for January cautiously shows signs of bottoming out but also still indicates contraction. We also note that France and Germany saw declining PMIs, making the increase dependent on the smaller markets. Manufacturing price pressures remain moderate despite the Red Sea disruptions, but the service sector indicates another acceleration in input costs. To us, this shows that the eurozone economy remains in broad stagnation and that risks to inflation are not small enough to expect an ECB rate cut before June. The eurozone continues to be plagued by falling demand for goods and services, although new orders did fall at a slower pace than in recent months. Current production and activity were weaker than in recent months, though, suggesting that January started with contracting output still. The slowing pace of contracting orders does suggest that there is a bottoming out happening though. Whether this is enough to show positive GDP growth in the first quareter depends on February and March. In any case, GDP growth is so close to zero that we still qualify the current environment as broad stagnation anyway. The PMI continues to show some concern around inflation. Even though demand remains lacklustre, services cost pressures are on the rise again due to higher wage costs which are being transferred to consumers. Cost pressures on the goods side remain low despite Red Sea disruptions as energy prices trend lower and demand overall remains weak. This also means that goods inflation continues to trend down according to the survey. So, despite Red Sea problems prominently featuring in the news, inflation concerns currently stem more from services than goods, interestingly. For the ECB, enough worries about inflation not trending down to 2% quickly still remain. We think that makes a first cut before June unlikely.

05:40GMT Thursday 25th January 2024 ECB and US Q4 GDP in focus By Michael Hewson (Chief Market Analyst at CMC Markets UK) European markets saw a much more positive session yesterday, carrying over the momentum from a buoyant US market, but also getting a lift after China announced a 0.5% cut in the bank reserve requirement rate from 5th February. US markets finished the day mixed with the Dow finishing lower for the 2nd day in succession, while the S&P500 and Nasdaq 100 once again set new record highs, as well as record closes, although closing off the highs of the day as yields edged into positive territory. This divergence between the Dow and Russell 2000, both of which closed lower for the second day in succession, and the Nasdaq 100 and S&P500 might be a cause for concern, given how US market gains appear to be being driven by a small cohort of companies share prices. Today's focus for European markets which are set to open slightly lower, is on the ECB and the press conference soon after with Christine Lagarde, where apart from questions on timelines about possible rate policy, Lagarde could face some questions a little closer to home amidst dissatisfaction over her leadership style from ECB staffers. When looking at the economic performance of the euro area, we've seen little in the way of growth since Q3 of 2022, while inflation has also been slowing sharply. Yet for all this economic weakness, a fact which was borne out by yesterday's flash PMI numbers, especially in the services sector, the ECB has been insistent it is not close to considering a cut in rates, having hiked as recently as last September. Only as recently as last week we heard from a few governing council members of their concerns about cutting too early, yet when looking at the data, and the fact that the German economy is on its knees, the ECB almost comes across as masochistic in its desire to combat the risks of a return of inflation. In a way it's not hard to understand given that after November headline inflation slowed to 2.4%, it picked up again in December to 2.9%, while core prices slowed to 3.4%. This rebound in headline inflation while no doubt driven by base effects will be used as evidence from the hawks on the governing council that rates need to stay high, however there is already evidence that the consensus on rates is splintering, and while no more rate hikes are expected the economic data increasingly supports the idea of a cut sooner rather than later. Markets currently have the ECB cutting rates 4 times this year in increments of 25bps, starting in June, although given the data we could get one in April. This contrasts with the market pricing up to 6 rate cuts from the Federal Reserve despite the US economy being magnitudes stronger than in Europe. No changes are expected today with the main ECB refinancing rate currently at 4.5%, however Q4 GDP due next week, and January CPI due on 1st February calls for a March/April rate cut could start to get louder in the weeks ahead, especially since PPI has been in deflation for the last 6 months. US bond markets appear to be starting to have second thoughts about the prospect of 6 rate cuts from the Federal Reserve this year, although there is still some insistence that a March cut remains a realistic possibility. Today's US Q4 GDP numbers might bury the prospect of that idea once and for all if we get a reading anywhere close to 2%. This seems rather counterintuitive when you think about it, the idea that the Fed would cut before the ECB when Europe is probably in recession and the US economy is growing at a reasonable rate, albeit at a slower pace than in Q3. Expectations for Q4 are for the economy to have slowed to an annualised 1.9% to 2%, which would be either be the weakest quarter of 2023 or match it. Nonetheless the resilience of the US consumer has been at the forefront of the rebound in US growth seen over the past 12 months, with a strong end to the year for consumer spending. This rather jars against the idea that US GDP growth might get revised lower in the coming weeks as some have been insisting. If you look at the December control group retail sales numbers, they finished the year strongly and these numbers get included as a part of overall GDP. Weekly jobless claims are also at multi-month lows of 187k, and while we could see a rise to 200k even here there is no evidence that the US economy is slowing in such a manner to suggest anything other than a modest slowdown as opposed to a sudden stop or hard landing.  The core PCE Q/Q price index is expected to slow from the 3.3% seen in Q3 to around 2%, which may not be enough to prompt a softening in yields unless we drop below 2%. EUR/USD – pushed up to the 1.0930 area before retreating. While above the 200-day SMA at 1.0830, the bias remains for a move higher towards the main resistance up at 1.1000.  GBP/USD – pushed up towards 1.2775 yesterday with support at the 50-day SMA as well as the 1.2590 area needed to hold or risk a move lower towards the 200-day SMA at 1.2540. We need to get above 1.2800 to maintain upside momentum. EUR/GBP – fell to 0.8535 before rebounding modestly. Also have support at the 0.8520 area, with resistance at the 0.8620/25 area and the highs last week. USD/JPY – finding a few offers at the 148.80 area over the last 3days which could see a move back towards the 146.25 area. A fall through 146.00 could delay a move towards 150 and argue for a move towards 144.00. FTSE100 is expected to open 19 points lower at 7,508 DAX is expected to open 36 points lower at 16,854 CAC40 is expected to open 10 points lower at 7,445.  

US GDP rises 3.3% (annualized) in Q4 A fairytale outcome for the US economy GBPUSD drifts lower US economic data continues to point to an economy that’s doing very well despite the various headwinds including very high interest rates. GDP data for the fourth quarter easily exceeded expectations, rising 3.3% on an annualized basis, adding to the increasing view that the US could be heading for a fairytale scenario, not just a soft landing. We’ve spoken a lot about resilence in the US economy over the last couple of years but that the economy can continue to show such strength and low unemployment with interest rates so high and inflation falling back toward target is unbelievable.   Cable edges lower after failing again at 1.28 The pound has repeatedly tested 1.28 against the dollar over the last couple of months and despite the occasional breach, it’s failed to significantly break higher.   GBPUSD Daily Source – OANDA It broke below a rising trendline last week, further signaling that the trend is weakening, amid divergence between price and the MACD. It’s now tested those highs again – and the trend line – and failed which could be another suggestion that the rally is running on fumes. A move below 1.26, the low of the last month, would further back this up and could trigger a sharper decline in the pair.

French industrial output continues its rebound French industrial production rebounded sharply in December. The worst appears to be over for the sector, and its recovery is set to continue into 2024. A brighter start to 2024 French industrial production rebounded sharply in December, rising by 1.1% over the month, following on from November's increase (+0.5% over the month). The data are also good in the manufacturing industry sub-sector, where production is up by 1.2% over the month (after +0.2% in November). The manufacture of transport equipment, industrial products and agri-foodstuffs all rose sharply in December. On the other hand, production fell in the equipment goods manufacturing branch. All in all, between the end of 2022 and the end of 2023, French manufacturing output rose by 0.3%. From these figures, we can conclude that the French industrial sector continues to recover. After a very complicated 2023 overall, the end of the year was a little better and suggests that 2024 is beginning under better conditions. The worst is probably over. In fact, all the indicators already published for January suggest that the recovery in industry should continue in the first quarter. In the surveys, industrial companies are slightly more confident about the future and more optimistic about their production in the coming months. In addition, order books have started to rebound, albeit still at very low levels. Demand no longer seems to be weakening. There are therefore signs of a sustained rebound in the industrial sector, and we can expect production to grow slightly faster in 2024 than in 2023. However, this rebound is likely to be gradual and not continuous over the course of the year, as external shocks such as blockades, strikes or geopolitical events could temporarily limit industrial output.   GDP growth to remain weak While the rebound is already visible in the industrial sector, this is not necessarily the case in other sectors. As a result, the better industrial performance will not be enough to produce dynamic GDP growth in the first quarter of 2024, and growth is likely to remain close to 0%. For the year as a whole, even if we expect a gradual recovery in other sectors from spring onwards, the very low starting point means that we are only forecasting 0.5% GDP growth in 2024 (compared with 0.8% in 2023). This is a much lower figure than the government's – likely unattainable – forecasts.

Czech National Bank Preview: Time to catch up We expect the pace of cutting to accelerate to 50bp, which will push the CNB key rate to 6.25%. The main reasons will be low inflation in the central bank's new forecast, which should allow for more cutting in the future. For year-end, we see the rate at 4.00% but the risk here is clearly downwards.   Optimistic forecasts could speed up the cutting pace to 50bp The Czech National Bank will meet on Thursday next week and will present its first forecast published this year. We are going into the meeting expecting an acceleration in the cutting pace from 25bp in December to 50bp, which would mean a cut from the current 6.75% to 6.25%. This means a revision in our forecast, which previously saw an acceleration taking place in March. Still, it's certain to be a close call given the cautious approach of the board – and that could bring a 25bp cut.   The board will have a new central bank forecast, which is likely to be a key factor in decision-making. Here we see the need for revision in a few places, but overall everything points in a dovish direction. On the global side, compared to the November forecast, we expect the CNB to revise down both GDP growth, rates and oil prices. On the domestic side, inflation has surprised downwards only slightly in the past three months for both headline and core inflation. Still, we expect some downward profile shift due to a better outlook for food, energy and oil prices. As for GDP, the CNB was the most pessimistic forecaster in the market in November and the incoming data was rather mixed in this regard, so we expect only modest changes here. The CZK was 0.35% stronger than the central bank's expectations in the fourth quarter of last year. On the other hand, it was slightly weaker in January. Overall, we do not see any significant impact on the new forecast here, but the lower EURIBOR profile after the revision may indicate a stronger CZK in the new forecast, or allow for faster rate cuts in the CNB model. The November forecast indicated roughly a 50bp cut in the fourth quarter last year and reaching 3.50% by the end of this year, delivering a total 350bp of rate cuts. As we know, the CNB delivered only 25bp last year, which will need to be reflected in the new forecast. Overall, we expect a slightly steeper rate path again with a 3.00% level at the end of 2025, which should have a dovish outcome for the market in our view. As always these days, we can also expect several alternative scenarios, one of which will be the board's preferred scenario, showing a slightly slower rate cuts profile than the baseline.   Inflation nowcast will be key to the decision We see from public statements that the dovish wing of the board (Frait, Holub) will push for a faster pace of rate cuts given inflation numbers indicating a quick return to the 2% inflation target this year and will be open to more than 50bp of rate cuts. For the rest of the board, we think the inflation indication for January and beyond in the central bank's new forecast is key. We are currently expecting 2.7% for January headline inflation, with room for it to come in lower if the anecdotal evidence of January's repricing is confirmed. This, in our view, will give the rest of the board the confidence to accelerate the pace of cutting as early as this meeting.   4% at the end of the year or lower depending on core inflation Looking forward, we believe the favourable forecast for the coming months will allow the 50bp pace to continue. Here, our forecast remains unchanged and we think core inflation will still prevent the board from going faster later. We therefore still assume a 4% key rate at the end of this year. But if core inflation continues to surprise to the downside, we find it easy to imagine lower levels here.     What to expect in FX and rates markets The CZK has weakened in recent days following comments made by Deputy Governor Jan Frait and touched 24.90 EUR/CZK, which is basically the weakest level since early 2022. If the CNB delivers a 50bp rate cut, it's obviously negative news for the CZK. But on the other hand, we believe that the market positioning is already heavy short and rates are already pricing in the vast majority of CNB rate cuts. That's why we see the cap at 25.20 EUR/CZK. A minor cut, however, could bring a temporary strengthening towards 24.70 given heavy dovish expectations. In our base case scenario, we think that after the 50bp rate cut and January inflation, the market should have hit the limit of what can be priced in and the CZK should start appreciating again later this year thanks to the economic recovery, good current account results and falling EUR rates improving the interest rate differential. The rates market fully priced in a 50bp move recently and expects another 50bp move for the next meeting, which is close to our forecast. However, the terminal rate is already priced in at 3% at the end of this year, which we don't have on paper until next year – but we still see this as a possible scenario if inflation remains under control. If we do see the CNB's forecast, the market can easily get excited for a lower terminal rate and overshoot market pricing. Therefore, we expect the combination of the 50bp cut and the dovish forecast to push market rates further down, resulting in further steepening of the curve. In the bond space, we maintain our positive view here going forward. Czech government bond supply has fallen significantly as we expected and, combined with the inflation profile and central bank cutting rates, offers a perfect combination in the CEE region. Here, we continue to prefer belly curves and see more steepening.