monetary tightening

FXMAG.COM: Could you please comment on the US NFP? On Friday, the US will publish the employment data for May 2023. The average forecast suggests NFP growth by 180 thousand after rising to 253 thousand earlier.This is not a confident expectation. After a winter during which the US employment market added over 200 thousand new jobs per month, these statistics look modest. However, in this case, high digits might imply a threat to the US economy. If the Federal Reserve System sees that companies continue to compete for high-skilled workers, it might continue with its tough monetary policy.Strong employment market data will encourage further interest rate hikes to prevent inflation from rising.The situation turns out paradoxical. Good employment reports are no longer seen positively because they could be the basis for a further rise in crediting costs.Data that differs from forecasts will cause increased volatility in the US stock market.

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.  

CAD: Our call is a BoC hawkish hold today The Bank of Canada moved considerably earlier than other central banks to the dovish side of the spectrum and has kept rates on hold since January. Now, stubborn inflation, an ultra-tight labour market and a more benign growth backdrop are building the case for a return to monetary tightening. Markets are attaching a 45% implied probability that a 25bp hike will be delivered today.   While admitting it’s a rather close call, we think a hawkish hold is more likely (here's our full meeting preview), as policymakers may want to err on the side of caution while assessing the lagged effect of monetary tightening. We still expect a return to 2% inflation in Canada in the early part of 2024 with the help of softer commodity prices. Developments in the US also play a rather important role for the BoC: recent jitters in the US economic outlook (ISM reports recently added to recession fears) and the proximity to a “toss-up” FOMC meeting would also warrant an extension of the pause.   Still, we expect another hold by the BoC to be accompanied by hawkish language. Markets are pricing in 40bp of tightening by the end of the summer, and we doubt policymakers have an interest in pushing back or significantly disappointing the market’s hawkish expectations given recent data. So, as long as a hold contains enough hints at potential future tightening, we think the negative impact on CAD should be short-lived and we keep favouring the loonie against other pro-cyclical currencies in the current risk environment.

Rates Spark: Enough out there to nudge market rates higher Weak economic data dents the European Central Bank’s ability to push rates up. Even if July and September hikes were fully priced in, Bund and swap will find it hard to rise above the top of their recent range. Direction is far from clear, but our preference is to position for upward pressure on yields.     Soft economic data dents ECB hawkish rhetoric For financial markets, a flurry of weak economic activity data – most prominently in the manufacturing sector such as yesterday’s German factory orders and tofay's industrial production – sits awkwardly with the European Central Bank's (ECB) message that more monetary tightening is needed.   The pre-meeting quiet period starts tomorrow, making today the last opportunity to skew investor expectations but markets pricing a 25bp hike at this meeting are unlikely to move much. Another important clue as to future policy moves will be in the staff forecasts released at the same time as next week’s policy decision.   The 2025 headline and core inflation projections at the March meeting stood at 2.1% and 2.2% annualised, above the ECB’s target and a clear signal that more tightening is needed – even above and beyond the path for interest rates priced by the market in late February.   Dovish-minded investors can point to a decline in oil and gas futures since the March meeting, as well as a downtick in consumer inflation expectations in the most recent survey released yesterday. Will this be enough for the ECB to no longer signal that it has ‘more ground to cover’? Probably not, but markets may not care. The focus among hawks is squarely on core inflation and the modest decline from a 5.7% peak in March to 5.3% in May hasn’t been met with much relief by the Governing Council, but it has pushed euro rates down relative to their dollar peers.        

The case for rates having already peaked is weakening We started by noting that markets seem confused by recent events and their pricing may reflect this. Cash rate futures point to rates rising to over 4.6% - a further 50bp of hikes. Our view is that this is too much and that the current cash rate of 4.1% could be the peak, though this view has certainly been damaged by the latest labour report.  Our principal argument for a more moderate rate outlook is that we do expect to see inflation coming down over the coming months, and consequently, the pressure for the RBA to keep hiking will lessen substantially – especially as they aren’t expecting inflation to come down much over the coming quarters, so the hurdle for surprises on the downside is quite a low one. Still, this isn’t likely to be plain sailing. What was once mainly a supply-side shock affecting energy and food prices has widened out to a much broader inflationary issue, with virtually all components of the CPI basket rising at a rate in excess of the RBA’s target range, and the annualised run-rate of inflation (currently about 4%) still inconsistent with getting inflation back to trend.     Further complicating the picture is the fact that despite the RBA’s tightening, house prices, which had been falling, ticked up in 1Q23. If the RBA’s tightening were sufficient to slow the economy, we would expect this to show up in housing - one of the most interest-sensitive parts of the economy. If it isn’t, then it is probably unlikely that we will see less sensitive areas, such as consumer spending dip as much as will be required for inflation to ease. That said, the house price increase seems at odds with sharply lower consumer confidence and so for now, our best guess is that the housing bump in 1Q23 was more of a blip than a concrete turn in prices. Nevertheless, a rapidly rising population, spurred by strong net inward migration as well as low housing supply could keep house prices and rents under further upward pressure. This area certainly bears close watching.     Conversely, the RBA has little interest in causing more hardship than needed in the residential property market, and will likely also be cautious about the outlook for commercial real estate should it squeeze growth too hard. Banking sector metrics look extremely solid, and delinquent and past-due loans aren’t flashing any warning signs. But as we’ve learned recently in other jurisdictions, even well-regulated financial markets are not immune to adjustment problems that are associated with monetary tightening of the scale we have seen in markets like the US, the EU, or Australia. And this, perhaps, also supports a more cautious outlook on rates than that currently priced in by markets.   Unemployment and wages (%)

The European Central Bank (ECB) has recently made a surprising shift in its approach towards financial stability, signaling a departure from its historically dovish stance. This decision, prompted by the challenges posed by inflation, has significant implications for both the performance of individual economies and the overall prosperity of the European Union.   In this article, we had the opportunity to discuss the ECB's decision with Petr Ševčík, an analyst from BITMarkets, who shared valuable insights into the repercussions of this move. BITMarkets, a platform that has been closely monitoring the rise of cryptocurrency trading in Europe, has observed increased trading activity in this sector since the beginning of the year. Cryptocurrencies, known for their volatility, have gained attention as a potential refuge in times of economic uncertainty and hardship. As inflationary pressures continue to burden traditional industries such as housing and banking, some investors are turning to alternative assets like cryptocurrencies.   The impact of the ECB's decision is already being felt across various sectors, with construction and materials stocks experiencing a 0.8% drop and bank stocks dwindling by 0.7%. These developments are a natural consequence of higher borrowing costs, leading to a slowdown in loan growth. However, amidst these challenges, there are signs of resilience in certain areas. Media stocks, for instance, enjoyed a 0.7% upside following the news, indicating that the markets may begin to respond more favorably to individual performance rather than being solely influenced by widespread conditions.    FXMAG.COM: Could you please comment on the ECB decision?   It's crystal clear that the reluctant ECB is that of the past. Historically known for adopting a very dovish approach towards financial stability of the bloc by avoiding sharp interest hikes, its decision to bump rates again highlights the struggles caused by inflation which are burdening the performance of individual economies and corporations and the livelihood of individuals; on a macro scale, this has been hindering the prosperity of the European Union for a daunting lengthy period. BITmarkets has witnessed the rise of crypto trading since the start of the year, and a notable portion of increased trading activity has stemmed from Europe. Cryptocurrency assets are volatile and always have been, but they have been regarded as refuge by some in times of economic uncertainty and hardship. What's apparent is that the housing industry and the banking sector are among the industries which are being damaged the most, with construction and materials stocks dropping 0.8% and bank stocks dwindling 0.7% following the news. From a wider perspective, this is only natural as borrowing costs increased which attributes the slowdown of growth in loans.  While the news was not taken very lightly as the continent's most popular indices shed their prices, I don't project much more dismay for Europe with regards to economic stability. Media stocks enjoyed a 0.7% upside and that speaks a thousand words. Inflation is cooling down and markets may begin to behave based on performance rather than being continuously-succumbed to widespread conditions. The European financial market has been a victim of calamitous market conditions for years, but the latest ECB move is one that can ultimately bring the EU out of its shell.

Stocks tumble on fears monetary tightening will trigger a recession Fed rate hike bets still only pricing in one last rate increase European bond yields plunge on downbeat global sentiment   US stocks are sliding as the global growth outlook continues to deteriorate following soft global PMI readings.  The risk of a sharper economic downturn is greater for Europe than it is for the US, so that could keep the dollar supported over the short-term.  This has been an ugly week for stocks and that is starting to unravel a lot of the mega-cap tech trades. The Nasdaq is getting pummeled as the AI trade is seeing significant profit taking.      Europe Brief: European stocks got rattled after France posted a surprise contraction with their Services PMI.  Almost all the European PMI readings disappointed and that is bursting the euro trade. Stubborn UK inflation is forcing the BOE to become a lot more aggressive with their rate hiking campaign, which will pile on significantly more pain on people with mortgages. UK Chancellor Hunt needed to do something for homeowners and this year-long break before repossessions is a step in the right direction. Over 2 million UK mortgage holders are going to see skyrocketing monthly mortgage bills and right now it seems it will steadily get worse.     Bostic The Fed’s Bostic delivered a dovish message today after favoring no more rate hikes for the rest of the year. Bostic is optimistic that the Fed will bring down inflation without tanking the job market.  Bostic is in the minority as other members will need to see a significant deterioration in the data.  Today, the service sector PMI declined not as much as expected and is still trading near pre-pandemic levels. The June preliminary Services PMI fell from 54.9 to 54.1, a tick higher that 54.0 consensus estimate. The economic resilience for the US will likely keep the majority of Fed officials with a hawkish stance.       

Strong data and soft inflation boost appetite US stocks shrugged off the early week pessimism on the back as of a set of strong economic data released yesterday.   The durable goods orders rose – along with strong jobs data, this is a sign that the US businesses are not in cash-saving mode, Richmond manufacturing index fell less than expected, house prices recovered and house sales beat expectations – in line with the rest of the strong data from US housing market over the past few weeks. US consumer confidence jumped more than expected in June, to the highest level since the beginning of last year.     We would've normally expected sentiment to be dampened by strong data because of more hawkish Federal Reserve (Fed) expectations, but the S&P500 jumped more than 1%, Nasdaq rallied almost 2%, while the Russell 2000 advanced around 1.5%.      Easing inflation is maybe why stock investors are happy with strong data The Australian inflation fell to a 13-month low, and the Canadian inflation fell more than expected, in a sign that the central bank efforts to pull prices lower is paying off. The AUDUSD was sharply sold below its 50-DMA which stands near the 0.6680 level, while the USDCAD rebounded off a fresh low since September on the back of soft inflation and a 2% fall in crude oil prices.   Across the Atlantic Ocean, some encouraging news came in regarding inflation, as well. The British shop prices dipped to 8.4% this month, down from 9% recorded in May. That was the sharpest decline in prices since the end of 2021 – when prices took a lift, and it was not thanks to the Bank if England (BoE) hikes, but it was because Tesco, Sainsbury's, Asda and Morrisons were asked to 'behave' in their pricing to prevent them from passing the higher costs, and higher wages on to their clients more than necessary. So, it is possible that Jeremy Hunt rolling up his sleeves would be more effective to bring inflation down than any BoE hike at this stage.   The good news for the Brits is that, Rishi Sunak and Jeremy Hunt have all the motivation in the world to bring inflation down if they don't want to be minced at next year's election. The bad news is that, if they don't achieve fast results, they will still be minced because the BoE will continue hiking rates and that will leave millions of households facing an enormous rise in their housing costs.   And the Bank for International Settlements, known as the central bank of the central banks, warned that the final stretch of the monetary tightening will likely be the toughest, with some 'surprises' on the way. Another banking crisis, real estate chaos, a financial crisis? We will see. Today, the Fed will reveal the result of its stress test for the banks. If they see no issue, they will keep pushing, until something breaks.     By Ipek Ozkardeskaya, Senior Analyst | Swissquote Bank

On Tuesday, the EUR/USD currency pair struggled to establish itself above the moving average line, failing to surpass the Murray level of "3/8"-1.0925, resuming its downward trend in the latter half of the day. However, to label this movement as a "decline" would be an overstatement, as the day's total volatility was merely 40 points. As such, the past week better embodies the idea of a "flat" market rather than a trending one. Currently, the currency market is experiencing a tranquil period.   The fundamental and macroeconomic landscapes are intact, but the market appears saturated by them. Time and again, macroeconomic reports are in line with market expectations. Statements by representatives of the Fed and ECB do not offer traders any new or crucial information. The euro continues to maintain a relatively high position but has been static in recent weeks. The subject of interest rates is becoming less pertinent to traders. It's worth noting that when a monetary tightening or easing cycle initiates, the market endeavors to anticipate it. If this happens concurrently in two or more countries, as is usually the case, the market also strives to consider all changes preemptively.     For instance, last year, the Fed began raising rates ahead of the ECB, resulting in an initial surge in the dollar's value (taking geopolitics into account). Subsequently, as inflation in the US began to ease, the euro began to appreciate. It has been on an upward trend for the past ten months, although it has been largely consolidating in the 1.05–1.11 range for the last 5–6 months. Consequently, we do not foresee any significant triggers for a sudden upswing in the value of the euro or the dollar.   The pair will likely continue to consolidate within the outlined range, and it might take considerable time before this process reaches completion. The market has already accounted for 90% of all forthcoming interest rate hikes by the Fed and ECB.   Currently, neither the euro nor the dollar holds a distinct advantage. Many experts have been forecasting a downturn, recession, and deceleration for the US economy, particularly for the labor market. These predictions have been circulating since last year, yet official statistics suggest no signs of a looming recession.   Over the past three quarters, the US economy has grown by at least 2%, significantly more than the growth observed in the European Union or Britain. The labor market continues to demonstrate robust performance month after month, even with the Fed's rate escalating to 5.25%. Unemployment has seen minimal growth, while Nonfarm Payrolls consistently reveal at least 200 thousand new job additions each month.     As such, the Fed can continue its monetary tightening policy as required, especially now that inflation has fallen to 4%. This factor might play against the dollar in the medium term. Since inflation is already approaching the target level, the Federal Reserve will begin to soften monetary policy in 2024. It is unknown when the ECB, dealing with higher inflation, will begin to soften. Nevertheless, inflation in the Eurozone continues to decrease steadily. It initially rose more than in the US. Hence, it needs more time to return to 2%. However, the ECB began raising the rate after the Fed. Thus, everything is in its place. The European regulator may start reducing the rate a few months later than the Fed.   The monetary policy of the Fed and the ECB currently does not imply a strong strengthening of the dollar or the euro. The average volatility of the euro/dollar currency pair for the last five trading days as of July 5 is 70 points and is characterized as "average." Thus, we expect the pair to move between levels 1.0779 and 1.0915 on Wednesday. A reversal of the Heikin Ashi indicator upwards will indicate a new round of upward movement.

Inflation outlook in Poland should improve, leading to rate cuts As expected, rates in Poland remained unchanged (reference rate still 6.75%). In the press release, the Council focused on 2H23 and 2024 – a period of more benign inflation prospects. The bank president should sound dovish at Friday's press conference, highlighting many disinflationary pressures and preparing the ground for rate cuts this year.   Communication by the central bank This month’s Monetary Policy Council statement is more concise than after the June meeting, but it speaks of a greater conviction about the decline in inflation in the second half of 2023 and 2024. Also, the MPC expresses its view that rate hikes are working and inflation is coming down to the target. National Bank of Poland President Glapiński is likely to speak in this vein tomorrow! The most important changes in the communication are: (1) a more optimistic picture of global inflation (2) more optimistic inflation trends in Poland - e.g. the sentences mentioning the still ongoing process of passing on high costs to prices have disappeared (3) a greater belief in the effectiveness of the monetary tightening, which has already started the process of bringing inflation down to the target: in the summary passage on future inflation, the MPC states that: "The Council assesses that the strong tightening of the NBP monetary policy is leading to a decline in inflation in Poland towards the NBP inflation target". Earlier, it had said that the strong tightening of the NBP's monetary policy made earlier would lead to a lowering of inflation. The statement also noted the low economic activity in the second quarter and elevated uncertainty in the global economy and the euro area. The decline in global inflation was highlighted, including a marked decline in producer price dynamics. Although still elevated CPI and core inflation was noted, there was mention that the latter is gradually declining. Regarding the domestic situation, the Council points out that the annual CPI fell once again to 11.5% year-on-year in June from 13.0% in May, while remaining unchanged for the second consecutive month in month-on-month terms. The Council estimates that core inflation also declined in June and notes a strong fall in PPI producer inflation, which will influence the CPI to fall further in future quarters.   New GDP and inflation projections In our view, the projections show a better inflation picture in the second half of the year and 2024, but the longer-term outlook is less optimistic: (1) the NBP’s CPI projection for 2023 remained unchanged, but for 2024 was revised down by 0.5 percentage points compared to the March publication, a short-term faster decline in inflation is emerging from these numbers, but the CPI projection for 2025, which has increased slightly, is of concern (see also below) (2) in our view, with average CPI projection for 2023 at 11.9% YoY, we still think that a decrease of headline CPI below 10% in August is still possible, which could lead to an interest rate cut after the summer. In contrast, annual GDP growth is expected to be -0.2 - 1.3% YoY this year (-0.1 - 1.8% assumed in March), 1.4 - 3.3% in 2024 (previously 1.1 - 3.1%) and 2.1 - 4.4% in 2025 (vs. 2.0 - 4.3%).\   National Bank of Poland projections   Our rate forecasts – we expect interest rate cuts in September and October The MPC is strongly focused on the second half of 2023 and 2024 – a period when the inflation situation looks better compared with the March projection, so we maintain our view that rate cuts are possible after the holidays, i.e. in September and October. Tomorrow, during its press conference the NBP President should sound dovish, highlighting many of the above-mentioned developments towards lower inflation and preparing the ground for rate cuts. In the longer term, we do not see a convincing weakening of inflationary pressures. With the CPI projection for 2024 at 5.3% YoY and a planned minimum wage increase of around 20%, the real minimum wage in 2024 will increase by more than 15%! We maintain our view that going down to the NBP's 2.5% target with such real wages will be difficult and long-lasting. Our models show core inflation stabilising at 5% YoY in 2024-25. At tomorrow's press conference by NBP Governor Adam Glapiński, we expect the tone to be more dovish than a month ago. It is possible that the governor will prepare the ground for interest rate cuts after the summer.

The Commodities Feed: Further US SPR purchases The oil market had a strong end to the week following the extension of Saudi voluntary cuts earlier in the week. For this week, markets will be focused on US CPI data on Wednesday, whilst specifically for the oil market, we have the IEA and OPEC oil market reports released later in the week.   The oil market managed to pull off a second consecutive week of gains with ICE Brent settling almost 4.8% higher last week. Cuts from both Saudi Arabia and Russia have provided some support, although the market will have to continue to contend with macro uncertainty, which has capped the market over the last couple of months. The recent action taken by Saudi Arabia will likely provide some comfort to longs as it sends the signal that the Saudis are committed to putting a floor under the market. The latest positioning data shows that speculators increased their net long in ICE Brent by 25,106 lots over the last reporting week to 184,906 lots as of last Tuesday. This move was predominantly driven by fresh longs entering the market, with the gross long increasing by 16,881 lots. Meanwhile, for NYMEX WTI, speculators increased their net long by 23,820 lots to 95,363 lots. This was driven almost exclusively by short covering. At 112,155 lots, the gross short in WTI is still sizeable and so with the right catalyst, there is the potential for a short-covering rally. Another factor which is providing some degree of support to the market is the refilling of the US Strategic Petroleum Reserve (SPR). On Friday the Department of Energy (DoE) announced that it will be looking to purchase around 6MMbbls of US sour crude oil for delivery in October/November.  Up until now, the DoE has successfully tendered for 6.3MMbbls, with this volume set to be delivered in August and September. There had been reports that the DoE was looking to buy roughly 12MMbbls this year, and if we see the total volume awarded in the latest announcement, that would get us to this 12MMbbls already. A large explosion at a Mexican platform, which was sadly deadly, saw Pemex reduce oil output by 700Mbbls/d. However, the bulk of these shut-ins appears to have been precautionary and 600Mbbls/d of this output has already returned, according to the company. Drilling activity in the US continues its decline with the latest data from Baker Hughes showing that the number of active US oil rigs fell by five over the week to 540. This is the lowest number since early April 2022. The number of active oil rigs in the US has fallen by 81 since the start of the year. Lower drilling activity suggests more limited supply growth. And this is a trend that we have seen in the EIA’s US crude oil supply forecasts with less than 200Mbbls/d of US supply growth expected in 2024. The EIA will release its latest Short-Term Energy Outlook on Tuesday, which will include US production forecasts for the remainder of 2023 and 2024. In addition to the EIA’s Short-Term Energy Outlook release on Tuesday, both OPEC and the IEA will release their latest monthly oil market reports on Thursday. Given the macro uncertainty, the market will likely be focused on any changes to demand forecasts in both reports. Away from energy markets, the big macro release this week will be US CPI numbers on Wednesday, which will likely further shape market expectations on how much more monetary tightening we could see from the US Federal Reserve in the months ahead.

In the FX   The US dollar index consolidates at the lowest levels since April 2022, as the oversold market conditions certainly encourage short-term traders to pause and take a breather. Also helping are some dovish comments from European Central Bank's (ECB) Knot yesterday, who said that monetary tightening beyond next week's meeting is not guaranteed, while at least two 25bp hikes were seen as almost a done deal by markets until yesterday. Ignazio Visco also hinted that inflation could ease more quickly than the ECB's latest projections. So the comments sent the German 2-year yield to a 3-week low. The EURUSD bounced lower after hitting 1.1275, and rising dovish voiced from the ECB could keep the EURUSD within the 1.10/1.12 range into the next policy decision.   Across the Channel, inflation numbers freshly came in this morning, revealing that inflation in Britain eased to 7.9% in June versus 8.2% expected by analysts and 8.7% printed a month earlier. Core inflation on the other hand fell below the 7% mark last month. Cable slipped below 1.30 as a kneejerk reaction as softer inflation tempered Bank of England (BoE) hawks. But even with a softer-than-expected figure, inflation in Britain remains high and stickier than in other Western economies, and that keeps odds for further BoE action sensibly more hawkish than for other major central banks. The BoE raised its policy rate to 5% at its latest meeting, and is expected to continue toward 6.5 to 7% range in the next few months. If inflation slows, the peak rate will be pulled to 6-6.5% range, but not lower. And rising rates, that weigh on mortgages in Britain where Brits must renew mortgages every 2-5 years, pressure housing market and fuels the worst living crisis in decades, combined with political shakes into next year's elections are all factors that could stall the rally in sterling against major peers. Cable benefited from a broad-based weakness in the US dollar since last September dip, but gaining field above the 1.30 mark could prove difficult.    

Rates Spark: The stretch before two key central bank meetings There was some selling of bonds yesterday, and it feels a bit vulnerable here considering the decent total returns recorded year-to-date against all odds given monetary tightening and the future recession risk. There is also a pre-FOMC and pre-ECB theme in the air. Many will wait to get the central bank(s) assessment of things before pulling the trigger.   Long duration buying in the past month morphs to a selling tendency Most of the past month has been dominated by bond buying, typically long duration in nature. The same has been seen in corporates, and there has also been a decent bid into high-yield bonds. A glance at total return year-to-date show some impressive bond market performances, led by higher beta products. There are always profit-taking risks attached to this. A lot of the buying in the past month or so had helped to keep core yields from getting too carried away to the upside. But yesterday more selling than usual was seen for a change, in particular out of Asia. This was a factor in unleashing Treasury yields higher. The low jobless claims number pushed in the same direction, but would not have been enough as a stand-alone to push the 10yr yield from 3.75% to 3.85%. And other data today has in fact been quite muted or negative for the economy. The terminal discount for the funds rate also remains elevated, with the Jan 2025 future still above 3.75%. That keeps the pressure focused on the upside for market rates. The 4% level for the 10yr Treasury yield is firmly in focus here, likely post next week's FOMC outcome; at least we'll likely need to get through that first.   Closing in on cycle peaks With inflation dynamics looking more encouraging, the general notion is that central banks are close to their cycle peaks in terms of tightening. If we look at current pricing, the market is seeing a good chance that the Fed will deliver its final hike of the cycle next week. Historical patterns suggest that a re-steepening of the yield curve led by the front end then followed as recession eventually ensued. And indeed, if it were to go by the Conference Board's Leading indicator, which posted another drop yesterday, we would have been in recession for a long time already.  However, the context looks somewhat different this time, as some parts of the economy still look unusually resilient. And markets are seeing a growing likelihood of a soft landing, which itself limits the drop in front-end rates as less aggressive rate cuts are then needed. On the flip side, that resilience continues to harbour potential upside risks to inflation. And central banks will therefore tread more cautiously and not take any chances. They are sensitive to their poor track records of forecasting inflation in the past and are basing their policies on current inflation dynamics rather than their models.   Curves have reflattened over past weeks, a clear steepening signal remains elusive      

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.

In a recent interview with FXMAG.COM, we had the privilege of discussing the current state of inflation in the United States with Michael Stark, an experienced analyst from Exness. As inflation has been a hot topic of discussion and concern for both investors and policymakers, we sought Stark's insights on whether the downward trend in inflation will continue in the third quarter. According to Stark, unless there are any significant unforeseen events, it is likely that inflation will continue to fall in the U.S., albeit not by a substantial margin. He points out that American non-core inflation has been steadily slowing since the previous summer, with monthly fluctuations showing some variability. One of the primary factors contributing to the deceleration in inflation is the strong cycle of monetary tightening, which has been one of the most robust in history. Coupled with the relatively steady price of oil compared to the previous year and supply chains returning to a semblance of normalcy for most products, the pressures on inflation have become less evident. Additionally, weaker job data in the USA, traditionally considered a significant driver of inflation, have also played a role in the moderation of price increases. FXMAG.COM: Will inflation continue to fall in the U.S. in the third quarter? Barring some exceptional event, yes, but maybe not by very much. American non-core inflation has slowed consistently since last summer although the monthly declines in the rate have been somewhat variable. This has been one of the strongest cycles of monetary tightening in history and, combined with the price of oil remaining relatively steady compared to last year and supply chains back to normal or something resembling normal for most products, the biggest pressures on inflation are much less clear now. Job data in the USA – traditionally cited as being a key driver of inflation – have also been weaker overall since the second quarter. However, it’s probably too early to start expecting a return to 2% inflation even by the end of the year. Now that the Fed is likely to pause hikes and possibly start cutting in the second quarter of 2024, we might see inflation stick above the old target. Inflation is quite unpredictable more than a few months ahead, but holding PMIs might suggest that it could remain above target for longer.  

In our conversation with Alex Kuptsikevich, an analyst from FXPro, we delve into the Bank of England's recent decision on interest rates and its implications for the British economy and the GBP. The central bank's move to raise its key interest rate by 25 basis points to 5.25% is a significant step, marking the highest rate since 2008. This decision comes as Britain grapples with one of the highest inflation rates among developed nations, leaving little room for inaction. Unlike the Federal Reserve and the European Central Bank, the Bank of England cannot afford to take a wait-and-see approach. The soaring inflation necessitates swift action, and indications suggest that the central bank may not stop raising interest rates until it reaches 5.75%, matching the peak of monetary tightening seen in 2007.   FXMAG: What is your assessment of the Bank of England's decision on interest rates? Should we still expect a hike in the Isles? And what's next for the GBP in the context of the BoE's decision? The Bank of England is expected to raise its key interest rate by 25 points to 5.25%, the highest since 2008. Britain's inflation rate, one of the highest in the developed world, makes it impossible to pause and look around - a privilege the Fed has used and the ECB may do in September. It is worth bracing for indications that the BoE will not stop raising interest rates before the end of the year, taking the rate to 5.75% - the peak of monetary tightening in 2007.   The Bank of England's hawkish stance is also likely to attract buyers to the Pound, which has weakened over the past three weeks. An appreciating currency will suppress imported inflation and dampen consumer demand, helping to bring CPI back to the 2% target. With explicit hawkish comments from the central bank, GBP can avoid breaking the upward trend of recent months and accelerating its decline.  

EUR: Hard to see it trade out of range According to our short-term fair value model, EUR/USD’s equilibrium level currently sits around 1.0950, quite close to spot. The pair remains overbought according to CFTC positioning data (+23% of open interest), but there are clear indications that the process of adding EUR longs/building USD net shorts has stalled again in July. All in all, it appears that EUR/USD has managed to navigate the worst (barring new volatility peaks) of the US bond sell-off relatively easily, a sign that markets remain reluctant to let go of a cyclical currency like the euro in the current market environment (despite a deteriorating outlook for the eurozone economy) and the room for a big dollar recovery remains still narrow given markets now expect the Fed to be done with monetary tightening. We had warned our readers that August might well have been a directionless month for EUR/USD: things can change (developments in the Russia-Ukraine conflict should be followed closely, to name one), but we have not received any strong indication so far that EUR/USD may materially drift away from a 1.09-1.11 range this month. Today, some focus will be on the ECB’s Consumer Expectation Survey, which includes inflation expectation figures, and final CPI numbers for July in Germany and other EU countries.  

AUD: Room for a big rebound We have just published an update of our macro and market views on Australia. As highlighted in recent commentary, we are very reluctant to align with the view that the Reserve Bank of Australia is done with monetary tightening, and think that the market is underestimating the risks of another rate hike, which is our base case. That should be driven by a surprise in the monthly inflation data, potentially already in September. This should pave the way for a recovery in the Aussie dollar, which currently is undervalued in the short and medium-term, having absorbed the negative implications of Chinese growth rerating and recent instability in global sentiment. We see substantial room for a recovery in AUD/USD before the end of the year, in line with our call for a USD decline, and target a return to the 0.69 July peak in the fourth quarter.  

Asia Morning Bites Chinese stocks weather the latest US investment ban. Chinese lending data today and 2Q23 GDP from the Philippines.   Global Macro and Markets Global markets:  It was another day of slight falls for US stocks on Wednesday, though things could have gone either way until late trading when there was a final dip lower. The S&P 500 fell 0.7% while the NASDAQ fell 1.17%. Chinese stocks were mixed, which isn’t a bad result considering the inflation data which turned negative, and the new US ban on investment in Chinese technology. The Hang Seng fell 0.32%, while the CSI 300 fell 0.31%. US treasury bond yields were also mixed on Wednesday, the 2Y yield rose 5.7bp to 4.808%, though the 10Y yield fell 1.4bp to 4.008% after a good auction.  EURUSD recovered a little ground, rising to 1.0976, but failed to make it above 1.10. The AUD and GBP were both fairly flat relative to the previous day, though the JPY saw further losses, rising to 143.657. Asian FX was fairly rangebound yesterday too, with most registering small gains of less than a quarter of a percent. G-7 macro:  US CPI inflation data for July is due today, and we are likely to see something we haven’t seen for some time, namely, annual inflation rising. The good news is that this is mainly due to base effects, and the month-on-month gain in the CPI index is expected to be modest at 0.2%, which is broadly in line with the Fed’s target. The bad news is that this indicates that the going will be a lot heavier for inflation from now on, without those nice helpful base effects that dominated the second quarter. Core inflation is expected to drop only 0.1pp to 4.7%. China: Aggregate finance data is released today. New CNY loans are forecast to rise by CNY780bn, which puts it slightly ahead of last year’s CNY678bn figure. Given the recent disappointing macro data, there might be some downward surprises here, though loans have been one of the stronger parts of China’s data in recent months.   Philippines:  2Q GDP is set for release today.  Market consensus is at 6.0%YoY, a slowdown from the 6.4% reported in 1Q.  Elevated prices likely capped household spending while capital formation also probably slowed due to the lagged impact of previous monetary tightening. Government officials are targeting full-year growth of 6-7%YoY, although given various headwinds, we feel that growth may be headed for a slowdown for the rest of the year.  What to look out for: US inflation Philippines GDP (10 August) RBI policy meeting (10 August) US initial jobless claims and CPI inflation (10 August) Singapore CPI inflation (11 August) Hong Kong GDP (11 August) US PPI inflation, University of Michigan sentiment (11 August)

Philippines: 2Q GDP disappoints as revenge-spending fades and rate hikes finally weigh on momentum 2Q23 GDP grew 4.3%YoY, much slower than the market expectation of a 6% gain.   2Q23 GDP disappoints in a big way The Philippine economy grew 4.3%YoY in the second quarter of 2023, much slower than the market expectation, which was for a 6% gain.  On a quarter-on-quarter basis, the economy contracted by 0.9% as high inflation and the lagged impact of previous monetary tightening weighed on economic activity.  This was the slowest pace of expansion since 2011, with growth momentum slowing due to a challenging global landscape, price pressures, lacklustre fiscal stimulus and elevated borrowing costs.    Overall, this was a disappointing report with the slowdown evident in all major sectors of the economy.  Household consumption posted slower growth of 5.5%YoY, slowing from the 6.4% expansion in 1Q23.  A combination of fading revenge-spending on top of an unfavourable base effect (presidential elections were held in 2Q 2022) capped household consumption.  Meanwhile, the aggressive tightening carried out by Bangko Sentral ng Pilipinas last year weighed on capital formation, with overall investment outlays unchanged from last year.  Lastly, government spending, which had been an important source of support throughout the pandemic, contracted by 7.1%YoY.  Year-to-date growth slowed to 5.3%, much lower than the government’s target of 6-7% growth, which now looks out of reach given our expectation for growth to slow further in the coming quarters.   PHL economic growth sputters to slowest pace (YoY%) since 2011   Governor Remolona stuck between slowing growth and rising inflation risk BSP meets next week to discuss monetary policy against a backdrop of slowing domestic growth momentum and rising upside risks to the inflation outlook.  The Philippines imports energy and grain, and the prices of both have been on the rise recently, potentially threatening the current downward path of inflation. 

Broader market concerns have weighed on the complex, whilst a stronger dollar has only provided further headwinds. However, for oil at least, the fundamentals remain constructive   Energy: Large US crude draws The oil market continues to come under pressure, with Brent falling 1.7% yesterday, following a raft of weaker-than-expected Chinese macro data this week. The latest Fed minutes will not be helping sentiment, with them suggesting that the US Fed may have some more work to do when it comes to monetary tightening. The strength in the USD over much of the week will also be providing further headwinds to the market. As for WTI, it settled below US$80/bbl for the first time since early August. However, whilst there are broader market concerns, oil fundamentals remain largely constructive as continued OPEC+ supply cuts should ensure that we see sizeable inventory draws for the remainder of the year.  The EIA’s weekly inventory report was largely constructive, showing that US commercial crude oil inventories fell by 5.96MMbbls over the last week.  This leaves crude oil inventories at a little under 440MMbbls, which is the lowest level since the start of the year. Crude oil inventories at Cushing fell by 837Mbbls, leaving them at 33.8MMbbls- levels last seen back in April. The large draw in commercial inventories was largely driven by a rebound in crude oil exports, increasing 2.24MMbbls/d WoW. Refiners also increased their run rates by 0.9pp over the week to 94.7%. Although despite stronger refinery activity, gasoline inventories still fell by 262Mbbls, whilst distillate stocks grew by 296Mbbls. Labour talks in Australia look as though they will roll into next week in an attempt to avoid strike action at several LNG facilities after there was no breakthrough in negotiations earlier this week. Reports suggest that talks will continue next Wednesday. The fact that talks are expected to continue next week has provided some comfort to the market, with TTF settling  2.65% lower yesterday. For Europe, given the comfortable storage situation (90% full), we would need to see a large amount of the roughly 41mtpa LNG capacity at risk, disrupted for a prolonged period, in order to be overly bullish for prices.

Metals - Gold struggles The gold market remains under pressure, with spot prices now trading below US$1,900/oz. The realisation that we are unlikely to see the Fed start cutting rates this year has weighed on gold. In fact, recent US macro data suggests that there is still the possibility that the Fed may have more work to do when it comes to monetary tightening. We could see some volatility later this week in gold prices with Jerome Powell set to talk at Jackson Hole on Friday, possibly providing some insight on Fed policy for the remainder of the year. Higher rates have seen 10 year real yields hit their highest levels since 2009 recently, and they continue to edge closer towards 2%. The stronger rate environment combined with USD strength is certainly not proving supportive for gold. ETF holdings in gold have seen 12 consecutive weeks of outflows - over this period we have seen outflows of around 4moz, leaving total ETF gold holdings at around 90moz. Speculators also reduced their net long in COMEX gold by  29,042 lots to 46,540 lots over the last reporting week. The latest trade data from China Customs show that imports of unwrought aluminium and products rose 20% YoY to 231.5kt in July. This leaves cumulative imports over the first seven months of the year at 1.43mt, up 12.2% YoY. On the export side, alumina exports jumped by 266% YoY to 130kt last month, while YTD exports have risen by 16% YoY to 700kt. This increase is driven largely by stronger flows to Russia.

Metals - Gold struggles The gold market remains under pressure, with spot prices now trading below US$1,900/oz. The realisation that we are unlikely to see the Fed start cutting rates this year has weighed on gold. In fact, recent US macro data suggests that there is still the possibility that the Fed may have more work to do when it comes to monetary tightening. We could see some volatility later this week in gold prices with Jerome Powell set to talk at Jackson Hole on Friday, possibly providing some insight on Fed policy for the remainder of the year. Higher rates have seen 10 year real yields hit their highest levels since 2009 recently, and they continue to edge closer towards 2%. The stronger rate environment combined with USD strength is certainly not proving supportive for gold. ETF holdings in gold have seen 12 consecutive weeks of outflows - over this period we have seen outflows of around 4moz, leaving total ETF gold holdings at around 90moz. Speculators also reduced their net long in COMEX gold by  29,042 lots to 46,540 lots over the last reporting week. The latest trade data from China Customs show that imports of unwrought aluminium and products rose 20% YoY to 231.5kt in July. This leaves cumulative imports over the first seven months of the year at 1.43mt, up 12.2% YoY. On the export side, alumina exports jumped by 266% YoY to 130kt last month, while YTD exports have risen by 16% YoY to 700kt. This increase is driven largely by stronger flows to Russia.

The Japanese yen faced considerable losses on Monday as USD/JPY surged to 146.23 during the North American session, marking a 0.57% increase for the day. The US dollar's strength has propelled it dangerously close to pushing the yen below the critical 146 line, a scenario witnessed last week when the robust US dollar drove the struggling yen to a nine-month low. Once synonymous with deflation, the Japanese economy has undergone a significant transformation in the era of high global inflation. With Japan's inflation hovering slightly above 3%, a level that many major central banks would eagerly welcome, the landscape has shifted. Notably, inflation remains relatively high by Japanese standards, as both headline and core inflation have consistently outpaced the Bank of Japan's (BoJ) 2% target. Japan's inflation data is closely scrutinized as the prospect of elevated inflation sparks speculations that the BoJ might need to tighten its lenient policy stance. Although the central bank has maintained that the high inflation is transitory, it's worth remembering that other central banks have made similar claims only to backtrack later. The Federal Reserve (Fed) and the European Central Bank (ECB) come to mind as examples. In the previous week, July's Consumer Price Index (CPI) remained steady at 3.3% year-on-year, while Core CPI experienced a slight dip to 3.1% year-on-year from the previous 3.3%. Looking ahead, Tuesday brings the release of BoJ Core CPI, the central bank's favored inflation metric, which is projected to decrease to 2.7% for July, down from June's 3.0%.   USD/JPY pushes above 146 line Bank of Japan’s Core CPI is expected to ease to 2.7% The Japanese yen has posted significant losses on Monday. USD/JPY is trading at 146.23 in the North American session, up 0.57% on the day. The US dollar has looked sharp and is within a whisker of pushing the yen below the 146 line, as was the case last week when the strong US dollar pushed the ailing yen to a nine-month low. The Japanese economy was once synonymous with deflation, but that has changed in the era of high global inflation. Japan’s inflation is slightly above 3%, a level that other major central banks would take in a heartbeat. Still, inflation is relatively high by Japanese standards and both headline and core inflation have persistently been above the Bank of Japan’s 2% target. Japan’s inflation reports are carefully monitored as higher inflation has raised speculation that the BoJ will have to tighten its loose policy. The central bank has insisted that high inflation is transient, but the BoJ wouldn’t be the first bank to make that claim and then backtrack with its tail between its legs. Remember the Fed and the ECB? Last week, July’s CPI remained unchanged at 3.3% y/y. Core CPI dropped to 3.1% y/y, down from 3.3%. On Tuesday, Japan releases BoJ Core CPI, the central bank’s preferred inflation gauge, which is expected to dip to 2.7% in July, down from 3.0% in June. China’s economic troubles have sent the Chinese yuan sharply lower, with the Chinese currency falling about 5% this year against the US dollar. A weak yuan makes Chinese exports more attractive, but this is at the expense of other exporters including Japan. As a result, there is pressure in Japan to lower the value of the yen in order to compete with Chinese exports.   USD/JPY Technical USD/JPY pushed above resistance at 145.54 earlier today. The next resistance line is 146.41 There is support at 144.51 and 143.64    

GBP: Volatile pricing ahead of PMIs Bank of England rate expectations have been quite volatile since the upside surprise in wages and CPI last week. The miss in retail sales on Friday saw peak Bank rate expectations as measured in the Sonia rate drop more than 10bp. Markets are currently looking at 5.95-6.0%, but today’s PMI release in the UK may well move pricing again. Consensus is expecting some slowdown in both manufacturing (already in contraction territory) and services (to 51.0). The Bank of England will also look at the details of the survey searching for evidence that price pressures are abating. EUR/GBP can make another attempt at breaking 0.8500 today, although the sustainability of sub-0.8500 levels is questionable unless markets price in more rate hikes in the UK or price out tightening in the eurozone.

New inflation methodology offers hope for BoE 1.28 could be major resistance point for GBPUSD A break of 1.26 could be bearish signal   Recent UK economic data has been a mixed bag, with wages rising at a much-accelerated rate but inflation decelerating as expected. While the Bank of England will be relieved at the latter, the former will remain a concern as wage growth even near those levels is not consistent with inflation returning sustainably to target over the medium term. The ONS released new figures overnight that appeared to suggest core inflation is not rising as fast as the CPI data suggests. The reportedly more sophisticated methodology concluded that core prices rose 6.8% last month, down from 7% the previous month and 7.3% the month before. The official reading for July was slightly higher at 6.9% but down from only 7.1% in May. So not only is the new methodology showing core inflation lower last month but the pace of decline is much faster. That will give the BoE hope that price pressures are easing and they’re expected to do so much more over the rest of the year.     GBPUSD Daily     It’s not clear whether this will prove to be a resumption of the uptrend or merely a bearish consolidation. It is currently nearing 1.28, the area around which it has previously run into resistance this month and around the 38.2% Fibonacci retracement level. Another rebound off here could be viewed as another bearish signal, which may suggest we’re currently seeing a bearish consolidation, while a move above could be more promising for the pound. If the pair does rebound lower then the area just above 1.26 will be key, given this is where it has recently seen strong support. It is also where the 55/89-day simple moving average band has continued to support the price in recent months.

Rising rice and energy prices in the Philippines fuel inflation concerns The 'crucial 3': will the return of rice and energy price spikes delay Bangko Sentral ng Pilipinas’ easing plans?   Philippine inflation on the downtrend... for now Philippine inflation hit a peak of 8.7% year-on-year in January 2023, driven by a mix of resurgent domestic demand and elevated global commodity prices. Inflation has since moderated to 4.7%YoY as of July.  A string of aggressive monetary tightening (rate hikes totalling 425bp) on top of moderating global energy prices helped nudge the inflation path towards the Bangko Sentral ng Pilipinas’ (BSP's) inflation target of 2-4%. The BSP projects inflation will settle back within target by the fourth quarter.  However, recent developments could derail the current slowdown, particularly with price pressures for key commodities flaring up again.   Rice, transport and power = the crucial three Past episodes of high inflation in the Philippines have been driven in large part by supply-side issues. Local rice production is inadequate to meet domestic demand and so the country relies on imports of the grain from neighbouring economies. The Philippines also depends on imported energy for power generation and transport, highlighting how vulnerable the economy is to sharp fluctuations in global energy prices.  We have identified three key items in the CPI basket, namely rice, electricity and transport, which combined account for 23.41% of the total. For the most recent inflation episode, the crucial three accounted for 41% of inflation for 2022, highlighting the importance of stabilising price movements for these key commodities.  Given their weight in the CPI basket and the country’s dependence on imports of rice and energy, any sharp upticks for the so-called “crucial 3” could spell a renewed flareup for Philippine inflation.      The 'crucial 3' for Philippine inflation: rice, transport and electricity   It's not a meal without rice Rice is the main staple in the Philippines and meals are not considered a “full meal” without it. This fact is reflected in the 9.6% weight of rice in the CPI basket. Crop damage from storms or inclement weather has forced the Philippines to import more of the staple to shore up supply in the past. Developments in 2023 cloud the domestic production outlook with the onset of the El Niño weather phenomenon on top of the recent export ban from India.  Legislation passed in 2019 (RA 11203) removed quotas on rice importation, which in theory could help augment domestic supplies, however the Philippines could face elevated import costs given the impact of El Niño on rice exporters and the India rice export ban. Rice inflation recently moved past the target (4.2%YoY) and could increasingly become a concern should supply conditions tighten further in the coming months.   Philippines reliant on rice imports   Energy dependent On top of being dependent on rice imports, the Philippines is also dependent on energy imports for power generation and transportation. Transport and electricity have substantial weights in the CPI basket, at 9.02 points and 4.8 points respectively. The spike in global energy prices in 2022 was one of the key drivers for inflation with transport and electricity registering inflation of 12.9%YoY and 18.5%YoY. The recent resurgence in global energy prices due to developments in Ukraine and production cuts has resulted in higher Philippine domestic pump prices. This development should eventually filter through to higher electricity costs with 13.5% of power generation driven by oil-based power plants.   Furthermore, high inflation for transportation and electricity often results in second-round effects. Expensive transport and electricity costs could fuel an increase in prices for items that require transport and electricity in production, resulting in even more price pressures.   Crucial 3' inflation spike to complicate BSP's plan to ease? BSP recently hinted at a potential policy reversal by the first quarter of 2024, pointing to forecasts where inflation would be well within target by that time.  The BSP is an inflation-targeting central bank with the goal of keeping inflation within the band of 2-4%. Recent tightening episodes were in 2014, 2018 and 2022 with BSP hiking rates to deal with price spikes induced by rising costs for rice and energy. The recent uptick in rice prices coupled with the resurgence in global energy costs could spark renewed price pressures and prevent headline inflation from settling well within the BSP’s inflation target band. We had originally pencilled in a BSP rate cut by the first quarter of next year given the disappointing second-quarter GDP report. However, if we continue to see rice and energy prices tick higher in the coming months, we could see BSP delaying its planned easing to mid-2024.   BSP could delay rate cuts should inflation flare up again      

Central banks The situation with central banks looks decidedly different to the 1970s, for two key reasons. First, while the response to the initial Covid wave was huge – and in hindsight probably too aggressive – policymakers have not shied away from applying the brakes ever since. No central banker wants to be remembered as the modern-day Arthur Burns, and there’s a clear incentive to err on the side of keeping rates too high for too long. While we expect rate cuts in 2024, it’s highly unlikely that rates will return to the ultra-low levels seen before the Covid pandemic. Meanwhile, central bank balance sheets are increasingly likely to be used for targeted financial stability interventions rather than to deliver large monetary stimulus.   The other major difference is that central banks are now independent, whereas with the exception of the German Bundesbank, that largely wasn’t the case in the 1970s. This independence, as well as monetary tightening in the 1980s, laid the basis for lower inflation expectations. Since the 1980s, central bank credibility has become an important asset in the fight against inflation. Therefore, central banks will be less inclined to ease monetary policy when inflation expectations are still high. Will that change? It’s unlikely, and independence has so far survived the era of populism relatively unscathed, at least among G10 economies. High interest rates are likely to be a key topic going into elections in the US and UK, among others, in 2024. But ultimately, central banks will be reluctant to return to the days of ultra-low rates.

Uncomfortably high inflation and wage growth should seal the deal on a September rate hike from the Bank of England. But emerging economic weakness suggests the top of the tightening cycle is near, and our base case is a pause in November. Markets have been reassessing Bank of England rate hikes Rewind to the start of the summer, and the view that the UK had a unique inflation problem had become very fashionable. At its most extreme, market pricing saw Bank Rate peaking at 6.5%, some 125bp above its current level. Since then, this story has begun to lose traction. The differential between USD and GBP two-year swap rates, a gauge of interest rate expectations, has halved. That reflects the growing reality that the UK inflation story looks less of an outlier than it did a few months back. Like most of Europe, food inflation has begun to slow, and further aggressive falls are likely judging by producer prices. Consumer energy bills fell by 20% in July, and another 5% decline is baked in for October. The Bank of England itself is now describing the level of interest rates as “restrictive” – a statement of the obvious perhaps, but nevertheless tells us that policymakers think they’ve almost done enough with rate hikes.   UK and US rate expectations have narrowed   A September hike is likely but November is less certain Still, we’re not quite there yet, and recent inflation data has continued to come in on the upside. Private sector wage growth – measured on a three-month annualised basis – is running at a cycle-high of 11%. Services inflation also edged higher in July, although this was partly attributable to some unusual swings in specific categories rather than broad-based moves. A September hike is therefore highly likely. Whether markets are right to be pricing another hike for November is less certain. We’ll only get one round of CPI and wage data between the September and November meetings. Wage growth is unlikely to have slowed much, but we’re hopeful for early signs that services inflation is inching lower. Various surveys suggest few service-sector firms are raising prices, and we think that reflects the sharp fall in gas prices. A lot also hinges on whether we continue to see signs of weakness in economic activity. Like Europe, the UK’s PMIs look worrisome and will have prompted some pause for thought at the Bank of England. The jobs market is also cooling, and the vacancy-to-unemployment ratio – which BoE Governor Andrew Bailey has consistently referenced – is closing in on pre-Covid highs. There’s also been an ongoing improvement in worker supply. We’re now at a point where survey numbers and various bits of official data suggest that both economic growth and inflation are losing steam. The inflation and wage growth figures aren’t there yet, but these are lagging perhaps most out of all economic indicators. A November pause isn’t guaranteed, but it remains our base case. To some extent, we’re splitting hairs. In the bigger picture, the Bank is becoming much more focused on how high rates need to go – and instead, the central goal will increasingly become keeping market rates elevated long after it stops hiking. Any further rate hikes should be seen as a means to that end.      

China concerns weigh on industrial metals It has been a summer of downward pressure for most metals. Renewed strength in the US dollar and a growing view that maybe the Fed has more work to do when it comes to monetary tightening has provided some strong headwinds to the metals complex. However, it is weakness in China which has been the key catalyst for the sell-off seen in most metals. The property sector remains weak, with housing starts and residential floor space sold still in deep contraction, whilst new home prices have started falling once again month-on-month. In addition, China’s manufacturing PMI remains in contraction territory. These are two important sectors for metals demand which are clearly struggling. Meanwhile, retail sales in China, which helped to support growth earlier in the year, are also weakening. Metal markets are likely to continue to be largely dictated by developments in China. However, it is difficult to see a swift recovery in China’s property sector. A number of base metal markets also appear to be more comfortable in terms of supply, at least in the prompt market. This is evident with the cash/3M spreads for aluminium, copper and zinc having all weakened recently and trading in contango. In addition, these three metals have seen inventory levels in LME warehouses growing over at least the last month.  

FX Daily: Peso too strong, renminbi too weak, dollar just right FX markets await today's release of the August US jobs report to see if we've reached any tipping point in the labour market. Probably not. And it is still a little too early to expect the dollar to embark on a sustained downtrend. Elsewhere, policymakers in emerging markets are addressing currencies that are too weak (China) and too strong (Mexico).   USD: The market seems to be bracing for soft nonfarm payrolls data Today's focus will be the August nonfarm payrolls jobs release. The consensus expects around a +170k increase on headline jobs gains, although the "whisper" numbers are seemingly nearer the +150k mark. Importantly, very few expect much change in the 3.5% unemployment rate. This remains on its cycle lows, continues to support strong US consumption, and keeps the Fed on its hawkish guard. We will also see the release of average hourly earnings for August, which are expected to moderate to 0.3% month-on-month from 0.4%. As ING's US economist James Knightley notes in recent releases on the US economy and yesterday's US data, there are reasons to believe that strong US consumption cannot roll over into the fourth quarter and that a recession is more likely delayed than avoided. But this looks like a story for the fourth quarter. Unless we see some kind of sharp spike higher in unemployment today, we would expect investors to remain comfortable holding their 5.3% yielding dollars into the long US weekend. That is not to say the dollar needs to rally much, just that the incentives to sell are not here at present. If the dollar is at some kind of comfortable level, policy tweaks in the emerging market space over the last 24 hours show Beijing trying to fight renminbi weakness and Mexico City trying to fight peso strength (more on that below). We suspect these will be long, drawn-out battles with the market. DXY can probably stay bid towards the top of a 103-104 range.

China Caixin services PMI slips to 51.8 UK100 erases earlier losses Potential breakout confirmation could be a bullish signal China is continuing its sluggish recovery this year with the latest Caixin services PMI slipping back to 51.8 from 54.1 and well below forecasts. As we saw in the official survey data last week, it highlights the economy is struggling from both weak internal and external demand. Measures to support the economy have been limited and targeted so far and there’s little to suggest that approach is going to change in the foreseeable future. The PMI data may be contributing to the weaker performance in China and Hong Kong overnight and the uninspiring start in Europe.     Confirmation of last week’s breakout in UK100  The chart isn’t offering too many clues either, with early declines erased and the UK100 trading marginally higher on the day. UK100 Daily Source – OANDA on Trading View The index has pulled off its lows over the last couple of weeks after a pretty miserable August but I’m not convinced the last month truly reflects the sentiment in the market going into the end of the year. It’s seen support this morning around 7,400, as it has on a number of occasions in months gone by after running into resistance yesterday around 7,500. That could perhaps be viewed as a bullish signal, a confirmation of the break above 7,400 last week, with 7,500 and 7,600 above the next notable areas of technical resistance. But broadly speaking, this still looks like an index that’s struggling for sustained direction. Perhaps with the end of global monetary tightening almost upon us, the outlook can become clearer which will enable a break in one direction or another.

The time is coming when the strongest trend is coming to an end. But this does not apply to the American dollar. In 2021, it strengthened due to expectations of monetary tightening by the Federal Reserve, and in 2022, due to its implementation. In 2023, investors expected the trend in the USD index to be broken. And at first, everything was going according to plan. However, in the summer, there was a 180-degree turnaround, which came as a real surprise to hedge funds. They remain short sellers of the American currency and are losing money.   Dynamics of the U.S. dollar and hedge fund positionsej     The September survey of Reuters experts suggests that in the short term, "bears" on EUR/USD will maintain their strength due to a strong economy and high U.S. Treasury bond yields. However, over the next three months, the euro will rise to $1.09. In 6 months, it will be worth $1.10, and in 12 months, $1.12. This forecast is based on the idea of a dovish pivot and the central bank's move towards reducing federal funds rates. Derivatives indicate that it will drop by 100 basis points in 2024. The same opinion was held about the U.S. dollar at the beginning of the year, but its opponents were proven wrong. At that time, investors were worried about a recession.   It was supposed to force the Federal Reserve to loosen its monetary policy. In the early autumn, markets began to fear not an economic downturn but its overheating. If the United States maintains its strength, inflation could accelerate, prompting the Federal Reserve to return to monetary tightening and further strengthen the American dollar. If we also consider that the American economy is the cleanest shirt in the basket of dirty laundry, the decline in EUR/USD seems logical. Indeed, following new manufacturing orders in Germany, German industrial production disappointed.   In July, it contracted by 0.8%. The leading economy in the eurozone has still not emerged from the slump. Is it surprising that the GDP of the currency bloc grew by only 0.1% in the second quarter? Less than the 0.3% in the initial estimate.     Thus, if in 2021-2022, the focus in the Forex market was on monetary policy and fear of high inflation, in 2023, they gave way to economic growth divergence. Judging by the strong labor market positions and the surge in business activity in the services sector to a six-month high, the U.S. GDP in the third quarter may expand by 3% or more. What's the point of selling the dollar? It's much more interesting to acquire securities denominated in it. The capital flow to North America has supported and will continue to support the "bears" on EUR/USD.     The ECB, on the other hand, can only sympathize. On the one hand, the European Central Bank is obliged to maintain "hawkish" rhetoric in the face of inflation exceeding 5%. On the other hand, the higher the interest rates rise, the greater the chances of a recession in the eurozone economy. Technically, on the daily chart of EUR/USD, the inability of the "bulls" to hold onto the key pivot level of 1.0715 indicates their weakness. The decline of the pair to 1.066 and 1.0595 continues. The recommendation is to hold shorts.  

Czech National Bank preview: Last meeting before first rate cut The CNB is starting to discuss the possibility of cutting rates and we believe that conditions will allow the first cut as early as November. In any case, the board will want to stay on the cautious side, and the tone of the press conference will reflect that. However, the CNB has little to offer from its hawkish arsenal given that a cut is only a matter of time now.   The debate on rate cuts begins The Czech National Bank (CNB) will hold its monetary policy meeting next Wednesday, which we believe will be the last one before the vote on cutting rates. This time there will be no new central bank forecast and the board will only discuss an internal update on the situation. For now, it seems that the CNB is happy with the numbers coming out of the economy. Economic growth was slightly above expectations in the second quarter, on the other hand, wage growth and headline and core inflation are below the central bank's forecast. Only EUR/CZK is pointing in an inflationary direction with weakening after the August CNB meeting, and more recently after the National Bank of Poland's (NBP's) surprise decision (of a 75bp rate cut) in early September. However, the CNB was expecting this direction, and based on recent communication we believe FX is not a game-changer.   Board members have already indicated that the September meeting will be used to discuss the rate-cutting strategy, so we could see some details from this discussion. In any case, the CNB will try to sell future rate cuts with a hawkish and cautious tone. However, we doubt that the central bank has anything more to offer from its hawkish arsenal to the markets, especially in the context of the current shift in market expectations towards a later rate cut. Moreover, the central bank's recent moves – the end of the FX intervention regime and the easing of capital and mortgage requirements – indicate a dovish bias of the board.   First rate cut in November Our forecast remains unchanged – the first 25bp rate cut in November along with a new central bank forecast. Of course, the risks here are clear. The central bank could wait for the January inflation number and cut rates at the start of next year. However, we believe that the combination of faster-falling inflation, weak economic numbers and FX at current or stronger levels will be a reason for the board to cut rates in November and avoid too much monetary tightening and inflation near the target in January. Looking ahead, we don't expect there to be more than two 25bp rate cuts (in November and December) before the January inflation number is released (after the February meeting). Further down the line, however, we expect the CNB to gradually increase the pace of cuts if the numbers confirm inflation is near the 2% target.   What to expect in FX and rates markets In the FX market, the Czech koruna suffered a depreciation after the end of the CNB's exchange rate regime in August and the NBP's surprise rate cut in September. In particular, due to the spillover shock within the region in the last few weeks, we believe EUR/CZK should be lower and are slightly positive on the CZK. This should be supported by the CNB's cautious tone next week. Of course, EUR/CZK levels will play a key role in the November decision and we believe the pain threshold for the CNB to delay rate cuts until the first quarter of next year is 25.0 EUR/CZK. In the rates market, we see the pricing of rate cuts in the short term, within two years, as more or less fair. If anything, we see less chance of big rate cuts in the first quarter, as the market currently expects. On the other hand, we see the biggest mispricing at the long end of the curve, which has out-priced a CNB return to the 3% equilibrium rate level. Thus, the IRS curve now points to rates above 4% in the long term and we see room for downward repricing here once rate-cutting discussions begin next week. Czech government bond (CZGBs) yields have moved higher following the sell-off in core markets, which we believe opens up a good opportunity to benefit from a clearly positive outlook. On the supply side, MinFin is already limiting issuance as the year-end approaches and the better-than-expected state budget result. In addition, MinFin is now starting to frontload next year's needs through switches, confirming a comfortable situation with nearly 75% of the CZGBs plan covered. Thus, we see the current yield as attractive ahead of the materialisation of a massive supply drop next year and by far the best inflation profile in the CEE region followed by the CNB rate cuts. Thus, we like CZGBs both outright and in the spread versus the IRS curve, which should head into negative territory in the coming months, in our view.  

RBA hikes rates - market reaction is curious Although the RBA hike was expected by the majority of the forecast community, markets were not completely sold on the idea, which is why it is curious that the AUD weakened on the decision and that bond yields fell.   RBA hikes but AUD softens It was no surprise that the RBA hiked the cash rate by 25bp today. Only three of the Bloomberg consensus expected the RBA to hold rates steady today. We were not among them. However, the market pricing was more circumspect, with only about a 59% probability of a hike priced in to today's meeting.  All of which makes the subsequent market reaction quite strange.  The AUD made a very brief run stronger on the announcement, but almost immediately fell back, dropping to about 0.643 from about 0.652 prior to the announcement.  Australian government bond yields also declined. 10Y government bond yields fell from about 4.76% to 4.70% and yields on 2Y government bonds fell from 4.37% to 4.31%. There was a slight decline in US Treasury yields at the same time, which may have influenced things, but it isn't a particularly satisfactory explanation.      RBA statement was reasonably hawkish This market reaction cannot either be put down to the accompanying statement by the RBA, which in our view leant in a hawkish direction.  The justification the RBA gave for today's hike was the slow progress being made towards their target inflation range, the arrival at which was put back to late 2025. The RBA also judged that the weight of information received since the previous meeting raised the chances that inflation would remain higher for longer.  The RBA's statement also kept the door open to the possibility of further hikes, saying that "Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks". Thanks to base effects, next month's inflation data will probably show another increase (see chart above). However, we don't think the RBA will respond again so soon if inflation does indeed rise. After that, when the November and December figures are released, absent the floods and energy shortages of last year, we should see inflation resume its downward trend, which may be enough to cement the view that this was the last hike this cycle after all.  The risk to this view comes from the current run rate for inflation. For the last 2 months, the CPI index has risen by 0.6% MoM. This isn't consistent with an inflation rate between 2-3% but rather one closer to 7%. So this also needs to slow down considerably over the coming months. If it doesn't, then instead of the rate cuts that we expect could be on the radar by mid-2024, we might still be looking at some further tightening before we can call this rate cycle truly over. As the RBA notes in their statement, "There are still significant uncertainties around the outlook".  

CEE: Turkey hiking rates again Today's calendar in the region is basically empty. Elsewhere today, we have a central bank meeting in Turkey. We expect another rate hike of 250bp to 37.5%, which is broadly in line with expectations, but surveys show a wider range of rate hikes. The latest inflation release in October showed the underlying trend starting to improve not only for the core rate but also the headline. Accordingly, we expect the bank to consider a slower hike. However, risks are on the upside given strong tightening moves since August. In FX, yesterday brought an unexpected turn in Czech rates. The market was heavily paid across the curve, more so than elsewhere in the CEE region. The rates move thus shot the interest rate differential up for once, erasing the potential for the CZK weakness we mentioned earlier. EUR/CZK responded by moving lower and back to 24.450. For now, this seems to match the rate move exactly. However, it is hard to say where rates will head today. Yesterday's statement from the Czech National Bank, released after the rate move, suggests that the discussion about waiting for January inflation continues. On the other hand, weak economic data and a stronger koruna are reasons for lower rates and bets on an earlier rate cut. Despite the timing of the first rate cut, we think the short end of the curve should be lower, leading the CZK to weaker levels. Thus, we remain negative on the currency.

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.

EUR: ECB versus data Unlike officials at the Federal Reserve, European Central Bank members have managed to deliver a more coordinated pushback on rate cuts, both at last week’s policy meeting and in post-meeting communication. Governing Council member Peter Kazimir said the risks of premature cuts are bigger than those of keeping monetary tight for too long, and fellow hawk Pierre Wunsch highlighted how rate cuts cannot be discussed until wages move to a level that is compatible with the inflation target. Despite that, it still appears quite hard to dissuade the market from its conviction that rates will start to be cut in April. Data remains the missing link for a more material repricing in ECB rate expectations, and another miss by the Ifo yesterday in Germany suggests we are not at peak pessimism yet on the eurozone economic outlook. EUR/USD can trade above 1.10 during the holiday period as the dollar enters a seasonally soft period, but rate differentials are still too depressed to argue for a sustainable rally above 1.10 just yet.

CAD: Macklem turns dovish The Canadian dollar is lagging other pro-cyclical currencies at the start of this week after Bank of Canada Governor Tiff Macklem said in a TV interview yesterday that he expects rates to be cut next year. This is a surprise statement by Macklem, who only two weeks ago reiterated the hawkish bias in the BoC policy statement. Offering a timeline for rate cuts appears inconsistent with the BoC's claim that it “remains prepared to raise the policy rate further if needed” and likely validates the market’s pricing for 100bp of easing next year – despite Macklem’s caveats on the disinflation progress. Despite our view of a dollar decline and outperformance of pro-cyclical currencies next year, we expect the Canadian dollar to underperform other commodity currencies as the BoC cuts rates aggressively (we estimate 150bp in 2024) on a grim economic outlook and as the loonie suffers from its correlation with US economic data.