Global Courant
With the Bank of Japan maintaining its ultra-accommodating stance of negative interest rates, interest rate differentials between the US and the Bank of Japan will persist, Goldman Sachs economists say.
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The US Federal Reserve, the Bank of Japan and the European Central Bank will all announce major interest rate decisions this week, each potentially approaching a pivotal moment in their monetary policy trajectory.
As Goldman Sachs strategist Michael Cahill put it in an email on Sunday, “This should be a memorable week.”
“The Fed is expected to deliver what could be the latest hike in a cycle that has been one for the books. The ECB will likely indicate that it is approaching the end of its own cycle after negative rates, which in itself is a great ‘mission accomplished,’” said G10 FX strategist Cahill.
“But as they come to an end, the BoJ could outshine them all by finally getting out of the starting blocks.”
The Fed
Each central bank faces a very different challenge. The Fed, which concluded its monetary policy meeting on Wednesday, interrupted its streak of 10 consecutive rate hikes last month as consumer price inflation in the United States fell to its lowest annual rate in more than two years in June.
But the core CPI, which excludes volatile food and energy prices, was still 4.8% higher than last year and 0.2% higher than the month.
Policymakers reiterated their commitment to bring inflation back to the central bank’s target of 2%, and the latest data stream has reinforced the impression that the US economy is proving resilient.
The market is almost certain that the Federal Open Market Committee will vote for a 25 basis point hike on Wednesday, bringing the target Fed Funds rate to between 5.25% and 5.5%, according to the CME Group FedWatch tool.
But with inflation and the labor market continuing to cool, Wednesday’s expected hike could mark the end of a 16-month period of near-constant monetary policy tightening.
“The Fed has communicated its readiness to hike rates again if necessary, but the July rate hike could be the last — as markets currently expect — if labor and inflation data for July and August provide additional evidence that wage and inflationary pressures have now eased to levels consistent with the Fed’s target,” Moody’s Investors Service economists said in a research note last week.
“However, the FOMC will maintain tight monetary policy to promote further weakening in demand and, consequently, inflation.”
This was echoed by Steve Englander, head of global G10 FX research and macro strategy for North America at Standard Chartered, who said the debate going forward will be about the guidance the Fed gives. Several analysts have suggested over the past week that policymakers will remain “data dependent” but will resist any talk of rate cuts in the near future.
“There is good reason to believe that September would be a spill unless there is a significant upward inflation surprise, but the FOMC may be wary of issuing even mild easing guidance,” Englander said.
“In our view, the FOMC is like a weather forecaster that sees a 30% chance of rain, but twists the forecast to rain because precipitation from an incorrect sunny forecast is considered greater than from an incorrect rain forecast.”
The ECB
Downward inflation surprises have also emerged in the eurozone recently, with consumer price inflation across the bloc reaching 5.5% in June, the lowest since January 2022. Still, core inflation remained stubbornly high at 5.4%, slightly higher than the month, and both figures still well above the central bank’s target of 2%.
The ECB raised its key interest rate by 25 basis points to 3.5% in June, diverging from the Fed’s pause and continuing a series of hikes that began in July 2022.
According to data from Refinitiv, the market is pricing in a greater than 99% chance of a further 25 basis point gain following the close of the ECB’s policy meeting on Thursday, and key central bank officials, along with transatlantic counterparts, have maintained an aggressive tone.
ECB Chief Economist Philip Lane last month warned markets against pricing in rate cuts within the next two years.
With a quarter-point increase, as with the Fed, the main focus of Thursday’s ECB announcement will be what the Governing Council indicates about the future path of policy rates, said Paul Hollingsworth, BNP Paribas Chief European Economist.
“Unlike June, when President Christine Lagarde said ‘it is very likely that we will continue to raise rates in July,’ we do not expect her to pre-commit the Council to another hike at the September meeting,” Hollingsworth said in a note last week.
“After all, recent commentary shows that even among hawks there is not strong conviction for a September hike, let alone broad consensus already this month to indicate it is likely.”
Given this lack of explicit direction, Hollingsworth said traders will read between the lines of the ECB’s communications to try to identify a bias toward tightening, neutrality or a pause.
At its last meeting, the Governing Council said its “future decisions will ensure that key ECB interest rates are set at levels sufficiently restrictive to achieve a timely return of inflation to the medium-term target of 2%, and will be maintained at those levels for as long as necessary.”
BNP Paribas expects this to remain unchanged, which Hollingsworth says represents an “implied preference for more tightening” with “leeway” in case incoming inflation data disappoints.
“However, the message in the press conference could be more nuanced, suggesting that perhaps more is needed, rather than that more is needed,” he added.
“Lagarde could also choose to reduce its focus on September by pointing to a possible Fed-like ‘skip’, leaving open the possibility of hikes at subsequent meetings.”
The Bank of Japan
Far from the discussion in the West about the last monetary tightening, the question in Japan is when the central bank will become the last monetary tightening.
The Bank of Japan kept its short-term interest rate target at -0.1% in June after entering negative rates for the first time in 2016 in hopes of boosting the world’s third-largest economy out of protracted “stagflation” characterized by low inflation and sluggish growth. Policymakers also kept the central bank’s yield curve control (YCC) policy unchanged.
Still, first-quarter growth in Japan was revised sharply higher last month to 2.7%, while inflation has remained above the BOJ’s 2% target for 15 consecutive months, standing at 3.3% yoy in June. This has sparked some early speculation that the BOJ could be forced to finally begin rolling back its ultra-loose monetary policy, but the market is still not praising any revisions to rates or YCC in Friday’s announcement.
Yield curve control is usually a temporary measure where a central bank targets longer interest rates and then buys or sells government bonds at a level necessary to meet those rates.
Under Japan’s YCC policy, the central bank targets short-term interest rates of -0.1% and 10-year government bond yields of 0.5% above or below zero, aiming to keep the inflation target at 2%.
Barclays noted on Friday that Japan’s output gap – the difference between actual and potential economic output – was still negative in the first quarter, while real wage growth remains negative and the inflation outlook is uncertain. British bank economists expect a shift away from YCC at the central bank meeting in October, but said the vote split could be important this week.
“We believe the Policy Board will reach a majority decision, splitting votes between relatively aggressive members who emphasize the need for YCC review (Tamura, Takata) and more neutral members, including Governor Ueda, and moderate members (Adachi, Noguchi) in the reflationist camp,” said Barclays Head of Economics Research Christian Keller.
“We believe this departure from a unanimous decision to maintain YCC could fuel market expectations for future policy reviews. In this context, the press conference following July’s MPM and the summary of opinions released on August 7 will be particularly important.”
A ‘memorable week’ ahead as Fed, ECB and Bank of Japan approach turning point
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