Three major central banks will likely go in three directions this week. Varying domestic economic developments and imperatives will push the Fed, ECB, and BoJ to sound different from one-another.
- Global cues are however similar: one of waning growth and inflation momentum
- The Fed, having hiked by over 500bps in this cycle, is likely in one-more-and-done territory
- The ECB can’t signal dovishness, but will maintain the status of quo of calibrated rate hikes
- The BoJ is heading toward lifting its ultra-lose monetary stance to something marginally hawkish
- Currency markets are already taking cues from these diverging paths of momentary policy
Three major central banks will likely go in three different directions this week. Although global cues are one of softening demand and inflation pressures, domestic economic developments and policy imperatives are not quite the same. The variation in directionality among major central banks is already influencing global markets, particularly in the currency space.
The dovish Fed
The US Federal Reserve is widely expected to hike the Fed Funds rate by 25bps this week, and we think this would be it for this globally consequential cycle. As noted widely, inflation has finally begun to ease, both at the headline and core level. Since the labour market remains tight, there is no room to signal rate cuts in the near future, but after over 500bps of rate hikes since last year, a signal that the cycle’s terminal rate has been likely achieved would be market positive, in our view. We think the Fed would continue with quantitative tightening, and with inflation easing, real rates would continue to rise, and by extension, monetary conditions would tighten further, but the overall signal from the central bank would be that the next time it makes a move, perhaps in mid-2024, it would be an easing measure.
The neutral ECB
The ECB is in no position to be dovish; in fact, it has been flagging an upcoming rate hike, backed by an upward revision in inflation forecasts. But economic growth momentum is waning rapidly, and headline inflation is trending lower. For now, we see a slightly more than even probability that a hike in September might be on the cards, but a faster than anticipated disinflationary process, especially if core inflation begins to converge toward headline, and weak activity outruns, could lower those expectations. We think the overall tone from the ECB will be one of status quo.
The hawkish BoJ
Japan’s monetary policy, the only hold out among major central banks in this cycle, is overdue a recalibration. We assess a 30% likelihood that the BOJ will make policy modifications at this week’s meeting, perhaps by widening the 10Y yield band or shifting the yield target from the 10Y to the 5Y segment. We think the current juncture of the Fed reaching it terminal rate presents a favorable opportunity for the BOJ to adjust YCC without provoking drastic market reactions. Nonetheless, we do not anticipate substantial policy changes, such as YCC exit or rate hikes, to be introduced at this meeting. The latest wage growth has yet to surpass the BOJ’s 3% threshold, which is considered necessary by the central bank to achieve a stable 2% inflation.