The market is expecting 25 basis point hikes from the Federal Reserve and the European Central Bank, and economists will be carefully observing what they say regarding their future rate plans. In contrast, the Bank of Japan is faced with a different test, with most experts predicting it will maintain its -0.1% short-term interest rate goal, even though prices are consistently above the target and indications of economic growth are emerging.
This week is expected to be momentous for the U.S. Federal Reserve, Bank of Japan and European Central Bank given they will be announcing key interest rate decisions. Goldman Sachs strategist Michael Cahill noted that the Fed's outcome could mark the final hike of a cycle. Moreover, the ECB may signal the end of its period of negative rates. However, the Bank of Japan might surpass its peers by getting out of the starting blocks. The Fed's decision follows June's data showing that U.S. consumer price inflation has dropped to a two-year low. The core CPI rate, which excludes volatile items, was 4.8% higher than a year ago and gained 0.2% for the month. Despite this, policy makers reiterated their commitment to bringing inflation down to the 2% target. The most recent economic data suggests America's economy is firming.
It is virtually definite that the Federal Open Market Committee will choose to apply a 25 basis point increase when they meet on Wednesday, moving the target fed funds rate to a range between 5.25% and 5.5%, according to the CME Group FedWatch tool. Although inflation and the labor market are both now beginning to slow down, Wednesday's projected hike could end a series of 16 months of continually tightened monetary policy. Last week, Moody's Investors Service conveyed in their research note that the Fed may still raise rates if required, however the July hike could be the final one if the labor market and July and August inflation data shows that wage and inflationary pressures have diminished to the point of meeting the Fed's target. The FOMC will maintain a strict monetary policy to promote and accommodate a continued reduction in demand and similarly, inflation.
Steve Englander, head of global G10 FX research and North America macro strategy at Standard Chartered, noted the upcoming debate on Fed guidance. Analysts have speculated that the Fed will remain "data dependent" and resist rate cuts soon, Englander stated, pointing out the FOMC may err on the side of caution by giving dovish guidance.In the euro zone, June consumer price inflation yielded a reading of 5.5%, the lowest since January 2022, with core inflation remaining at 5.4%. In reaction to this, the ECB raised its interest rate in June to 3.5%, in contrast to the Fed's pause on policy. Odds of a quarter-point hike on Thursday are highly likely, according to Refinitiv data, and ECB figures have kept to a hawkish stance. Chief Economist Philip Lane advised against pricing in cuts over the next two years. Thursday's ECB announcement is likely to center on the future path of policy rates, observed BNP Paribas Chief European Economist Paul Hollingsworth.
In comparison to President Christine Lagarde's June statement that "it is very likely the case that we will continue to increase rates in July", Hollingsworth noted in a note last week that there is no expectation for the Council to express commitment towards another hike come September's meeting. Recent comments have not made a strong case towards a September rate hike, or even signaled a broad consensus to do so this month. This lack of a definite direction has led traders to interpret the ECB's communications to formulate an inclination towards tightening, neutrality or a pause. At the most recent meeting of the Governing Council, it was expressed that the "key ECB interest rates will be brought to levels sufficiently restrictive to achieve a timely return of inflation to the 2% medium-term target and will be kept at those levels for as long as necessary."
BNP Paribas anticipates that this situation will not alter, which Hollingsworth believes is "implicitly biased for more tightening" with room for adjustment in the event that incoming inflation data falls short. He further commented that, "Lagarde could opt for a reduction in the concentration on September by alluding to a possible Fed-style 'skip', giving the possibility of rate increases at following meetings."Regarding Japan, contrary to the speculation in the West about the conclusion of the monetary tightening, the query in Japan is when its central bank will emerge as the last to tighten its monetary policy. The Bank of Japan preserved its short-term interest rate goal at -0.1% in June, having adopted negative rates in 2016 in the pursuit of reviving the economy of the world's third-largest nation from a sustained state of "stagflation" (characterized by low inflation and slow economic growth). The central bank also kept its yield curve control (YCC) policy unchanged.Nevertheless, the first-quarter growth of Japan was substantially increased to 2.7% in June while inflation has stayed above the Bank of Japan's 2% target for 15 consecutive months, arriving at 3.3% year-on-year in June. This has sparked some early speculation that the BOJ may eventually have to begin the reversing of its ultra-low monetary policy, although the market is still pricing no adjustments to either rates or YCC for Friday's announcement.
Yield curve control is generally a short-term approach in which a central bank targets a longer-term interest rate and adjusts the supply of government securities either through buying or selling to reach the desired level. Japan has implemented a YCC policy whereby it has set the short-term rate to -0.1% as well as the 10-year government bond yield to 0.5% above or below zero, with the intention to ensure the 2% inflation objective. Barclays highlighted on Friday that Japan's output gap remained unfavourable in the initial quarter of the year, wage growth stayed in negative territory and the inflation outlook is unsure. The economics analysts of Barclays predicted a change away from YCC at the central bank's October conference, but remarked that how the board members' vote is split will be significant. Christian Keller, head of economics research at Barclays, said, "We suspect the Policy Board will come to a majority decision, with the votes split between the hawkish members, who stress the importance of altering YCC (Tamura, Takata) and those with a more impartial stance, including Governor Ueda, and the dovish members (Adachi, Noguchi) in the reflationist camp." He added, "We think this departure from a unified decision to keep YCC can stir up market anticipation for future policy modifications. In this perspective, the July post-MPM press conference and the summary of opinions issued on 7 August will be especially crucial." Note: This article has been revised to explain that the US Federal Reserve took a pause on its run of 10 successive rate hikes last month, so as to evaluate where inflation was headed.
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