ECB: Decaf Or Double Espresso?

• ECB is expected to leave the policy rate at 4% and trim their macroeconomic projections. President Lagarde’s press conference will likely generate more fireworks.

• Japan wage growth quickens, raising odds of a BOJ rate hike next week. JPY is outperforming and JGBs underperforming.

• Fed Chair Jay Powell testifies today in front of the Senate Banking Committee.

USD remains under broad downside pressure as recent US economic data releases are not strong enough to justify a material upward adjustment to US interest rate futures. Meanwhile, other major central banks don’t appear in a rush to cut policy interest rates. For instance, the Bank of Canada warned yesterday “it’s too early to loosen the restrictive policy”, triggering a sharp correction in USD/CAD.

Fed Chair Jay Powell stuck to the script during his testimony before the House Financial Services Committee yesterday. Powell unsurprisingly noted that “rate cuts will depend on path of the economy”, adding the “strength of economy and labour market means we can approach that carefully, thoughtfully”. Powell will likely repeat the same message when he testifies today in front of the Senate Banking Committee (3:00pm London).

In our view, the encouraging US economic growth outlook suggests the Fed can continue being patient before loosening policy which is USD supportive. The Atlanta Fed GDPNow estimates Q1 real GDP growth at a solid 2.5% saar (the next update is today). Indeed, the latest Fed Beige Book noted that “economic activity increased slightly, on balance, since early January”.

The US February Challenger job cuts report (12:30pm London) and the January trade balance print (1:30pm London) are today’s domestic highlights. As a background, the US trade deficit has been narrowing since 2022 to total roughly US$773bn in the 12-month to December 2023. Importantly, the US trade deficit is more than offset by net foreign investments in US long-term securities (totalling US$1092bn in December), indicative of solid underlying demand for USD.

EUR/USD is holding on to yesterday’s gain, trading around 1.0900 before today’s ECB triple header: interest rate decision (1:15pm London), President Christine Lagarde’s press conference (1:45pm London), and the updated macroeconomic projections (2:45pm London). The ECB is widely expected to leave the policy rate at 4% and reiterate its plan to reduce reinvestment from maturing securities purchased under the PEPP over the second half of the year and discontinue them at the end of 2024. The ECB is also expected to slash GDP growth and inflation forecasts. The economy unexpectedly stagnated in Q4 2023, and inflation figures had recently been continuously below the ECB’s predicted levels, suggesting a faster than anticipated disinflationary process.

ECB President Christine Lagarde’s post-meeting press conference will likely generate more fireworks as it will be scrutinized for any hints about the timing and scope of future interest rate cuts. Lagarde previously indicated that borrowing costs could be lowered from the summer, noting the Eurozone Q1 wage numbers will be important for the ECB’s policy assessment. The Eurozone Q1 indicator of negotiated wage rate is scheduled to be released on 23 May, two weeks before the 6 June ECB rate-setting meeting.

GBP/USD is consolidating near the top-end of its year-to-date 1.2520-1.2800 range and 10-year gilt yields are trading heavy just under 4%. Yesterday, the UK government turned on the fiscal tap but the implication for monetary policy is small. Indeed, the Office of Budget Responsibility (OBR) estimates the UK output gap to widen by only 0.1pts in 2024/25 and diminish thereafter. The UK OIS curve continues to imply over 60 bp of BOE policy rate cuts in 2024 starting in August.

Today, the BOE February Decision Maker Panel (DMP) survey (9:30am London) may add more insights on the future monetary policy path. The BOE will likely pay particular attention to the expectations for future UK wage growth to gain confidence that a sustained slowdown in average regular earnings growth is underway.

JPY outperformed across the board overnight and 10-year JGB yields rose towards the top-end of its multi-week 0.68-0.74% range after Japan reported stronger than expected wage growth. Moreover, probability implied by interest rate futures of a 10 bp BOJ policy rate hike next week rose briefly to a high around 78% before settling back down around 50%.

Japan annual total labour cash earnings surged to a multi-month high of 2% in January (consensus: 1.2%) from 0.8% the previous month. As if on cue, BOJ board member Junko Nakagawa pointed-out that the certainty of reaching the price goal is rising and the chances are increasing that companies will give higher pay increases at annual wage negotiations later this month.

Nevertheless, we don’t believe the faster wage growth in Japan is a slam dunk for a BOJ March rate hike because the increase in total cash earnings is the result of a one-off 16.2% increase in special cash earnings (like bonuses). The less volatile scheduled cash earnings growth print remained muted at 1.4% y/y for a second consecutive month in January.

The next important technical support levels for USD/JPY are offered at 147.67 (100-day moving average) and 146.15 (200-day moving average). A sharper decline in USD/JPY below those key levels will be tough to sustain because Japan’s improving inflation backdrop and soft economic activity suggest the BOJ’s normalization process will be gradual and brief.

AUD/USD is higher on broad USD weakness and firmer iron ore prices. In Australia, demand to purchase new dwellings remains subdued. The value of new housing loans commitments unexpectedly dropped in January by 3.9% (consensus: +2%) on lower owner-occupier loan commitments (-4.6%) and investor loan commitments (-2.6%). Forward-looking indicators like the “time to buy a dwelling” sub-index from the Westpac consumer sentiment survey suggests buying sentiment will stay weak.