ECB Poised to Trim Rates

• The ECB is widely expected to cut the key deposit facility rate 25bps and the rates on the main refinancing operations and marginal lending facility by 60bps.

• Sticky underlying US price pressures argue for a cautious Fed easing cycle. US August PPI is up next.

• Sweden reports a soft August CPI print. Odds of four Riksbank policy rates cuts by December rise.

USD mixed and holding on to most of its post-US CPI data gains. Risk off impulses have abated as the tech/semiconductor sector is driving the advance in global equity markets. The S&P500 closed 1% higher yesterday, powered-forward by a 6.7% surge in the semiconductor industry group. Equity futures point to further gains at the open.

The US August CPI print largely matched consensus. Headline CPI inflation dropped four ticks to a 41-month low at 2.5% y/y. However, underlying price pressures remained sticky well above 2% which helped reduce odds of a 50bps Fed funds rate cut next week to about 10% from over 30%. Core (ex. food and energy) and super core (core services less housing) remained at 3.2% y/y and 4.5% y/y, respectively, for a for a second consecutive month in August.

Moreover, the pick-up in US inflation momentum argues for a cautious Fed easing cycle. Core CPI increased one tick more than expected in August by 0.3% m/m after rising 0.2% and 0.1% the previous two months. Also, super core CPI rose 0.3% m/m in August (the most since April) vs. 0.2% in July and virtually flat in June.

Overall, there is room for an upward adjustment to US interest rate expectations in favor of USD. First, the US labor market is not falling out of bed. Second, US consumer spending is resilient. Third, underlying inflation is sticky. Fourth, financial conditions are loose. US August PPI and weekly jobless claims are up next (both at 1:30pm London).

EUR/USD is consolidating near yesterday’s lows just above 1.1000. The ECB policy rate decision (1:15pm London) and President Christine Lagarde’s press conference (1:45pm London) take the spotlight today.

The ECB is widely seen cutting the key deposit facility rate (DFR) 25bps to 3.50%. The ECB is also expected to slash the rates on the main refinancing operations (MRO) and marginal lending facility (MLF) by 60bps to 3.65% and 3.90%, respectively. This would be in line with the changes to its operational framework for implementing monetary policy announced in March. Specifically, the ECB wants to narrow the MRO-DFR spread from currently 50bps to 15bps and keep the MRO-MLF spread at 25bps. The narrower MRO-DFR spread is aimed at improving liquidity condition and steer short-term money market rates closer to the ECB's monetary policy decisions.

Moreover, we anticipate the ECB to maintain its cautious easing guidance that “It will keep policy rates sufficiently restrictive for as long as necessary” and “follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction.” The update macroeconomic projection will likely offer better policy guidance. Inflation is tracking the ECB projection. But sluggish Eurozone economic activity suggests the risk is the ECB tweaks lower its inflation and real GDP growth forecasts. This can lead to a downward adjustment to Eurozone interest rate expectations against EUR.

GBP/USD retraced some of yesterday’s losses. UK housing market activity continues to improve. The August RICS residential market survey showed the proportion of surveyors reporting a rise in prices minus those reporting a fall turned positive for the first time since October 2022 and the price expectations index rose to a 27-month high at 14. Overall, the encouraging UK economic outlook suggests the Bank of England is unlikely to slash the policy rate by more than is currently priced-in (50bps by year-end) and offers GBP support.

SEK is trading on the defensive following Sweden’s soft August CPI print. The policy relevant CPIF inflation eased more than expected to 1.2% y/y, the lowest since December 2020 (consensus: 1.4%, prior: 1.7%). CPIF ex-energy matched consensus and printed at 2.2% y/y, same as in July and the lowest since December 2021. Sweden’s disinflation backdrop supports the Riksbank Governor Erik Thedeen’s expectations for “three additional cuts” by December and raises the risk of four cuts.

USD/JPY is up over 1.5% after making a fresh low for the year yesterday near 140.70. Positive financial market risk sentiment, reflected by the rally in Asian equities, largely outweighed the tailwind to JPY from encouraging Japan economic data and hawkish BOJ comments.

Japan’s Q3 BSI all-industry business outlook survey is indicative of a continued modest recovery in real GDP growth. The BSI for large firms rose 5.1% q/q, the biggest quarterly increase since Q3 2023, vs. 0.4% in Q2 and the outlook for Q4 is up 7.2% q/q. Business conditions in both manufacturing and non-manufacturing firms improved.

BOJ policy board member Naoki Tamura delivered some hawkish comments. Tamura argued for the need to raise the policy interest rate to around 1% in the latter half of the bank's projection period that runs through fiscal year 2026 as he’s concerned about upside risks to prices. This implies about 75bps of policy rate hikes over the next two years, which is less than currently priced-in by the swaps market (37bps).

Still, we doubt the BOJ will tighten more than the money market implies because Japan underlying price pressures remain low. In fact, Japan PPI inflation cooled more than expected in August and is a downside risk to CPI inflation. PPI fell -0.2% m/m (consensus: 0%, prior: +0.5%) to be up 2.5% y/y (consensus: 2.8%) vs. 3.0% in July. Lower input cost for firms should translate to lower prices for consumers. Bottom line: JPY upside is limited.

AUD/USD is up over 1% overnight supported by a recovery in iron ore prices and Asian stock markets. Australia consumer inflation expectation over the next 12 month dipped 0.1pts m/m to its long-term average of 4.4% in September. The data will not move the needle on the RBA’s hawkish policy guidance. The August monthly CPI indicator (September 25) and Q3 CPI data (October 30) are more policy relevant.