An upbeat week for market sentiment as the Fed and ECB - despite hiking rates - signalled more patience going forward, while optimism around stimulus measures in China was also a key factor. In other news, the Bank of Japan announced it would tweak Yield Curve Control, coming to the view its parameters needed to be made more flexible to sustain monetary easing with an outlook for meeting its inflation target remaining elusive.
RBA pause may extend on declining inflation
Slowing inflation and weak retail sales data saw markets price out the chance of an RBA rate hike to around 1 in 4 ahead of next week's meeting. While lagging behind global trends, a disinflationary process is starting to play out more clearly in Australia. Headline CPI (0.8%q/q) fell from 7% to 6%Y/Y and the core rate (0.9%q/q) eased from 6.6% to 5.9%Y/Y, both well down from their 2022 peaks of 7.8% and 6.9% respectively (reviewed here).
To date - and similar to offshore - disinflation in Australia centres on goods, with services prices remaining elevated. Goods inflation declined from 7.6% to 5.9%Y/Y, though with services inflation still rising after ticking up to 6.3%Y/Y from 6.1% this could yet prove the decisive factor for the RBA next week. However, a 0.8% fall in June retail sales may indicate to the Board that the balance risks with regards to monetary policy could be tilting towards over-tightening, particularly with the cumulative effects from its tightening cycle yet to flow through.
End of the line for the Fed?
The Fed's FOMC left markets with few surprises at this week's meeting. After holding rates steady last month, the Committee resumed its tightening cycle with a 25bps increase to a 5.25-5.5% range. Whether this marks the peak rate remains the key question. Taking a data-dependent outlook, the FOMC maintains that it could follow through with the additional tightening it signalled in its June projections; however, the data could make the case against that scenario. FOMC Chair Jerome Powell delivered a nuanced message in the post-meeting press conference by highlighting that with rates taken further into a restrictive setting, patience was now appropriate in returning inflation to the 2% target, allowing the lags from their earlier hikes to play through and also recognising that some additional tightening in credit conditions associated with the regional bank failures in the US is likely.
Price and wage pressures in the US are easing, while GDP growth surprised to the upside in Q2 (0.6%), the data overall indicating a soft landing remains on track - provided the Fed does not overtighten. Underlying inflation on the core PCE deflator declined from 4.6% to 4.1%yr in June, a low back to September 2021. Meanwhile, amid strong labour market conditions wages growth on the employment cost index softened to a 4.5% annual pace from 4.9% previously. In isolation these are elevated rates for prices and wages, but they are trending in the right direction - particularly for a Fed prepared to be more patient.
ECB out for the summer
While the ECB hiked its key rates by 25bps this week (to 3.75% on the depo rate), it headed for its summer break leaving markets with the message that further tightening is no longer a foregone conclusion. A backdrop of deteriorating growth - July's flash PMI reported euro area activity contracted at its fastest pace in 8 months in July - and cooling inflation - headline rate (5.5%) having roughly halved from its peak - has prompted a more nuanced tone on the outlook for policy from the ECB. Reflecting this, the wording in the Governing Council's decision statement was tweaked slightly to state that rates will be "set at..." (rather than "brought to" used previously) "sufficiently restrictive levels for as long as necessary..." to hit the 2% inflation target.
In the post-meeting press conference, ECB President Christine Lagarde said the Governing Council was now "deliberately data-dependent" and that it has an "open mind" about what decisions it will make at the next meeting in September and in the meetings after that. Notably, over the summer break, the ECB will have the benefit of two additional incoming inflation reports that will be key inputs to a revised set of economic projections that will be presented to the Governing Council to consider at its next meeting. President Lagarde said those projections and further information on how tighter monetary policy is working through the economy will determine whether the Governing Council hikes rates or holds steady.
Also of note, the ECB announced it would cut the interest paid on the threshold of reserves banks are required to have on hold at their national central banks. These reserves are currently remunerated at the depo rate (3.75%) but this will be cut to 0% in late September, a move the ECB says will improve the "efficiency of monetary policy" implementation by reducing its interest bill. The reason for the change is that the ECB notes that with ample liquidity in the financial system, monetary policy is being transmitted via its deposit facility - where banks park their excess reserves (those over and above minimum thresholds) - with these balances being remunerated at the depo rate.