This week is likely to see the last interest hikes before Christmas from the US Federal Reserve, Bank of England and European Central Bank.
There will also be a pile of other key economic data under the tree, including the UK jobs and inflation numbers, and global flash PMIs on Friday, plus a festive smorgasbord of business activity indicators from the US, Europe and Asia.
But the Federal Open Market Committee (FOMC) meeting this evening will be the star at the top of the tree, although could be trumped by inflation elves the day before if there is a notable shift.
After four consecutive 75-basis-point hikes, inflation is still lingering well above 7% and the jobs market remains tight, but a step down to a 50bps hike is expected by both markets and economists as the FOMC feels it has made “substantial progress” so far.
However, the market has started to price-in that policymakers essentially will stop hiking and ‘pivot’ from the start of next year, despite Powell and other Fed speakers generally remaining fairly hawkish and lately insisting that the “ultimate level of rates will need to be somewhat higher than thought at the time of the September meeting”.
Amid this stark contrast, there will be a massive focus in this coming meeting on the ‘dot plot’ showing the pace of future rate hikes and the expected peak interest rate, as well as the latest economic projections.
“If the Fed hints at a 5% or higher terminal rate, then this could trigger a risk-off response in financial markets,” said market analyst Fawad Razaqzada at City Index, adding that the Fed would need to be pretty dovish to cause the dollar to sell-off more from current levels.
But this seems unlikely, suggested economist James Knightley at ING, as the Fed “will be concerned by the recent steep falls in Treasury yields and the dollar, coupled with a narrowing of credit spreads, which are loosening financial conditions – the exact opposite of what the Fed wants to see as it battles to get inflation lower”.
The market’s moves were triggered by a weak core CPI print for October, while the Fed’s favoured inflation measure of core PCE deflator was even softer. Fresh CPI data will be available.
“The market reaction seems excessive to us given this is just one month of data, annual core inflation is still running at triple the target, and to hit 2% year-on-year the month-on-month readings need to average 0.17% over time – and we aren’t there yet. The Federal Reserve will need to see several months of core inflation readings of 0.1% or 0.2% to be confident that inflation is on its way back to target and this is likely to be a key plank of its messaging.”
Deutsche Bank economists forecast 25bps hikes in February, March and May, which would take the terminal rate to 5.1% but acknowledge the risks are for bigger hikes.
They also call for a moderate recession in the middle of 2023 and Fed rate cuts at the end of next year, though the path “could still be complicated by strong labour market reports, rising earnings and broadening price pressures”.
“Meanwhile,” predicted Rabobank, “obscured by Powell’s hawkish consensus view, the dot plot is likely to show considerable disagreement about the terminal rate. This could become more prominent in 2023 when the subset of voters becomes more dovish.”
BoE and ECB decisions
The BoE and ECB decisions follow, with similar downshifts also expected.
Threadneedle Street last month followed a succession of 50bps rate raises with its first ever 75bps hike, while the ECB has made two consecutive 75bps hikes.
The BoE is expect to cap off a tumultuous year by going back to its more familiar 50bps rate increases, which will lift the base rate to 3.5%.
There will be no monetary policy report or press conference, but the statement and the minutes from the Monetary Policy Committee (MPC) meeting should include a re-evaluation of the fiscal policy stance following Chancellor Hunt's autumn statement
UK policymakers are seen by Rabobank’s macro strategist Stefan Koopman continuing to raise rates to 4.75% in the first half of 2023 – “deeply into restrictive territory for a stagnant economy” – as inflation remains high and the labour market continues to be tight.
“The central bank can only stop raising interest rates when inflation is on a clear downward trajectory, not just because of favourable base effects, but also due to a significant deceleration in wage and services prices growth.
“We expect it will take several months before this becomes evident, even as economic activity has already started its decline.
“On the other hand, if the recession hits much harder and faster than anticipated, as the central bank warns the public, a weaker labour market and increased job insecurity should keep pay, inflation, and eventually short-term interest rates in check. In that case, there is downside risk to our forecast.”
As for the ECB, which has tightened rates by 2% since July, Deutsche Bank economists are calling for a 50bps hike and “hawkish communications strategy” but there could be “one more 75bps hike before the downshift happens”, with a 3% terminal rate expected.
Other macro matters
Feeding inputs for the MPC, UK data will started the week at a canter, with monthly GDP, industrial production and trade released on Monday, followed by jobs market data yesterday.
Last jobs data showed an unemployment rate of 3.6%, employment near all-time highs at 75.5% and wage growth at 5.7% excluding bonuses or 6% with.
Today, the day before the policy meeting, we will get inflation data, which last time saw the consumer price index rise to a multi-decade high of 11.1% for October.
The busy week will finish with UK retail sales and the GfK consumer confidence data on Friday.
Elsewhere, there will be a number of European sentiment indicators, including the ZEW survey for Germany and the Eurozone on Tuesday, and manufacturing confidence in France on Thursday.
For the US, outside of the CPI figures, there’s retail sales and industrial production in the US on Thursday, and likewise for China.
Ahead of the Bank of Japan's meeting next week, tthe quarterly Tankan survey of business yesterday, where many economists expect a deterioration in business conditions for large manufacturers and flat growth for large non-manufacturers.
Tokyo will also release tax reform proposals this week too.