Central banks set to lead the week, as the Fed, Bank of England and Bank of Japan prepare to deliver their latest announcements

The Federal Reserve (Fed)’s interest rate decision, press conference and quarterly forecasts will likely dominate the week.

Last week’s US retail sales and consumer confidence releases complicated the picture for the Fed. A marked upward revision to April’s sales (and a solid May), underpinned our expectations that consumer spending would rebound from a lacklustre first quarter (Q1). This would support final domestic sales growth – even as GDP looks set to soften as net trade and inventory unwind from a supportive first three months of the year.

We forecast Q2 GDP growth at 2% annualized, as underlying growth prospects currently look solid. However, June’s University of Michigan Consumer Sentiment Index survey showed that five to 10-year inflation expectations dropped from a joint three-year high of 2.6% in May to a series low, at 2.2%, reinforcing concerns about forecasts moving lower. Ahead of the meeting, Fed members have been silent on the likelihood of an easing, and instead have focused on the importance of upcoming trade developments. We expect this message to be reiterated, with the Fed awaiting the outcome of important trade negotiations alongside the G20 meeting on 28-29 June. On our expectation of a more benign than considered outcome here i.e. the avoidance of immediate escalation, we expect that the central bank will not rush into easing in July.

However, with trade uncertainty likely to weigh on the GDP outlook and downside risks building for the inflation outlook, we forecast two rate cuts this year – most likely in September and December – but then suggest policy on hold, at 1.75% - 2%, across 2020. The Fed is also unlikely to adjust its balance sheet policy this time, particularly as pressure on the effective funds rate appears to have eased after its technical adjustment at the last meeting and growing expectations for rate cuts.

Industrial production made a poor start to Q2, dropping by 0.5% month-on-month in April, highlighting the downside risks to our 0.26% quarter-on-quarter euro area Q2 GDP forecast.

Attention will focus this week on June’s flash PMIs, which we expect to be broadly unchanged. However, the backdrop of elevated uncertainty because of the US/China trade deal breakdown, and mixed Chinese data, could have weighed further on manufacturing sentiment.

More importantly, this week all eyes will turn to the Sintra forum, where attention will focus on the comments of European Central Bank president, Mario Draghi. In addition, the European Union summit on 20-21 June will be interesting to watch, not only because discussion on top EU job appointments are on the agenda, but also because the EU Council will discuss country-recommendations and in particular the opening of an Excessive Deficit Procedure for Italy. There seems to be lively debate within the EU Council, with some countries pushing to wait for the 2020 Budget in September, while others would like to go ahead and test the Italian government’s willingness to comply. A formal decision is expected at the 9 July Eurogroup meeting.

Central banking will also be in focus in the UK, with the Bank of England’s latest monetary policy announcement due on Thursday.

We expect no change, but recent Bank commentary has remained hawkish, focusing on the UK’s tight labour conditions and the inflationary combination of solid wage expansion and weak productivity growth. That said, downside risks to the UK outlook appear to have grown since the BoE’s May Inflation Report meeting. Domestically, April’s output data suggest downside risks to Q2 GDP growth. In addition, the Tory leadership process continues to create political uncertainty and a rising perception of risk of a no deal Brexit or Brexit-extension beyond 31 October while global growth risks have grown reflecting concerns of further US trade war escalation.

As such, we expect June’s decision to leave policy on hold and not to set up an August hike. A hike in November would be possible if global and domestic risks recede, but to us this is unlikely. We continue to expect that the BoE will not tighten policy this year, but risks will grow next year if a global trade war slump can be avoided (our central forecast), when we would expect two rate hikes (to 1.25% by year-end). This week will continue to focus on the Conservative leadership race, after last week saw frontrunner Boris Johnson establish a clear lead of 114 votes in the first poll. The process continues this week and will go to Tory party members until the finish on 22 July. However, it is increasingly difficult to see anyone but Boris Johnson winning this race.   

Emerging market central banks preparing for the Fed’s move.

This week, several central banks in developing countries - including Brazil, Taiwan, Indonesia, the Philippines and Colombia - will hold their monetary policy meetings. They are mostly expected to stay on hold in June, though the odds of monetary easing have increased considerably recently, given the Fed’s dovishness, the threat of a further escalating trade war and synchronised growth deceleration worries. Last week, Turkey and Peru left policy rates unchanged, but Russia’s central bank proceeded with a first cut - 25 basis points to 7.5%. So far this year, among 83 emerging market central banks, 23 cut interest rates - a cumulative 2,025bps, between Russia, Chile, India, Malaysia and the Philippines. Only six tightened policy - 675bps, between Argentina, Tunisia and Pakistan, while 54 banks remained on hold.

The Bank of Japan holds its monetary policy meeting on 20-21 June and the most likely scenario is that it will stay on hold. The short-term policy rate target (-0.1%) and 10-year JGB yield target of 0% (with a band of +/- 20 bps) should remain unchanged, while the ETF programme and the long-term decrease in net Japanese government bond purchases should continue. The Bank of Japan (BoJ) will not move without any Fed adjustments, which we deem unlikely this month. Secondly, Q1 GDP growth surprised on the upside and Q2 activity remains solid, even while we expect it to decrease a little. Finally, Governor Haruhiko Kuroda has emphasized that the BoJ will ease when it judges inflation has lost upward momentum – and this is currently not the case, as the “new” core CPI (excluding food and energy) has continued to slowly increase, reaching 0.6% year-on-year – (+0.3 percentage point since December 2018)..  

 

Upcoming events

US: Building Permits and Housing Starts (Tuesday), FOMC announcement (Wednesday), Current account, Philadelphia FED Index and US-China Economic and Security Review Commission (Thursday), Flash PMI and Existing home sales (Friday)

Euro Area: EU19 HICP and German ZEW Survey (Tuesday), ECB Economic Bulletin and EU19 Consumer confidence (Thursday), EU19, German and French flash PMI (Friday)

UK: Tory Party Ballot (Tuesday), CPI, RPI, PPI and Conservative Party Leadership ballot (Wednesday), Retail Sales and MPC announcement and Tory party ballot (Thursday), PSNB (Friday)

China: New home prices (Tuesday)

Japan: Trade Balance (Wednesday), BoJ Announcement (Thursday), CPI and flash manufacturing PMI (Friday)

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