Market focus turns to the ECB

OVERNIGHT

Asian equity markets are mostly up this morning as sentiment was lifted by a cut in China’s 1-year funding rate which was seen as signalling the likelihood of further stimulus measures. That may have been prompted by April retail sales and industrial production data which suggested that China’s economic rebound is slowing. Last night, US interest rates were left unchanged at the Federal Reserve’s latest policy update. But it was seen as a ‘hawkish pause’ as the Fed signalled the possibility of two further hikes this year. 

THE DAY AHEAD

After yesterday’s US monetary policy announcement, attention today will turn to the European Central Bank and its update for Eurozone monetary policy. In contrast to the Fed, the ECB is almost certain to increase interest rates again by 25bp, which would mean rates have gone up by  400bp in total since last summer. 

ECB President Lagarde has previously said there is still ‘more ground to cover’ to bring inflation back to target. Despite revised data indicating the Eurozone was in mild recession over the winter, inflation remains a concern. Headline CPI inflation is falling but both it and ‘stickier’ core inflation are still well above the 2% inflation target.

Assuming today’s hike is as expected, the key focus for markets will be on the prospects for further interest rate rises in July and possibly beyond. In particular, whether Lagarde comments at the post-meeting press conference sounds as hawkish as last time or are tempered by recent weaker-than- expected data will be watched. Previous indications have suggested that a June hike will probably not be the last, and markets are partly pricing in another 25bp hike in July.

Further clues will be provided by today’s forecast updates. The ECB has said that policy will be guided by three criteria: incoming data, underlying inflation dynamics and indications of the extent of the impact of which previous policy decisions are feeding through to the economy. These will be encapsulated in the ECB forecast updates which may show inflation not falling to target until 2025, making it difficult to call an early halt to rate rises. 

Today’s US data will be watched for clues on how long the Fed’s ‘pause’ will last. Of most interest will be May retail sales. Those surprised on the upside in April suggesting that consumer activity is still holding up reasonably well. May is forecast to be weaker but we forecast core sales to still be solid. Also to be watched are jobless claims, which have been pointing to some easing of labour market pressures. 

MARKETS

US Treasury bond yields are higher this morning after a slightly more hawkish than expected Fed message on interest rates. UK gilt yields posted small falls yesterday. In currency markets, the US dollar fell sharply against the euro and sterling in early trading yesterday but partially rebounded after the Fed announcement.