Bank of England - stagflation risk lowers bar for rate hike
GBP: As expected, the BoE MPC votes unanimously to keep the Bank Rate unchanged at 0.75%. However, dissent to support stopping asset purchases grows to two who mention rising inflation expectations. A step closer to hiking— guidance from the last meeting that some tightening would be necessary during the forecasting horizon stays in the statement but is augmented by the comment that “some developments during the intervening period appear to have strengthened that case”. November meeting now seems live— even the 7 who vote to continue asset purchases “agree that any future initial tightening should be implemented by an increase in Bank Rate, even if that tightening becomes appropriate before the end of the existing UK government bond purchase program” in December. MPC also announces a supply-side review for the November Monetary Policy Report and indicates it will be able to take a decision on rates at that meeting even if full labor market data is not available.
- GBP: MPC’s base case now seems to be that if there is no sign that UK unemployment rises “significantly” over the next 6 weeks, a majority of the MPC will probably vote for a 15bp rate hike in November 2021 and another 25bp in February or May at the latest, triggering balance sheet reduction. By early 2024, the MPC would have reached its terminal rate of 1.25%. Following the meeting overnight, UK rates pricing now discounts a 23% chance of a 15bp rate hike in November while for February 2022, the probability rises from 72% to fully priced. Meanwhile, Citi analysts’ more pessimistic view on UK growth and the labor market sees the team thinking unemployment will rise enough to make the MPC hold off this November. However, Citi analysts admit that even their pessimistic forecasts are not enough to prevent the hawkish MPC from wanting to send the signal that they are alert to high inflation. As a result, the team now expects a 15bp hike in February with the Bank rate rising to 0.5% by May, triggering balance sheet reduction after which the Bank is expected to stay put as inflation recedes and the economy continues to struggle to muster momentum.
SNB more cautious than expected
- CHF: As expected, SNB leaves the policy rate unchanged and remains willing to intervene in FX markets as the Swiss Franc remains “highly valued”. SNB also sees the current inflation spike as temporary and as expected, revises up its 2021 and 2022 Swiss inflation forecasts by only 0.1pp each to 0.5% and 0.7% respectively with 2023 inflation unchanged at 0.6% and Q2’24 also unchanged at 0.8%. The only potentially hawkish risk on the housing market or recommendation to reintroduce bank capital buffers (following a speech by SNB member Fritz Zurbruegg) recently, does not materialize. On the growth outlook, SNB revises its 2021 GDP forecast lower and sees slowing growth momentum in an otherwise unchanged SNB monetary policy assessment. As a result, more than any other central bank, risks for the SNB remain skewed toward avoiding early tightening.
- CHF: SNB’s focus is likely to remain on the Franc - not just global growth concerns, but political events in Germany, France and potentially Italy, have the potential to trigger new upward pressure on the Franc over the next 6-12 months. As the SNB already has the lowest interest rate and the largest balance sheet relative to the size of its economy and faces less inflationary pressure, risks are even more asymmetrically biased against early tightening moves relative to other central banks (the BoE for example).
US PMIs roughly in line with expectations but euro zone and UK flash September PMIs decline across the board
- USD: US Markit PMI: Production hampered by supply chain disruptions – the September Services Markit PMI release is roughly in-line with expectations at 54.4 but marginally lower than its July level of 55.1 with the employment subindex dipping just into contractionary territory at 49.9 – effectively this points to flat employment levels. Input prices rise mildly to 72.5 while output prices fall a touch to 62.9 – both elevated by historical standards. Meanwhile, the manufacturing PMI comes in at 60.5, a touch below expectations for 61.0 with output and new orders both down very slightly but employment improves a little to 53.5. Input prices dip a little after last month’s high-water mark to 86.9, while output prices climb a little higher to 74.4, a new record. Supply chain disruptions are evident throughout the data, particularly in manufacturing that are maintaining prices at extremely elevated levels. With demand elevated, prices are unlikely to move from their current perch.
- EUR: Euro zone - PMIs markedly lower, price tensions worsen – the euro area Manufacturing PMI for September comes in lower than consensus at 58.7 and the prior month (Consensus 60.3, Citi 60, Prior 61.5) as does the euro area Services PMI at 56.3 (Consensus 58.5, Citi 58.5, Prior 59.7). This leads to a similar result for the euro area Composite Output PMI, coming in at 56.1 (Consensus 58.5, Citi 58.2, Prior 59.5). Decline in euro area PMIs accelerates in September which sees the second consecutive monthly drop in composite PMI, down by -3.4 pts MM, after a -0.6pts MM in August, albeit from elevated levels. Markit points to “the peaking of demand in the second quarter, supply chain bottlenecks and concerns over the ongoing pandemic”, as likely the reasons for the decline with “firms’ costs rising at the fastest rate in 21 years while selling price inflation accelerates in September”. The drop in services PMI is perhaps more surprising than manufacturing and is led by Germany that sees Services PMI drop to 56.0 versus (Consensus 60.3, Citi 60.2 and Prior 60.8). Germany’s manufacturing PMI also weakens though this is largely expected but no explanation is given in the press release about the German services slowdown. Citi analysts see the recent weakness in PMIs as consistent with sizable deceleration in euro area GDP in 4Q, as level of output closes in on pre-pandemic norm.
- GBP: UK flash September PMIs – momentum eases but inflationary pressures continue to build - flash UK services PMI for September prints at 54.6, a little below both Citi and consensus (Citi 56.0, Consensus 55.0). But it is manufacturing PMI that provides the main disappointment, falling to 56.3 (Citi 61.0, Consensus 59.0). Unlike August, demand seems to fall among manufacturers, with new orders and backlogs easing alongside output. Among services, new orders and outstanding business also fall back while employment growth moderates overall. Meanwhile, price pressures remain elevated with input pressures accumulating among manufacturers. Firms are now responding by raising selling prices even as output price inflation reaches record levels.
CAD: Canadian retail sales fall by less than expected in July, down 0.6% relative to -1.2% expected and Citi at -2.2%. Ex-auto retail sales fall 1.0%MoM. But overall, the data shows strong underlying demand and some normalization away from goods and toward services despite the monthly volatility. Citi analysts expect sales to advance strongly in August which points to continued strong domestic demand.
Data/ Events for the remainder of this week
- EUR: German election due September 26 - A “Traffic Light” coalition of SPD, Greens and FDP from a CDU/CSU-led “Jamaica” base case would likely make a large public investment program and further European integration more likely. But the debt brake could still limit how much debt-financed investment such a government could provide, as changing the constitution would probably be out of reach.
EUR: German Ifo Business Climate, Sep – Citi: 99.5. prior; 99.4; Ifo Expectations, Sep – Citi: 97.0, prior: 97.5; Ifo Current Assessment, Sep – Citi: 102.0, prior: 101.4 - concerns about the delta variant domestically should dissipate as case numbers have stabilized and hospitals remain largely empty. The export-oriented manufacturing sector may be facing more short-term headwinds from supply shortages, but at least the China relationship suggests only limited further downside, with the Li Keqiang index remaining in solid growth territory /7.5% YY in July). Overall, Citi analysts expect a largely stable reading.
This is an extract from the Daily Currency Update, dated September 24, 2021. Please approach a Citigold Relationship Manager if you would like more information. For the latest updated CitiFX house views and strategy (updated every Monday) please click here -