BoC board meeting - neutral BoC takes backseat before election

BoC board meeting - neutral BoC takes backseat before election                                                                       

• CAD: BoC leaves the policy rate unchanged at 0.25% overnight and maintains the current pace of QE purchases of C$2 billion per week, as expected. The characterization of recent softer GDP growth attributed to supply issues is seen as modestly hawkish but balanced with somewhat dovish additions to the discussion of inflation. Overall, the statement is seen as mostly neutral, with most language unchanged from the July statement, including in the last paragraph on policy guidance. The statement mentions a number of supply chain issues as weighing on Q2 activity and continuing to create downside risks for growth into H2. While softer growth in itself would not suggest a more hawkish BoC, ultimately longer-lasting supply issues will continue to put upward pressure on prices, which could keep the BoC more cautious of inflation over the medium term. The BoC still expects stronger activity in H2 this year, in line with the Citi analysts’ outlook for stronger, services-led H2 GDP growth with any weakness more clearly tied to supply issues than any demand concerns related to new virus cases. 

• CAD: However, the less-dovish characterization of the growth slowdown is somewhat balanced by a more-dovish adjustment to the inflation description. The statement adds a mention of moderate wage increases and anchored medium term inflation expectations, seemingly as a justification for why elevated headline CPI is largely transitory. The BoC will be primarily focused on labor market conditions as an indication of a closing output gap, and wage metrics will be increasingly important to watch as employment levels continue to recover. Still, the mention of wages and medium-term inflation expectations is a dovish offset to a recognition that supply issues have created greater upside risks to inflation than just a few months ago.

• CAD: Governor Macklem will speak tonight on “QE and the reinvestment phase”, with an audience Q&A but no media press conference as the BoC aims to maintain a neutral stance ahead of the September 20 federal election. Citi analysts’ base case remains for another reduction in asset purchases to C$1 billion per week in October, with purchases reaching net zero by the end of the year or the January 2022 meeting at the latest. As QE tapering has been underway for some time already, indications of further slowing should be unsurprising. Investors though will be more curious to hear any BoC guidance on the reinvestment phase, particularly the degree to which maturing bonds will be reinvested (fully or partially) or expectations for the balance sheet at the time of eventual rate hikes.       

ECB board meeting preview - to marginally reduce pace of asset purchases under PEPP 

• EUR: ECB Board meeting – Citi analysts expect the ECB’s governing council to slightly reduce the pace of asset purchases under PEPP at its meeting tonight from ~€80bn per month in Q3 2021 to around €60-70bn per month in Q4 2021. This would be similar to the ~€60bn per month pace in Q1 2021. The reduction has been hinted at by ECB governing council, including BoF Governor Villeroy and Vice President Guindos and is largely expected, given the easing in euro area financing conditions since July while eurozone inflation has risen and surprised (HICP 3.0% vs 2.7% expected; Core HICP 1.6% vs 1.5% expected). Euro area inflation expectations have also risen substantially (by 28/26/11bp across 2/5/10y inflation swaps) while the impact of the Covid outbreak on euro area growth has been relatively limited (with real GDP up by 2.0% QoQ in 2Q 2021 vs the Eurosystem staff June forecast of 1.4% amid vaccination rate reaching nearly 70% of the euro area population).     

• EUR: More importantly, tonight’s ECB meeting is seen as opening the forum to address strategic questions on policy, including the relative risks for growth and inflation and future of the asset purchase programs. This comes amid an increasing divergence within the ECB about the role of asset purchases and interest rate policy within monetary policy, a split in forward guidance applying to each, and therefore a likely widening gap between their relative horizons. This also relates to addressing the future of asset purchases beyond PEPP (maturing in March 2022) though it looks highly unlikely that markets will learn anything more about the future of PEPP until the December meeting. Instead, tonight the ECB may try to disentangle the current purchase pace from the future of PEPP and maintain its flexibility and data-dependency. That said, with consumer demand less strong in the euro zone and less uniform across economies than in US, while concerns about supply-driven inflation are weaker and additional fiscal stimulus likely smaller, this implies the ECB should be more dovish over time than the Fed, and in particular, maintain asset purchases for much longer period of time than almost all other G10 central banks. 

• EUR: ECB Staff forecast changes — Citi analysts look for an upward drift in 2021 mid-points with respect to both euro area GDP and inflation. But caution is still likely to prevail at least until the December meeting when the next set of staff projections will give a perspective of what the inflation gap might look like in 2024. Bottom Line - the ECB has been a contributing factor to rising EU yields and recent EUR buying. However, a modest reduction in Q4 bond purchases is unlikely to add to the momentum and could in fact trigger profit-taking in EURUSD over time.       

Data for the remainder of this week       

• USD: US August PPI Final Demand MoM – Citi: 0.5%, median: 0.6%, prior: 1.0%; PPI Final Demand YoY – Citi: 8.1%, median: 8.3%, prior: 7.8%; PPI ex Food, Energy MoM – Citi: 0.5%, median: 0.5%, prior: 1.0%; PPI ex Food, Energy YoY – Citi: 6.5%, median: 6.6%, prior: 6.2%; PPI ex Food, Energy, Trade Services MoM – Citi: 0.4%, median: 0.6%, prior: 0.9% - Still, persistent strength in PPI goods this year leads Citi analysts to continue to see upside risks for goods prices in CPI, beyond just auto prices. Meanwhile, rising services prices in PPI could be a sign that longer-lasting labor shortages might eventually result in more broad-based price gains in CPI as well.         

• CAD: Canada Net Change in Employment (Aug) – Citi: 130k, prior: 94.0k; Unemployment Rate – Citi: 7.0%, prior: 7.5%; Hourly Wage Rate Permanent Employees – Citi: 1.2%, prior: 0.6% - BoC will continue to monitor a number of factors to gauge the recovery in the labor market, including the employment population ratio, which would need to rise closer to its pre-COVID level of ~62% (60.3% currently) before BoC considers rate increases. Citi analysts also expect wage growth to become increasingly important to assess tightness of the labor market. 

This is an extract from the Daily Currency Update, dated September 9, 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 - 

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