ECB - a continuous shift toward policy conservatism?

ECB - a continuous shift toward policy conservatism? There are 3 takeaways from last week’s ECB statement and press conference                                                                  

• The decision last week by the ECB to reduce moderately the pace of asset purchases was not justified merely on the ground of easier market conditions, but also, and very explicitly, on the basis of an improvement in the euro area inflation outlook. Citi analysts though, think that the improvement cited to inflation is questionable if one considers the very modest increase in the end point of the ECB staff’s own inflation projection (to 1.5% in 2023, still well short of the 2% statutory objective). The inference from the ECB decision appears to be that the governing council, or at least a substantial number of governors, assign to asset purchases a less ambitious objective than they assign to interest rate policy. And by justifying the reduction on purchases on this basis, they underline the separation of those policies.   

• The second noteworthy message from the Q&A by President Lagarde last week is that the governing council, or the majority at any rate, appears to conclude that risks to euro area inflation are now to the upside. Indeed, President Lagarde underlines both upside and downside risks to growth, but only upside risks to inflation. In particular, it seems there is an implicit assumption that second round effects will take place and will make the near-term upward shock to prices more persistent. That is possible but Citi analysts point to the absence of evidence of such second round effects so far and furthermore, this assumption seems somewhat inconsistent with the outcome of the ECB’s Strategy Review conducted earlier this year, which had suggested greater ECB tolerance for inflation overshoots.  

• The third observation is that the upward revision to euro area GDP and inflation projections seem to indicate a view by the ECB that output and prices will converge reasonably rapidly towards pre-pandemic levels. While this looks optimistic, it is also consistent with the idea that the ECB governing council is close to declaring that the downward impact of the pandemic on inflation has been countered.

• Bottom line - Citi analysts see the ECB now signaling that it not only sees the state of the euro area economy as having improved, but its reaction function is ready to move towards a more conservative direction. This points towards the marginalization of the role of asset purchases (QE) in monetary policy and perhaps, the termination of PEPP on schedule in March 2022 though asset purchases are likely to continue via an enhanced APP program to avoid the prosect of a hard taper.         

Data releases Friday    

• USD: US PPI inflation moderates, but still strong - US producer price index (PPI) rises 0.7%MoM and 8.3%YoY in August, close to Citi and market expectations. The core measure ex food, energy and trade services is also up 0.34%MoM, but below consensus for 0.6%MoM. But core goods prices still continue to rise rapidly – up 0.6%MoM – though somewhat slower than the 0.8%-1.0%MoM increases that prevailed over the prior five months. Services inflation is also a strong 0.7%MoM. The August report is perhaps underwhelming relative to recent history, but still shows significant inflationary pressure in the goods sector. Importantly, firms have recently been successful at passing some price increases through to consumers, suggesting that rising PPI goods prices may lead to higher CPI rather than profit margin compression. Clearly supply chain issues and inflationary pressure are much more intense in the goods than the services sector. That said, if worker shortages are showing up in higher transport costs, the US may begin to see a broader array of services also passing on higher costs to consumers. This represents part of the upside risk to US inflation in 2022 and one or even several months of inflation data may not be enough to resolve the persistent vs transitory inflation debate.

• GBP: UK July GDP disappoints  - A marked slowdown – UK GDP grows by just 0.1%MM in July, below both Citi and consensus forecasts (Citi 0.3%, Consensus 0.5%), with growth on a three-month basis printing at 3.6% (Citi 3.6%, Consensus 3.8%). Accounting for the change in taxation during the pandemic, Citi analysts think this implies UK GDP remains roughly 3% below its pre-pandemic level. The largest shortfalls remain in services with monthly growth having slowed in recent months after having peaked in March with consumer services contracting for the first time since January - primarily as a result of a softening of retail sales. UK GDP now seems on a more subdued trajectory with Citi analysts expecting challenges ahead as income support is dialed down later this month.

• CAD: Still-strong Canadian August job gains, with modest signs of emerging labor shortages - Canadian employment rises a solid 90.2k jobs in August, another strong month of job gains during the phased reopening period over the summer months but less than Citi expectations for 130k though above consensus for 68k. The unemployment rate falls further to 7.1%, partly as the participation rate declines to 65.1% while average hourly wages of permanent employees is 1.2% higher on the year in August compared to 0.6%YoY in July. Employment is now only 150k jobs away from pre-COVID levels in February 2020, with around 350k job gains necessary to meet the BoC’s goal for employment before considering rate increases. However, Citi analysts expect that as initial re-openings have now passed, job growth could slow over the coming months, although indications are that demand for workers remains high. While anecdotes of labor shortages are not yet noticeable in hard employment data, there are some modest signs of growing issues in August data. Citi analysts will be closely watching the path of wage growth over the coming months.        

Week Ahead         

• USD: US August CPI MoM – Citi: 0.4%, median: 0.4%, prior: 0.5%; CPI YoY – Citi: 5.3%, median: 5.3%, prior: 5.4%; CPI ex Food, Energy MoM – Citi: 0.2%, median: 0.3%, prior: 0.3%; CPI ex Food, Energy YoY – Citi: 4.1%, median: 4.3%, prior: 4.3% - Citi analysts expect a 0.24%MoM increase in core CPI in August, rounding to 0.2%MoM but with risk of a stronger print that rounds to 0.3%. Services prices (shelter prices) will be the even more important components of hard inflation data to watch over the coming months and Citi analysts expect a solid 0.24% increase in primary rents and a 0.33% increase in owners’ equivalent rent in August. Other services prices will also be important to watch for signs of a tight labor market that has already resulted in a number a wage increases and could translate to upward pressure on consumer prices. 

• USD: University of Michigan Consumer Sentiment – Citi: 73.9, median: 72.0, prior: 70.3; University of Michigan Inflation Expectations 1y – Citi: 4.7%, median: NA, prior: 4.6% - Citi analysts expect a moderate rebound in the University of Michigan consumer sentiment index to 73.9 in September after a sharp drop in confidence to 70.3 in August sparked by concerns of a renewed slowdown in activity. The drop in sentiment is likely in part related to elevated prices of many consumer goods. Inflation expectations components of the University of Michigan survey will also continue to be particularly important for the outlook for inflation. Citi analysts expect the 1-year ahead measure to rise slightly back to 4.7% although the 5-10 year expectations will be more important for the Fed.          

• GBP: UK jobs: Vacancies, June-August Forecast: 1,003k 3M/3M Prior: 657k 3M/3M; Employment, May-July Forecast: 147k 3M/3M Prior: 25k 3M/3M; Unemployment Rate, May-July Forecast: 4.5% 3M Avg Prior: 4.8% 3M Avg; Average Weekly Earnings, May-July Forecast: 8.2% 3M YY Prior: 8.8% 3M YY; AWE Ex-Bonus, May-July Forecast: 6.8% 3M YY Prior: 7.4% 3M YY – Citi analysts expect the UK labor market to deliver a further round of tight prints as vacancies continue to set new records, and unemployment falls back. However, with employment likely to remain 600-700k below pre-Covid levels, and 1.5 million either partially or fully furloughed in July, the team still expects labor market slack to remain quite significant.

• NZD: NZ Q2 GDP Citi QoQ forecast; 1.0%, Previous; 1.6%; Citi YoY forecast; 15.9%, Previous; 2.4% - strong contribution from the construction sector thanks to the hot housing market is expected to continue driving the solid growth momentum in NZ in Q2. Elsewhere, consumption will remain a key driver of growth, and services-orientated industries are likely to benefit from improved sentiment as the economy was open across Q2. Exports should be further boosted by the travel bubble with Australia. Overall, the solid growth trajectory of NZ’s economy prior to lockdowns should confirm that the RBNZ will probably maintain its hawkish rhetoric in the near term. However, Citi analysts still believe that the odds of a sharp tightening cycle are still low because of the ongoing uncertainty related to the pandemic. Therefore, the team only pencils in a 25bps rate hike in October, and no further hikes this year whereas markets now price no RBNZ rate hikes this year. 

• AUD: Australian August Labor Force Survey; Citi employment change forecast;-175k, Previous; +2.2k, Citi unemployment rate forecast; 5.1%, Previous; 4.6%, Citi participation rate change forecast; 65.4%, Previous; 66.0% - the reference period for the August Labor Force Survey will encapsulate the lockdowns across NSW and VIC. Consequently, job growth is expected to decline significantly across the two states. Discounting the noisy monthly data, the two metrics more relevant for the state of the labor market are the number of hours worked across the economy, and the number of people employed but working less or zero hours for economic reasons. Overall, Citi analysts believe that the risk is that employment may not fall as sharply because stimulus payments could keep some workers attached to their job but the team still expects the unemployment rate to peak at around 5.4% later in the year as the economy reopens. 

• CAD: Canadian CPI NSA MoM (Aug) - Citi: 0.1%, median: 0.1%, prior: 0.6%; CPI YoY – Citi: 4.0%, median: 3.9%, prior: 3.7% - Citi analysts  expect a 0.1% increase in headline CPI in August following a strong 0.6% jump in July. While this would be a more moderate increase in prices, it would be relatively stronger than the usual non-seasonally-adjusted price declines that typically happen in H2. However, a number of survey measures, including inflation expectations and the share of firms indicating difficulty meeting demand, suggest upside risks for core CPI. This may make BoC increasingly uncomfortable with a number of months of elevated core inflation.  

This is an extract from the Daily Currency Update, dated September 13, 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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