FX

Still dovish BoJ and moderation in Japan’s core CPI points to retention of easy policy (with modifications)

_{Posted on Feb 25, 2023}

JPY: BoJ Governor-nominee Kazuo Ueda avoids surprising markets - Friday’s confirmation hearing for BoJ nominee governor Kazuo Ueda suggests that his views are not meaningfully different from those held by Governor Kuroda. Notably, the bulk of his comments are focused on developments in Japan’s prices and wages outlook as a possible trigger for changes to BoJ monetary policy rather than to market function-related issues. While Ueda-san sees some positive signs for underlying inflation in Japan, he believes the ongoing rise in CPI currently is being primarily driven by higher import prices than demand strength and therefore expects CPI inflation to fall below 2% toward the middle of next fiscal year (FY2023). In his view, it is appropriate to continue with the current monetary easing as policy normalization is conditional on underlying inflation (supported by strengthening domestic demand) approaching the 2% target.

JPY: In this regard, last week’s wage negotiations between Toyota and Honda versus the workers’ union may be a barometer for things to come. Both companies fully accept workers union’s demand for wage hikes with monthly wage gains having almost doubled at Toyota while Honda raises its monthly base salary excluding seniority-based pay by 3.3%, surpassing the 3% wage growth the BoJ and the JTUC expect. Nevertheless, markets are cautious about extrapolating these two data points to the overall outcome for now. That said, Citi analysts continue to expect that the BoJ will modify YCC (yield curve control) further or abolish it relatively soon after Ueda takes office in April – probably in June or perhaps July, when policymakers update BoJ’s quarterly outlook report.

JPY: January nationwide core inflation up at +4.2%, +2.9% estimated for February - Japan’s nationwide core CPI increases to 4.2% YoY in January, picking up from a 4.0% YoY advance in December and marking the highest inflation outturn since September 1981 (4.2% YoY). The result though is slightly weaker than the median market projection for a 4.3% YoY climb. Meanwhile, core CPI inflation excluding special factors (i.e., energy, mobile phone charges and hotel charges) also picks up, albeit modestly to 3.33% YoY in January even as prices of consumer durable goods drop MoM for a second consecutive month, potentially indicating a fading impact of past Yen depreciation and underling services inflation remains below 1% YoY. Citi analysts pencil in +2.9% YoY for core inflation in February – that looks likely to slow as the government measures to curb electricity and gas prices take effect and +2.5% YoY in March. With the impact of past increases in international commodity prices and earlier Yen depreciation likely fading from mid-year, core CPI inflation looks likely to slow to the 1% range from September.

US core PCE – higher for longer?

USD: US core PCE inflation rises 0.57%MoM in January, stronger than consensus expectations for 0.4% and just above Cit’s 0.54%. The January increase plus revisions higher to Q4 sees the Y/Y reading jump to 4.7% from an upwardly revised 4.6%. With revisions higher to Q4, Y/Y core PCE at 4.7% is only barely slower than earlier in the year and could see it outpace CPI this year. Overall, US core PCE inflation is running consistently in a 4.5-5.5% range since late-2021 which is largely related to the still-strong non-shelter services prices receiving a much larger weight in core PCE than in core CPI (about 55% compared to 30%).

Week Ahead

USD: US February ISM Manufacturing – Citi: 48.1, median: 47.8, prior: 47.4 - ISM manufacturing should rise moderately in February to 48.1, the first gain since August and the largest since February 2022. However, manufacturing activity generally should remain on the softer side, reflecting months of softer goods demand.

USD: US February ISM Services – Citi: 55.3, median: 54.5, prior: 55.2 – ISM services for February will be in focus this week after January ISM services rebounded from below-50 in December to a strong 55.2 level. Citi analysts expect ISM services to remain around the mid-to-low-50s consistent with still-strong services activity.

EUR: Euro zone headline inflation should edge lower in the February flash HICP but only slightly, confirming the passthrough of lower gas prices takes time. However, Citi analysts expect another solid MM print on core CPI. Services inflation should edge higher while the January uptick in core goods HICP is likely to reverse only partially and probably not before March/April. Euro Area HICP, February: Citi Forecast 8.5% YY, Consensus 8.2% YY, Prior 8.6%YY; Core CPI, Feb: Citi Forecast 5.4% YY, Consensus 5.3% YY, Prior 5.3%YY.

EUR: ECB will publish minutes of the February meeting. Views on the terminal rate and support for 50bps hikes beyond March will be scrutinized but also divergences in assessments within the governing council on how restrictive current rates are and extent of backing to President Lagarde’s comment on inflation risks being “more balanced”.

GBP: What does BoE Governor Bailey (and the final PMIs) have to say? – in UK, the focus for the coming week will be on BoE Governor Bailey’s speech on the 1st March, the DMP data for February and the final print for the services PMI. The former will likely be central to calibrating any risk of a pause in March.

AUD: Australia Q4 GDP: Citi QoQ forecast; 0.8%, Previous; 0.6%; Citi YoY forecast; 2.8%, Previous; 5.9% - Australia’s GDP likely finished 2022 solidly, growing by 0.8%. This would be stronger than the 0.6% result for Q3 and produce a 2.8% YoY change. Mechanically, the 0.8% GDP growth forecast would be marginally higher than RBA’s 0.7% from the February SMP. But the RBA expects slower household consumption, dwelling and business investment and fall in GNE and softer domestic activity is unlikely to alter its desire to tighten rates further.

CAD: Canada Quarterly GDP Annualized (Q4) – Citi: 2.1%, median: 1.5%, prior: 2.9% - Canada’s real GDP by expenditure should end 2022 by rising 2.1% (QoQ SAAR) in Q4, with possible upside risks. This would be a stronger forecast than Statistics Canada’s preliminary estimate of 1.6% (annualized) and the Bank of Canada’s latest forecast of 1.3% in the January MPR. Stronger GDP growth in Q4 than in the BoC’s latest forecasts, particularly with a pick-up in domestic demand, would be a signal that activity at the end of 2022 and into 2023 is stronger than the BoC previously anticipated. This could lead to a more explicit signal that further rate hikes remain on the table.