Sunset Market Commentary

Markets

The ECB today hiked rates by 25 bps in a decision supported by a “solid majority”. The deposit rate now stands at a record 4%. As per bond portfolios, Lagarde explained there was no discussion about a potential quicker rundown of APP (through active sales) or PEPP (through a sooner than currently communicated ending of reinvestments). Frankfurt’s statement opens with “Inflation continues to decline but is still expected to remain too high for too long.” Indeed, projections were lifted upwards for this year and the next by 0.2 ppts to 5.6% and 3.2% respectively, mainly on the account of higher energy prices. The 2025 forecast was lowered marginally to 2.1% (-0.1 ppt). Core inflation is seen at 5.1% this year, 2.9% in 2024 and 2.2% in 2025 with minor downward revisions for the latter two. In any case, all gauges remain above the 2% target over the policy horizon, warranting another hike “to reinforce progress towards its target”. Related to this, ECB president Lagarde said that some indicators of inflation expectations must be monitored carefully. We assume the 5y5y forward inflation swap (rising to 2.6%) is one of those. GDP forecasts were cut (sharply) in every year through 2025 amid further tightening of financing conditions and weakening domestic & external demand. Growth is expected at 0.7% this year (-0.2 ppts vs June), 1% in 2024 (-0.5 ppts) and 1.5% in 2025 (-0.1 ppt). Risks remain tilted to the downside. The ECB retains policy rate optionality through its data-dependent approach and Lagarde later refused to say rates indeed hit their peak. However, the statement this time also added that “Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” It’s a dovish twist that does suggest the tightening cycle has ended. Despite that it clearly states rates are needed at a high enough level for a long enough period, it immediately sparked market speculation about the timing of a first rate cut. German Bunds strengthen following today’s decision as a result, even as it wasn’t fully priced in. Yields lose between 1.6-6.7 bps with the belly of the curve outperforming. The euro slips. EUR/USD specifically was additionally hit by a dollar-supporting triple whammy of strong US retail sales, higher than expected PPI numbers and another consensus-beating reading of US jobless claims. The pair trades at the lowest level since early June around 1.067.

News & Views

Inflation in Sweden for the second consecutive month declined faster than expected. August headline inflation printed at 0.1% M/M and 7.5% Y/Y (0.0% M/M and 9.3% in July). The Riksbank’s reference, CPIF inflation (using a fixed interest rate), eased -0.1% M/M to 4.7% Y/Y (was -0.2% M/M and 6.4% Y/Y in July). Core CPIF (ex. energy), was reported at -0.3 M/M and 7.2% Y/Y (from 8.0%). Despite the easing, 0.5%+ M/M rises were still registered for several sub-categories, suggesting still broad-based underlying inflationary tendencies. The August inflation data probably won’t change the scenario for the Riksbank to raise its policy rate by 25 bpn to 4.0% next week. In the June policy statement, the RB indicated it intended to raise the policy rate at least one more time this year. However, this ‘commitment’ didn’t help the Swedish currency, with the krone setting a new all-time low against the euro in august and holding near that level. Weakness of the currency became an important topic for RB policy. Giving higher rates outside Sweden, further interest rate support beyond next week is probably needed to change SEK fortunes. EUR/SEK hovered near 11.94 post the inflation data, with the all-time top (low for the krone) at EUR/SEK 11.963.

A quarterly survey of the Norges bank questioning regional contacts in the country shows participants expect output growth at 0.3% in Q3 2023 Q3 followed by a slowdown to 0.1% in Q4. Reduced construction activity and weaker household demand are dampening activity growth, while investment related to energy production, and commercial services continues to rise. A number of contacts also point out that the krone depreciation over the past year has helped improve Norwegian firms’ competitiveness. Contacts expect annual wage growth of 5.4% in 2023 and 4.6% in 2024. At the same time, contacts report reduced profitability in Q3 compared with the same time in 2022. The Norges Bank holds a policy meeting Thursday next week where it is expected to raise the policy rate by 25 bps to 4.25%, potentially marking the end of the rate hike cycle. The krone (EUR/NOK 11.5) currently hovers in a short-term consolidation pattern between EUR/NOK 11.40/60.