Weak PMIs Keep ECB Jumbo Cut Speculation Alive

In focus today and over the weekend

Today, focus turns to the German Ifo growth indicator for October. The Ifo survey is more extensive than the PMIs and it will be very interesting to see if it mirrors the recent uptick observed in the PMIs yesterday.

In the euro area, September data on credit growth and money supply is published today. Credit growth has started to rebound, and the latest ECB bank lending survey showed increased demand for lending as well as unchanged credit conditions in Q3.

In Japan, all eyes are on Sunday’s general election. Polls have indicated the ruling coalition is in danger of losing its Lower House majority, after a slush fund scandal forced the previous prime minister out. Changes in the political scene could impact the backing for further BoJ rate hikes. We still look for another rate hike in December or January.

Economic and market news

What happened overnight

In Japan, CPI Tokyo Ex-Fresh Food declined to 1.8% (cons: 1.7%, prior: 2.0%), undershooting the BoJ’s 2% target for the first time since May.
What happened yesterday

In the euro area, October flash PMIs came in at: Composite at 49.7 (cons: 49.7, prior: 49.6), services at 51.2 (cons: 51.5, prior: 51.4) and manufacturing at 45.9 (cons: 45.1, prior: 45.0). Overall, the data shows that the growth momentum in the euro area remains fragile at the start of Q4 with PMIs suggesting stagnation. Looking ahead, we expect growth to remain weak in the final quarter of the year, but we still expect positive support by services activity amid a decent labour market, rising real incomes and diminishing headwinds from falling interest rates.

For the first time in four years, employment numbers in the service sector have decreased for Germany and France. Signs of labour market softening and subdued economic growth, pave the way for lower interest rates. Currently, the ECB is set to lower interest rates in December with traders pricing in a 43% chance of a 50bp rate cut. For that to happen, we anticipate a significant deterioration in key metrics to be required. Before the next rate meeting data on inflation, wages and another round of PMIs could change the economic outlook.

ECB policymakers Martins Kazaks (hawk) and Bostjan Vasle (hawk) advocated for a step-by-step approach to cutting rates, as weakness in the euro zone is ‘single biggest concern’ despite domestic price pressures continuing to remain ‘sticky’, US election worries and energy price risks. ECB’s Nagel (hawk) followed by saying that the ECB should not be hasty but cautious about lowering interest rates.

In the US, flash PMIs edged up beating expectations: Composite at 54.3 (cons: 53.8, prior: 54.0), services at 55.3 (cons: 55.0, prior: 55.2) and manufacturing at 47.8 (cons: 47.5, prior: 47.3). In total, the indicators point towards robust growth with manufacturing likely past the bottom.

Fed policymaker Beth Hammack (voting member) echoed the words of Fed Chairman Jerome Powell, acknowledging the impact of previous rate hikes on reducing inflation but noting that it has not yet fallen to the 2% target.

New home sales reached the highest level in 1.5 years of 738,000 (cons: 720,000, prior: 716,000), climbing 4.1% following the fall in mortgage rates last month as the Fed began cutting interest rates. In recent weeks mortgage rates have climbed as expectations for another 50bp cut from the Fed have diminished following solid US economic data.

In the UK, preliminary PMIs for October surprise to the downside: Composite at 51.7 (cons: 52.5, prior: 52.6), services at 51.8 (cons: 52.4, prior: 52.4) and manufacturing at 50.3 (cons: 51.5, prior: 51.5). Overall, the PMIs point to a more muted growth outlook for the rest of the year and should put the domestic demand worries at the BoE to a slight ease, ahead of the much-anticipated UK budget release.

FI: The October euro area PMIs came out in line with expectations, though markets interpreted the details as renewed signs of disinflation. Euro swap curves declined from the back with the 10Y tenor closing 5bp lower. Pricing of the ECB December meeting still stands at -35bp with another -35bp priced in January. The short end of the market remains highly responsive to any ECB commentary regarding the possibility of a significant rate cut in December. Yesterday, even typically hawkish members such as Kazaks and Wunsch seemed a bit hesitant to dismiss the potential for a ‘jumbo’ cut. Peripheral spreads tightened, while the Bund ASW-spread was close to unchanged at 16.7bp.

FX: The USD rally lost steam yesterday when NOK, JPY and EUR came out on top among G10 currencies. EUR/USD rose above 1.08 and USD/JPY fell below 152. EUR/NOK briefly dropped to 11.80-level.