ECB raises rates 25bp as expected

The European Central Bank raised interest rates by 25bp as expected yesterday, taking the deposit rate to 3.5%. President Lagarde said the ECB would “very likely” raise rates again in July and indicated that the bank would data-dependent thereafter, leaving open the option for a September rate hike. The ECB’s updated economic projections show a sharp upward revision to the core inflation forecast – inflation excluding food and energy is expected to average 5.1% in 2023, up from 4.6% in the March projections. The forecast for 2024 core inflation was also revised higher to 3.0% from 2.5% previously. Real GDP growth projections for both this year and next were also revised slightly lower.  Like the Fed, the ECB highlighted strong wage growth (due to a tight labour market and increased minimum wages) as a key driver of inflation, but also flagged higher corporate profit margins.

US economic data was mixed yesterday, with something for both hawks and doves. Advance US retail sales data for May showed a rise of 0.3% m/m, well above expectations for a -0.2% m/m decline but slightly slower than the April reading of 0.4% m/m. Excluding autos and gas, retail sales rose 0.4% m/m, double the forecast rate. US consumers have continued to spend even as inflation has eroded purchasing power and borrowing costs have increased 500bp in a little over a year. Excess savings from the pandemic may be supporting spending growth, but the San Francisco Fed economists expect these savings will be exhausted by the end of this year.  Separately, the Empire Manufacturing survey came in much stronger than forecast in June at 6.6 and was sharply higher than in May (-31.8), as orders and shipments rebounded. The survey also pointed to easing cost pressures.

On the dovish side, initial jobless claims in the US rose by a higher-than-expected 262k in the week to 10 June, and continuing claims also rose by more than forecast in the week to 3 June. While the data is volatile the 4-week moving average of initial claims is now the highest since November 2021, indicating some softening in the labour market. Industrial production also contracted -0.2% m/m in May, against expectations of a 0.1% m/m gain.

Consumer inflation in Saudi Arabia accelerated slightly in May to 2.8% y/y from 2.7% in March and April. Prices rose 0.2% m/m, driven by higher housing and transport costs in May. Entertainment and miscellaneous costs also rose sharply at 0.5% m/m, while restaurant and hotel prices declined m/m for the first time since August 2021. On an annual basis, housing costs rose 8.4% y/y while entertainment and hospitality price inflation were in the 3-5% range. Food inflation slowed to just 0.9% y/y last month, down from a recent peak of 4.4% y/y last October.  Year to date CPI inflation is running at 2.9%, broadly in line with our 3% expected average this year.

Today’s Economic Data and Events

• 10:00 Bank of Japan policy meeting, no change expected
• 13:00 EZ final CPI (May) forecast 6.1% y/y
• 18:00 US University of Michigan consumer sentiment (Jun) forecast 60.0 (59.2 prev).

Fixed Income

• There was a rally in Treasuries on Thursday, following higher-then-expected initial jobless claims. Yields on the 2yr UST closed the day down 5bps at 4.642%, while the 10yr yield declined 7bps to 3.717%.
• Moves in UK government bonds were mixed on the day, with yields on the 2yr Gilt jumping 10bps to 4.895% and yields on the 10yr dropping fractionally to 4.376% from 4.384%. There were broad-based rises in European bond yields, on the back of the ECB’s decision to hike rates. The 2yr Bund yield was up 11bps to reach 3.098%.    

FX

• Both the Euro and Sterling strengthened against the dollar on Thursday. The EURUSD rose by 1.06% to 1.0945 while GBPUSD gained 0.95% to 1.2784.
• Commodity currencies also saw broad-based gains against the dollar with USDCAD down 0.76% to 1.3223 while AUDUSD jumped 1.3% to 0.6885 and NZDUSD rose 0.4% to 0.6233.

Equities

• The hawkish pause by the FOMC on Wednesday and the ECB hike yesterday meant a lacklustre day for European equity markets yesterday. The DAX closed down 0.1% while the CAC dropped 0.5% on the day. In the UK, the FTSE 100 fared better however as it gained 0.3%.
• In the US, equity markets shrugged off the hawkish messaging from central banks, and the major benchmarks all closed higher. The S&P 500 closed up for the sixth day running for the first time since late 2021, adding 1.2%, while the NASDAQ also added 1.2%. The Dow Jones closed up even more at 1.3%.
• Asian markets also had a strong run earlier in the day, with Chinese stimulus measures buoying sentiment for the Shanghai Composite (up 0.7%) and the Hang Seng (2.2%). The wind went out of the Nikkei’s sails after the strong gains of recent days but it closed down only modestly at 0.1%.
• Locally, the DFM closed up 0.5% while the ADX dropped 0.1%.

Commodities

• Oil markets saw strong gains yesterday as sentiment improved markedly from the previous day. Both benchmarks gained 3.4% yesterday, taking Brent futures to USD 75.67/b, while WTI went up to USD 70.62/bl. This was the biggest gain in six weeks.
• The positive sentiment was seemingly driven by the Chinese stimulus measures, and hopes that this would stimulate the economy and oil demand through the second half of the year.