25bp rate hike as expected

As expected, the Swiss National Bank has raised its key interest rate by a further 25 basis points to 1.75%. This brings the total amount of rate hikes in this cycle to 250 basis points in one year, well below the European Central Bank’s 400bp and the Federal Reserve’s 500bp. At the same time, the SNB continues to intervene in the foreign exchange market by selling currencies, thereby strengthening the Swiss franc and bringing down imported inflation. After years of foreign currency purchases, this reduces the size of the SNB’s balance sheet and is therefore a particularly effective form of quantitative tightening against inflation.

Long-term inflation concerns

This rate hike comes against a backdrop in which inflation remains above the SNB’s inflation target of between 0 and 2% – although it has fallen sharply. It reached 2.2% in May, a steady decline from the 3.4% reached in February 2023. Core inflation fell below 2% to 1.9% in May. Thanks to lower energy prices and the appreciation of the Swiss franc, the SNB expects inflation to continue to fall to 1.7% in the third quarter.

Despite this encouraging decline, the SNB continues to see inflation as a problem and expects it to strengthen over the coming winter due to second-round effects. Inflation is also expected to become increasingly domestic, and therefore less easily combatted by strengthening the exchange rate. Of particular concern is an expected rise in rents, which account for 16% of the consumer basket and are indexed to interest rates in Switzerland.

In light of this situation, the SNB has revised up its inflation forecasts for the next few years and now expects inflation to remain above 2% until the end of the forecast horizon in the first quarter of 2026. It’s expected to average 2.2% in 2023, 2.2% in 2024 and 2.1% in 2025. In other words, aside from the fall expected this autumn, the SNB does not expect any moderation in inflationary pressures and believes that the current situation is likely to persist. This signal growing concerns about the long-term outlook for inflation.

Another hike expected in September

This upward revision of forecasts is a particularly hawkish signal and suggests that the SNB will raise rates again. President Thomas Jordan almost pre-announced this at the press conference, stating that tighter monetary policy will be necessary to bring down inflation. As a result, we are now expecting another rate hike of 25 basis points in September.

At a time when other central banks seem to have lost confidence in their models and are looking primarily at the actual rate of inflation, the SNB seems to be taking a different approach by focusing primarily on inflation forecasts. The fact that the ECB is likely to be more aggressive than previously expected – probably raising rates again in July and September – should further reinforce the SNB’s decision. After September, the SNB rate is likely to remain at 2%, with a rate cut looking unlikely between now and 2026.

SNB remains prepared to sell FX

EUR/CHF has edged higher today after the SNB avoided the more aggressive 50bp rate hike option. However, this exchange rate remains heavily managed by the SNB and we doubt it will embark on a major rally just yet.

In today’s press conference, the SNB said that it had been selling FX over recent quarters. This is consistent with its policy – elaborated upon last year – that it wanted to keep the real Swiss franc stable to fight inflation.

As you can see from the chart below, the SNB has been effective in keeping the real exchange rate stable. To deliver real exchange rate stability it has allowed/engineered a 2% nominal appreciation of the trade-weighted Swiss franc over the last quarter.

With the inflation differential between Switzerland and its main trading partners (the eurozone and the US) expected to narrow over the coming quarters and following years, the SNB will presumably not have to engineer quite as much nominal appreciation to keep the real CHF stable.

If we are right with our forecast for a weaker dollar over the next 12 months, it looks like a lower USD/CHF will do the heavy lifting for the modest gains in the nominal CHF, needed to keep the real exchange rate stable. This means that EUR/CHF will probably continue to trade in a 0.97-0.99 range for most of this year and will only be allowed by the SNB to trade substantially higher if USD/CHF falls even harder.

The SNB has been effective in keeping the real exchange rate stable

source: ING

The Bank of England raised its interest rate by 0.5% to 5%

The division of votes was 7 to 2 so two people were against the increase.

The continuation of inflation requires further escalation.

If there is evidence of more sustained pressures, then further tightening of monetary policy is needed.

The committee acknowledges that second-round effects on domestic price and wage developments from external cost shocks are likely to take longer to dissipate than they emerge.

However, CPI inflation is expected to moderate significantly over the course of the year, mainly reflecting energy price developments.

We will continue to closely monitor the impact of the significant rate increase thus far.

Net commodity price inflation is also much stronger than what was predicted.

Food price inflation is expected to decrease further in the coming months.

In recent data, significant bullish news has been published, which indicates further continuation of the inflation trend, against the background of tight labor market and continuation of flexibility in demand.

The BoJ has unanimously decided to maintain its ultra-easing monetary policy as it is still looking for clearer signs of sustainable inflation growth. We believe higher-than-expected inflation, a continued solid economic recovery, and growing pressures from the weaker yen will eventually convince the bank to revise its YCC policy in July

The Bank of Japan’s no change decision was very much in line with market expectations

The Bank of Japan’s (BoJ’s) monetary policy statement hasn’t changed much at all on its view on the growth and inflation outlook and hasn’t given a hint of any exit plans. The BoJ kept its dovish stance by repeating that “the bank will not hesitate to take additional easing measures if necessary”.

What is more worth noting, however, is that the BoJ pointed out that wage gains are expected, accompanied by changes in firms’ price and wage-setting behaviour. We believe that this is the change of structural and behavioural disinflation factor that the BoJ has been looking for.

To be precise, the latest labour cash earnings data were disappointing despite the surprisingly solid Shunto (Spring wage negotiations) results. Thus, an improvement in earnings is another factor to watch to gauge the BoJ’s policy action and we will also see how earnings data unfold in the coming months.

We believe that rising asset prices are another important factor in sustainable inflation. With recent rallies in Japanese equity markets and the gradual rise in housing prices, the positive wealth effect is likely to keep inflation above the BoJ’s target, in our view.

Dovish comments from Governor Ueda

Governor Kazuo Ueda’s comments at the press conference were no different from what the statement suggested. Ueda is concerned that the outlook for wage growth is highly uncertain and wants to see clearer signs of sustainable inflation. There were no hints about future policy adjustments in his comments.

However, we still think that the BoJ can change its YCC policy in July for the following reasons:

1. First, the BoJ is likely to upgrade its inflation forecast in the quarterly outlook report in July. That could more easily justify the BoJ’s policy action. As mentioned previously, we expect inflation to remain higher for longer than expected.
2. Second, the overall bond market functions have improved, although there have been some fluctuations since December’s YCC band widening, and the market is not testing BoJ’s YCC upper limit of 10Y JGB. Thus, we believe that the market stress has been reduced, and it is a good time for the BoJ to revisit its YCC policy to reflect changes in market conditions.
3. Third, a weaker yen will likely add more inflationary pressures. If the BoJ continues to maintain its current policy setting, it would risk leaving the BoJ “behind the curve”. We believe that Japan’s economy is recovering solidly compared to other major economies and will continue to outperform in the future. But, if monetary policy fails to reflect this shift of economic fundamentals and the BoJ keeps its dovish policy, then the yen should depreciate even more.
4. Lastly, by the time of the July meeting, the US Federal Reserve will have already decided on monetary policy, and where the UST will be is another factor the BoJ should consider.

From now on, we will be closely watching upcoming data releases such as June Tokyo CPI, labour cash earnings, and the movement in JPY, to see if these give a clearer signal of sustainable inflation.

source: ing

The Energy Information Administration (EIA) estimates that US shale oil production could remain flat in July, with drilled but uncompleted wells (DUCs) inventory falling further in May. For metals, China’s surprise cut in short-term rates has been supportive of prices as Beijing appears to be taking measures to support economic growth

Energy – US shale production flat

In its latest drilling productivity report, the Energy Information Administration (EIA) estimates that the US shale oil production could be flat at around 9.38MMbbls/d in July compared to an estimated 9.37MMbbls/d in June. The report also showed that drilled but uncompleted wells (DUCs) dropped by thirty over the month of May 2023 to 4,834 wells, the lowest level since May 2014. DUC have been falling continuously since start of the year with YTD drop of around 270 wells since the end of 2022 reflecting lower investment into oil exploration for the year. Low inventory of DUC could also make it challenging for the US to increase production quickly even if prices move up.

Canada is witnessing an increase in wildfires once again which could hurt the oil and gas production in the region. The Alberta province reported seventy-six active wildfires as on Monday compared to seventy-one on Friday; while across Canada, around 431 wildfires reported of which around 208 are reported to be out of control. Last month, the country faced production disruption of around 200-300Mbbls/d of oil and gas production at one point, although some of the oil fields have subsequently restarted production since then. Spreading wildfires could increase disruption again this month as well. WCS discount over the WTI has dropped back to US$12.9/bbl currently after increasing to around US$15/bbl at the start of the month.

Metals – Share of Russian aluminium in LME warehouses grows

Industrial metals (except for nickel) edged higher in the morning session as China trimmed its short-term policy interest rate unexpectedly. People’s Bank of China lowered its 7-day reverse repurchase rate by 10bps to 1.9% in a sign that Beijing has been taking measures to support the flagging economic growth. The move also provides some confidence to the market that China could take further steps to push up economic growth.

Recent data from LME shows that share of Russian aluminium inventory out of total exchange inventory increased to 68% in May from 52% in April following increased withdrawals of aluminium from LME warehouses in Asia. The data shows that there was a total of 263,125 tonnes of Russian aluminium in exchange warehouses, while Indian-origin aluminium stood at 116,800 tonnes falling from 46.5% in April to 30% in May. Meanwhile, the exchange said that 19% of the 167,550 tonnes of aluminium requested for delivery in May was still Russian metal.

Agriculture – USDA slashes weekly corn crop ratings on dry weather

The USDA’s latest crop progress report shows that US soybean plantings continue to rise with 96% planted as of 11 June, well above the 87% seen at the same stage last year and above the 5-year average of 86%. Similarly, spring wheat plantings are 97% complete, which is above the 92% planted at the same stage last season, and in line with the 5-year average. On the crop condition, the agency rated around 38% of the winter wheat crop in good-to-excellent condition, up from 36% a week ago, and 31% seen last year. On the other hand, the USDA rated 61% of the corn crop in good-to-excellent condition as of 11 June, lower from 64% a week ago and 72% seen at the same stage last year largely on account of dry weather.

The USDA’s weekly export inspection data for the week ending 8 June pointed towards weakening demand for US grains. USDA’s export inspections of corn stood at 1,169.1kt in the above-mentioned period, lower from 1,206.8kt in the previous week and 1,221.8kt reported a year ago. For wheat, US export inspections stood at 246.6kt, down from 304.4kt from a week ago and 411.9kt reported a year ago. Meanwhile, US soybean export inspections fell to 140.2kt compared to 222.3kt from a week ago and 609kt from a year ago.

source: ing

While there has been some speculation about rate cuts, today’s cut was not widely expected, and coming just ahead of the monthly activity data suggests that this set of numbers could be very weak

Reverse repo rate cut, 1Y MLF next?

Before today’s hike, the received wisdom had been that the People’s Bank of China would not use blanket rate cuts as a first resort, but would rather use some of its more focused tools, such as targeted RRR cuts. So the 10bp cut of the 7-Day reverse-repo rate today raises some questions. 

The first of which is whether this will be followed by a cut to the 1-Year Medium-Term Lending Facility (1Y MLF) on Thursday. Our first guess on this is, yes, probably. After all, window guidance on deposits was also lowered earlier in the month, so there does seem to be a general easing of policy going on. 

The next question is, why now? What has changed? Certainly, China’s reopening has been quite tepid, with a catering-led consumer spending surge that already looks to be losing steam and manufacturing still struggling. Activity data on retail sales is also due on Thursday, and it may be no coincidence that rates are being eased only days ahead of this release if it turns out that the reopening is already sputtering. 

If the one engine of growth – retail sales – is not delivering what is required of it, and if the other sectors of the economy are failing to pick up the slack, then broader stimulus measures like these would seem appropriate. The consensus forecast for retail sales is for a 13.8% year-on-year rise, which sounds pretty strong. But it translates into about a 1% month-on-month (sa) decline, and the apparent strength is all due to base comparisons. 

7-Day reverse repo rate and USD/CNY

CNY weaker will drag other currencies with it

The Chinese yuan has weakened above 7.16 at times today, adding to the month and a half of weakness it has already experienced. Further stimulus may prompt some short-term reversals, or slow the slide. But it may take a more concerted improvement in the macro data before the CNY turns decisively. Short of a substantial boost from fiscal policy, such as loans from the central government to local governments to spur infrastructure spending, that doesn’t look on the cards just yet, though today’s move does indicate that the authorities’ patience with the weak recovery is wearing thin. 

source: ing