ECB Has Room to Cut More

• Steady Rate Cuts, Slow QT From ECB
• UK’s Softer Labor Market
• Australia’s Employment Growth
• Spotlight on Next Week

Weekly Highlights

ECB: Steady Rate Cuts, Slow QT

The ECB delivered on the widely anticipated 25-bp rate cut this week and implicitly endorsed market expectations of further cuts, which we also share. In fact, even when, several weeks ago, investors were not really looking for another rate cut until December, we argued that there was no need for the ECB to pause in October.

Overall economic performance, while uneven across countries, has been soft on average in the eurozone as a whole. The latest eurozone inflation print 1.7% y/y as of September also says the ECB can ease up on rates a little further, even as it remains attentive to wage pressures. The labor market indeed remains more of an inflation threat in the Eurozone than it is in the US, at least when seen through the lens of unit labor cost growth. This remains elevated in the eurozone, while it has already decelerated sharply in the US. However, it seems only a matter of time until the eurozone data shows more meaningful progress.

The three policy rates were all lowered by 25 bp each, leaving the main refinancing activity rate at 3.40%, the deposit facility rate at 3.25%, and the marginal lending facility at 3.65%. No changes were made to balance sheet policy, but more meaningful adjustments will come at the end of 2024, when the ECB will cease all reinvestments into the PEPP (Pandemic Emergency Purchase Program). Currently, partial reinvestment of maturing securities are being made. ECB’s QT will pick up some pace in early 2025.

UK’s Softer Labor Market

In a low growth and high rate economy, it is more challenging for the BoE to manage both growth and inflation. Indeed, after last year’s mild recession, a strong first half this year was encouraging news for the whole economy, but it also added inflationary pressures via elevated wage growth.

The UK inflation has declined sharply this year, driven by lower energy and food prices. Leading indicators such as the PMIs also showed that companies are less willing to pass higher costs to consumers. Meanwhile, real wage growth has turned positive again. In fact, the main source of UK inflation now is the labor market which is still tight compared to the pre-Covid period. The BoE shares this view. In fact, the bank might worry that employment could turn out to be stronger than official data suggested, especially given the increased volatility of LFS estimates.

However, apart from the downtrend in unemployment rate which continued in the past few months, other indicators in labor market suggested further easing. The unemployment rate edged down one tenth to 4.0% for the three months to August, slightly lower than expected. But vacancies also declined and are merely 3% higher than the pre-pandemic. Regular wage growth eased to 4.9% y/y, down sharply from 7.9% y/y a year ago. Private sector wage growth also edged down by two tenths to 4.8% y/y, compared to 8.1% y/y last August.

Australia Labor Market Strengthens

The labor market strengthened further in September, as it added 64.1k jobs of which 51.6k were full-time jobs. The participation rate rose a tenth to a record high of 67.2%, and the unemployment rate eased a tenth to 4.1%. This data (again) blew past expectations, implying resilient labor supply on the heels of strong demographic growth as well as acute cost of living pressures.

These headline numbers may be reflective of the skew from government sector-led job creation, as 77% of the jobs in Q2 were added in just four industries: public administration, healthcare, education, and utilities. These dynamics are similar to what is happening in the US, but the key difference is that Australia’s economic growth is markedly weaker. Growth in hours worked rose to 2.4% y/y from 1.7%, implying either (continued) productivity drag or a recovering economy. Given the continued acute cost of living pressures and government sector led employment growth, we see higher odds of the former.

The data almost nullifies the chances of near-term rate cuts, which we fear will lead to persistent below trend economic growth. Although there is a good chance of soft inflation print at the end of the month, the odds of near-term rate cuts remain low, consistent with the guidance from the Reserve Bank of Australia.

Spotlight on Next Week

• Bank of Canada expected to deliver 50-bp cut. 
• UK consumer confidence to remain low. 
• Europe’s manufacturing lethargy to persist.