For the Sake of Its Economy, China Must Address Youth Unemployment

The Bank of England looks set to keep its cards close to its chest on Thursday and not speed up its progress towards cutting interest rates, as it awaits clearer signs that the country's hot inflation problem has been doused.

The BoE is widely expected to keep Bank Rate at 5.25%, its highest level since 2008, in its March policy announcement at 1200 GMT, a day after data showed inflation fell to its lowest in almost two-and-a-half years but stayed too high for comfort.

Investors will be watching closely for any hint of an acceleration of discussions within the Monetary Policy Committee about when to cut borrowing costs for the first time since the onset of the COVID-19 pandemic.

The U.S. Federal Reserve indicated on Wednesday that it remained on course to cut rates three times this year but stayed on alert about the path of price growth ahead.

The European Central Bank has tried to cool talk about a run of rate cuts that has gathered steam as investors increasingly consider the fight against global inflation to have been won.

Britain's headline inflation rate - which topped 11% in October 2022 and led to a historic living standard squeeze - fell by a bit more than expected to 3.4% in February from 4.0% in January but was still the highest in the Group of Seven.

Although it is expected to drop to the BoE's 2% target in April, it is forecast to pick up again slightly after that, and services inflation - which largely reflects strong wage growth - remains high at 6.1%.

Analysts polled by Reuters expect the BoE's Monetary Policy Committee to split three ways for a second time in a row but this time with only one vote for a hike and one for a cut with the other seven in favour of keeping Bank Rate at 5.25%.

At February's meeting, two MPC members voted for an increase to 5.5% and one for a cut to 5.0% with six backing a hold.

Most analysts and investors think the BoE will only cut rates for the first time in the third quarter, probably at its August meeting.

But financial markets currently put a roughly 60% chance on the BoE cutting rates in June with almost three quarter-point reductions priced in for borrowing costs over 2024.

The central bank wants to see wage growth slowing further before making its move.

Britain's minimum wage will rise by nearly 10% next month, and retailers that often pay staff only slightly more have raised salaries ahead of the increase.

Employers overall have offered pay settlements of about 5% since the start of 2024. Average wage growth is about 6%, higher than about 4% in the United States and the euro zone.

James Smith, an economist with ING, said stronger-than-expected falls in services inflation and wage growth data could lead to a BoE rate cut in June.

"But more likely we think the Committee will wait for a few more numbers and also a new round of forecasts, which makes August a more likely candidate for the first rate cut," he said.

As well as employers, mortgage-holders and consumers, the ruling Conservative Party is also keen to see rates come down as it struggles to rein in the opposition Labour Party's strong lead in opinion polls with an election expected later this year.

Finance minister Jeremy Hunt took the unusual step of commenting on what Wednesday's inflation data might mean for the BoE, saying: "As inflation gets closer to its target that opens the door for the Bank of England to consider bringing down interest rates."

The BoE will not hold a press conference on Thursday as no new economic forecasts are due to be published.

The yen rose sharply on Thursday in part due to a broadly weaker dollar, but also drew support from expectations of further rate hikes from the Bank of Japan later this year and some jawboning efforts from Japanese government officials.

Down Under, the Australian dollar jumped after data on Thursday showed employment rebounded sharply in February and the jobless rate dived far below forecasts, pointing to a still-tight labour market.

The yen gained more than 0.5% to 150.46 per dollar, reversing some of its heavy losses in the wake of the BOJ's policy pivot.

Analysts said factors supporting the yen's rise included growing bets of another BOJ rate hike in July or October, as well as a rebound in business confidence in the Japanese economy.

Earlier on Thursday, the country's finance minister Shunichi Suzuki also said the government was watching currency market moves with "a high sense of urgency", following the yen's decline to a four-month trough of 151.82 in the previous session and toward a multi-decade low.

"I think there's a bit of jawboning going on... given that the speed of the yen move has probably been a bit too rapid for what the Ministry of Finance officials would like to see," said Moh Siong Sim, a currency strategist at Bank of Singapore.

"That may have explained why dollar/yen has come off as well."

Still, the main driver remained a sliding U.S. dollar, after the Federal Reserve maintained its interest rate cut projections for the year in the face of upside surprises on inflation, and did not strike a more hawkish tone as some investors had feared.

At the conclusion of the Fed's policy meeting on Wednesday, Chair Jerome Powell said recent high inflation rate readings had not changed the underlying trend of slowly easing price pressures in the United States. The central bank stayed on track for three rate cuts this year, even though it projected slightly slower progress on inflation.

That sent the greenback tumbling as traders were quick to rebuild bets of a Fed easing cycle beginning in June, with markets now pricing in a 75% chance of a rate cut that month, as compared to 59% chance a day earlier, according to the CME FedWatch tool.

The euro and sterling notched one-week highs against the dollar on Thursday, rising to $1.0939 and $1.2803, respectively.

"The Fed really, really wants its soft-landing ending. Stronger growth, lower unemployment, higher inflation - and yet still no change to the median dot," said Seema Shah, chief global strategist at Principal Asset Management.

"Powell has perhaps shown his cards: he needs a good reason not to cut rates, rather than a reason to cut rates."

The dollar index was little changed at 103.22, after having slid more than 0.5% in the previous trading session.

With the Fed meeting out of the way, focus now turns to a rate decision from the Bank of England (BoE) later on Thursday, where expectations are for the central bank to keep rates on hold.

British inflation slowed in February, official data on Wednesday showed, keeping the BoE on track to start cutting borrowing costs later this year.

A resurgence in Australia's February employment figures and a downtick in its jobless rate gave the Aussie a boost on Thursday.

Figures from the Australian Bureau of Statistics on Thursday showed net employment jumped 116,500 in February from January, surging past market expectations for a 40,000 increase, while the jobless rate dropped to 3.7%.

The Australian dollar jumped 0.6% to a one-week high of $0.6626.

"Employment data is always very volatile, and no single month of data should be read in isolation. However, today's figures are too strong to ignore," said Rob Carnell, ING's regional head of research for Asia-Pacific.

"In light of this data, (the Reserve Bank of Australia) are probably quietly relieved that they did not go further and adopt an outright easing bias this week."

The RBA had, at its policy meeting earlier this week, held interest rates steady and watered down its tightening bias.

Elsewhere, the New Zealand dollar was last 0.24% higher at $0.60965, though its gains were capped by domestic data showing New Zealand's economy shrank slightly in the fourth quarter, putting the country into a technical recession.

The New Zealand economy was broadly flat over the December quarter. The production measure of GDP fell by 0.1%, slightly weaker than the zero growth that we and the Reserve Bank were expecting. Both the expenditure and income measures (the latter being a new addition to today's release) were flat in inflation-adjusted terms.

Along with some modest revisions to growth in previous quarters – mostly due to recalculating the seasonal factors – output has shrunk by 0.3% over the last year. Again, this was softer than the flat outturn that we and the Reserve Bank had forecast.

The mix of activity was similar to what we expected. Goods-based sectors are tending to do it tougher, with declines in retail, wholesaling, manufacturing and residential construction. This was partly offset by gains in the services sectors, though even here the growth was patchy. Finance, rental services and professional services saw solid gains, but transport and arts and recreational services were down as the recovery in international tourism faltered over the quarter. The biggest lift was in public administration (up 2.8%), though it's likely that at least some of this related to the October election.

In the context of the very strong population growth that New Zealand is currently seeing, a flat outturn for GDP is quite a soft result. Output was down 0.7% in per capita terms for the December quarter, and has fallen by 3.1% compared to a year ago. That's a sharp decline compared to history – something that would normally be associated with recession – but in this case it highlights the degree to which the economy had become overheated in the first place.

On balance, today's report suggests slightly less need to keep monetary policy tight for an extended period. That said, the scale of the surprise for the RBNZ is less than we saw in the September 2023 release, which the RBNZ has tended to downplay. There is also a lot of water still to go under the bridge before the May Monetary Policy Statement, including the next QSBO business survey (early April), the March quarter CPI (mid-April) and the March quarter labour market surveys (early May). There's also the crucial first Budget for the new coalition Government – while that will be unveiled after the MPS, the RBNZ will no doubt be briefed on the key details.

As widely expected, the FOMC left the target range for the federal funds rate unchanged at 5.25-5.50% at the conclusion of its March meeting. The last rate hike occurred in July 2023, and the Committee has left its policy rate unchanged in the eight months since.

The Summary of Economic Projections (SEP) signaled that all but two of the Committee members expect to start cutting rates this year, with the median participant projecting 75 bps of easing by year-end 2024 (chart). The 2024 median dot was unchanged from the December SEP, although the distribution drifted higher in a sign that policymakers remain on guard against sticky inflation. In that vein, the median dots for 2025 and 2026 rose by 25 bps in each year, consistent with 75 bps of easing in 2025 and another 75 bps of cuts in 2026.

The median "longer-run" dot also moved higher. The longer-run dot represents each participant's view of the level of the federal funds rate that would be most consistent with achieving the Federal Reserve's dual mandate of maximum employment and price stability over the long-run. The increase in the longer-run dot was small, just 6 bps, but it marks the first time the median has been above 2.5% since March 2019. We suspect the longer-run dot will drift higher very slowly to reflect a neutral rate that may have moved somewhat higher relative to the pre-pandemic period. Markets appear to be ahead of the Committee and are priced for short-term interest rates to be between three and four percent over the longer-run (chart).

Elsewhere, the Committee's projections for the economy reflected continued resilience in both output and price growth. The median projection for real GDP growth in 2024 is 2.1%—up from 1.4% in the December SEP. Growth projections in 2025 and 2026 were also revised up by two tenths and one tenth of a percentage point, respectively. The Committee's inflation projections also rose modestly, most notably an increase in the median projection for 2024 core PCE inflation from 2.4% to 2.6% (chart). That said, the median forecasts for core inflation in 2025 and 2026 were left unchanged in a sign that the Committee remains confident that inflation progress will continue, just at a slightly slower pace than previously believed.

The post-meeting statement contained virtually no changes to what was released following the January 31 meeting. Job gains were still characterized as "strong," although the phrase that hiring has "moderated since early last year" was stricken with payrolls averaging 265K the past three months. The remainder of the statement contained no changes. Economic activity continues to expand at a "solid" pace, and inflation "remains elevated." Notably, the FOMC continues to seek "greater confidence that inflation is moving sustainably toward 2%" before reducing the fed funds rate.

Overall, the updated Summary of Economic Projections suggests that the FOMC believes that inflation is on a path back to its 2% target, but it is likely to be achieved slightly later than previously expected. We currently expect the Committee to first ease policy at its June 12 meeting, at which time officials will have seen three more months of inflation and employment data, and ultimately reduce the fed funds rate by a total of 100 bps this year (chart). However, with the Committee more upbeat on prospects for economic activity and a bit more worried about inflation, the risks to our outlook are skewed toward the FOMC beginning to ease a little later in the summer (at its July 31 meeting), or potentially proceeding at a slower pace (e.g., every other meeting).

The Committee also reaffirmed its ongoing pace of balance sheet runoff, commonly referred to as quantitative tightening (QT), but Chair Powell's comments in the post-meeting press conference suggested that changes are coming. Powell stated that it is the Committee's view that it would be appropriate to slow the pace of asset runoff "fairly soon." Note that a slower pace of QT would still involve shrinking the Fed's balance sheet, just at a slower pace than what has occurred since QT ramped up in mid-2022. Coming into the meeting, our forecast assumed that the FOMC would announce a plan to slow the pace of QT at its June meeting. In light of Powell's comments today, an announcement at the May meeting seems slightly more likely than a June announcement, although we would not be surprised if it slipped to the June meeting. Either way, we expect the runoff caps for Treasury securities to be reduced to $30 billion while mortgage-backed securities caps are dropped to $20 billion, with this slower pace of runoff continuing until roughly year-end 2024.

Fed policymakers on Wednesday kept their 2024 U.S. interest rate projection unchanged, but the floor for rates once cuts start is moving higher.

In their quarterly Summary of Economic Projections, officials raised the median outlook for 2025 and 2026, and more importantly, increased their longer-run median interest rate outlook above 2.5% for the first time in five years.

The median 2025 and 2026 rate views were raised by three tenths of one percent to 2.9% and 3.1%, respectively, and the longer-run rate was lifted by one tenth of a percentage point to 2.6%.

As the Fed maintained its long-run inflation projection at its 2% target, this implies a slight increase in what policymakers deem to be the neutral real rate of interest, or 'R-star', to 0.6% from 0.5%.

These were small changes, particularly to the longer run projection, but they could be significant.

Collectively, they show the Fed recognizes that policy needs to be tighter for longer in the post-pandemic world to get inflation back down to target and keep it there. Seven Fed officials now see a neutral rate of 2.9% or higher, compared with four in December.

Another way of looking at it, with growth consistently surprising on the upside, the post-pandemic U.S. economy is much less responsive to interest rate hikes than it was before March 2020.

These are hardly new revelations - rates futures markets have for some time priced in a higher terminal rate than that implied in the SEP projections - but the highest neutral rate outlook since 2018 is a marker.

The question now is whether that gap between the market-based and Fed view for the terminal rate, the policy rate once the easing cycle ends, begins to converge.

"We're on a higher glide path," said Gregory Daco, chief economist at EY. "There's a more consistent view between the market and the Fed on ending the easing cycle at a level that is higher than what had been consistent with previous cycles."

Fed Chair Jerome Powell downplayed the new neutral rate projection, calling the move "modest" and noting that the long-term horizon is shrouded in huge uncertainty.

In addition structural factors like demographics, productivity trends and cross-border capital flows help determine 'R-star', and the pace of change in these can be glacial.

But Powell did say his "instinct" is that interest rates will not return to pre-pandemic low levels.

Again, this is not a particularly revelatory position but it does chime with what the bond and rates markets have been signaling recently.

Breakeven inflation rates on 10- and 30-year inflation-linked Treasury bonds are hovering around 2.3% and drifting closer to 2.5%, a sign that bond traders are not fully convinced the Fed will get inflation back down to target.

Interest rate futures currently imply a terminal rate of 3.7% by the end of 2026, a good bit higher than the Fed's projected 3.1% over the same time horizon, never mind the long-run neutral view of 2.6%.

With growth running hotter than nearly all forecasts and inflation proving stickier than Fed officials would like, it's more likely that any convergence will see the Fed's rate view drift towards the market's rather than the other way around.

"There is still a clear difference between the market and the Fed in terms of where the terminal rate will land," says Charlie Ripley, senior investment strategist at Allianz Investment Management.

"The main implication (of this) is that a policy rate set lower than the natural rate for a longer period of time could bring on unintended price instability or unwanted inflation."

The first step to closing that gap was taken on Wednesday. It may not be the last.

1. Australian employment data is strong, so the RBA is possible to raise rates.

2. New Zealand's economy slips into recession, so the central bank has to cut rates earlier.

3. WSJ's Timiraos says the Fed has not cut the rate-cut expectations.

4. Fed rate decision: Three rate cuts in 2024, scaling back rate-cut forecasts for 2025.

Australian employment soared and the unemployment rate fell in February, highlighting the continued resilience of the country's labor market against the restrictive monetary policy. 116,500 new jobs were created in February, almost triple the expected 40,000. The unemployment rate fell to 3.7% from 4.1% and the employment participation rate fell slightly to 66.7%. As a result, the AUD/USD rose as much as 0.4%, while the policy-sensitive three-year bond yield climbed to 3.68%. The Reserve Bank of Australia (RBA) kept its benchmark interest rate at a 12-year high of 4.35% this week and declined to hike rates. Employment data on Thursday and monthly inflation data due next week will help shape the policy debate further.

New Zealand's economy unexpectedly contracted in the last three months of last year as high interest rates continued to dampen consumer spending and investment, confirming the economy was in recession. Following a 0.3% decline in GDP in the third quarter of last year, New Zealand's fourth-quarter GDP fell by 0.1% quarter-on-quarter, compared with an expected 0.1% increase, and fell by 0.3% year-on-year, worse than the expected 0%.

In the face of aggressive monetary tightening by the Reserve Bank of New Zealand (RBNZ), as it tries to control inflation, weak growth could pressure policymakers to consider an early shift to lower interest rates. The RBNZ has kept interest rates on hold at 5.5% since last May and hinted last month that it didn't plan to cut rates until 2025. Most economists expect the bank to cut rates for the first time in the last months of 2024.

Wall Street Journal reporter Nick Timiraos wrote after the Fed rate decision that, despite the strong U.S. economic growth in recent months and higher-than-expected inflation, the Federal Reserve officials did not significantly change the expectations of rate cuts. Most officials still expect three rate cuts this year, but some officials predicted milder rate cuts than last year.

Federal Reserve Chairman Jerome Powell acknowledged that inflation has been stickier than expected over the past two months and warned policymakers that they should not "ignore data we don't like." But he said officials had previously anticipated that the decline in inflation could be bumpy and it was too early to say that the recent downward trajectory of inflation had stalled or reversed. We don't know if it's a bump in the road (of bringing inflation down) or something else. We have to find out.

On March 20, local time, the Fed left interest rates unchanged at its policy meeting, in line with market expectations. The monetary policy statement is as follows:

Recent indicators suggest that economic activity is expanding at a solid pace. Job growth remains strong and the unemployment rate remains low. Inflation has slowed over the past year but remains high.

The economic outlook is uncertain and the Committee maintains a high level of concern about inflation risks.

In considering any adjustment to the target range for the federal funds rate, the Committee will carefully assess the latest data, the evolving outlook, and the balance of risks. The Committee does not expect that a reduction in the target range would be appropriate until it gains greater confidence that inflation is moving sustainably toward 2%. In addition, the Committee will continue to reduce its holdings of Treasuries, agency debt, and agency mortgage-backed securities by its previously announced plans.

The Committee's assessment will take into account a wide range of information, including labor market conditions, inflationary pressures and inflation expectations, and financial and international developments.

The SEP was also updated at this meeting, with upward revisions to economic growth forecasts across the board: 2.1% in 2024 (vs. the previous 1.4%), 2.0% in 2025 (vs. the previous 1.8%), and 2.0% in 2026 (vs. the previous 1.9%).

In terms of inflation expectations, the 2025 inflation estimate was raised slightly to 2.2% from the previous 2.1% and the core inflation forecast for the current year was raised slightly to 2.6% from the previous 2.4%.

In terms of the dot plot, expectations for three rate cuts in 2024 were unchanged, but the number of supporters increased to nine from six. The number of rate cuts in 2025 was scaled back (by 50 basis points, that is, 2 rate cuts, each by 25 basis points).

UTC+8 16:30 Swiss Central Bank March Interest Rate Decision

UTC+8 17:30 Eurozone March Markit Manufacturing PMI Preliminary Value

UTC+8 17:30 UK March Markit Services PMI Preliminary Value

UTC+8 20:00 Bank of England March Interest Rate Decision

UTC+8 21:45 U.S. March Markit Manufacturing PMI Preliminary Value