Strong US labor market data dealt a blow to the narrative of central banks' dovish pivot. Persistent underlying price pressures imply a need for higher rates, regardless of softer commodities and slower growth. Tactical successes in ongoing global geopolitical tensions could turn into more instability.
In the US, the Fed remains squarely focused on reining in inflationary pressures, downplaying evidence of softening private demand. For now, this seems warranted, with last week's data adding to evidence of strong labor demand and risks of an acceleration in wage pressures as labor supply continues to struggle.
In the euro area, deteriorating business sentiment and weakening production and sales data all point to a sequential moderation in activity in the third quarter. The input cost price shock may have lost momentum but its delayed pass-through adds to concerns over the region’s inflation stickiness.
In the UK, the Bank of England delivered a 50 basis point hike as expected but the significant growth and inflation revisions were a surprise. We maintain our view that the Bank will hike once more by 25 basis points in September then keep rates on hold for the foreseeable future. This week, the focus will be on June GDP and developments in the leadership contest.
In Japan, yen depreciation pressures have eased on expectations for a slower pace of rate-hiking by the Fed. However, the Bank of Japan’s yield curve controls (YCC) still face the classic trilemma of international finance, leaving Japan exposed to exchange rate instability in both directions.
China responded with its most significant measures against Taiwan in decades, but we think the overall response is still relatively restrained. In addition, we believe the disappointing NBS manufacturing PMI mainly reflects a housing drag and softened new export orders.
In Emerging Asia, the Reserve Bank of India increased its policy rates by 50 basis points, delivering a cautious message. Meanwhile, growth in Indonesia remains robust, though weakness in EM Asia PMIs suggest growth is expected to moderate.
In Emerging EMEA, PMIs across the region showed continued weaker economic activity in July, resulting in less hawkish rate decisions than expected from the Czechia and Russia last week. We think most major economies will shift focus gradually to growth from inflation starting in the fourth quarter.
In Latin America, the political situation remains fluid across the region, amid new authorities taking office, elections, and social pressures, which are maintaining uncertainty over the fiscal and activity outlook and suggest that volatility is likely to persist.
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