ECB leads the Fed on rate cuts; Chinese economy improves but downside risks could undermine growth
US
Despite employment data surprising to the upside, a slowing economy may keep the path open to three rate cuts this year. In May, the Non-manufacturing PMI rose from 49.4 in April to 53.8 and so back into expansionary territory. Non-farm payrolls jumped 272,000, up from 165,000 in April, and average hourly wages were up 0.4% MoM and 4.1% YoY against rises of 0.2% and 4.0% in April. However, other data point to a slowdown, including the drop in ISM Manufacturing PMI from 49.2 to 48.7 in May, the rise in unemployment rate to 4%, the highest since January 2022, and the fall in job openings (JOLTS) to a 3-year low of 8.05m in April.
A range of indicators point to a cooling economy: (i) quarterly GDP growth slowed from 3.4% in Q4 to 1.3% QoQ annualized in Q1; (ii) consumer confidence fell to a 6-month low in May; (iii) inflation-adjusted consumption contracted -0.01% MoM in April; and (iv) the ratio of job openings to unemployed workers fell to 1.24, close to its pre-Covid level. Meanwhile, Moody’s is warning of possible downgrades to 6 regional banks that are heavily exposed to commercial real estate. Demand-pull inflation is also softening. Given the outlook for inflation and growth, we see the Fed potentially starting rate cuts in September, with 3 cuts bringing policy rates to 4.50-4.75% by the year-end.
Eurozone
ECB cut rates as expected but inflation in service sector raises uncertainty over rate outlook for 2H24. The Manufacturing PMI rose from 45.7 in April to 47.3 in May, but the Services PMI inched down from 53.3 to 53.2, meaning that the Composite PMI climbed to a year-high of 52.2. In addition, Q1 GDP growth came in at 0.3% QoQ, up from the previous quarter’s flat growth of 0%. However, retail sales slipped -0.5% MoM in April.
The European Central Bank (ECB) has made its first cut to interest rates since 2019, reducing the benchmark deposit rate by 25bps to 3.75% at June meeting in response to a fall in inflation. However, ECB President Christine Lagarde has said that going forward, inflation will likely remain above the 2% target (this is forecast to average 2.5% for 2024 and 2.2% in 2025) and so further cuts will depend on development of growth and inflation. Thus, with May’s Eurozone services inflation print coming in at 2.9% YoY, it is uncertain whether the ECB will cut the rates at its every meeting. Against this uncertain background, we expect that the ECB may decide to cut the benchmark rate two more times this year to 3.25% by the end of 2024.
China
China's real estate problems slightly subsided. Exports improve but face risks from rising trade tensions. The contraction in sales of new homes by 100 largest developers slowed from -44.9% YoY in April to -33.6% in May. Meanwhile, the government has implemented additional measures to support the real estate sector: (i) USD 41.5bn in soft loans for state enterprises to be used to soak up some of the glut of new housing; and (ii) cuts in the down payment ratio required for buyers of first and second homes. Export growth in May also accelerated to 7.6% YoY from an average of 1.5% in Q1, exceeding market expectations of 5.6%.
Although home sales have slightly improved, sentiment remains weak and the market is continuing to struggle under the weight of oversupply, which is expected to take 2-3 years to clear. The real estate sector will therefore continue to contract through 2H24, though at a slower pace given recent government assistance. Meanwhile, improving exports will help support a near-term recovery in manufacturing. However, increasing reliance on foreign markets, amid weak domestic demand, may expose the Chinese economy to the risks arising from rising trade protectionism across many countries in the periods ahead.
Thai officials move to boost domestic tourism. Inflation returns to the target range, supporting MPC to leave rates unchanged this year.
The government is rolling out a set of initiatives to provide a short-term boost to domestic tourism. At a cabinet meeting held 4 June, the government agreed to make temporary changes to the tax system that will help to lift domestic tourism: (i) Individuals can deduct up to THB15,000 per person from their personal income tax for expenses on tour guides, hotel, homestay, or other types of temporary accommodation when this money is spent in any of 55 second-tier provinces. (ii) Companies can deduct expenses from their corporate income tax for organizational training and seminars with a deduction for 2 times for events held in second-tier provinces and 1.5 times for events held in leading tourist areas. These measures will be in place between 1 May and 30 November 2024. Claimants will need to submit an e-tax invoice and e-receipt to qualify.
Officials hope that these temporary tax breaks will help to boost tourism and provide a lift to the economy by stimulating businesses in tourism supply chains, labor markets and domestic consumption. During the first 4 months of this year, Thai tourists made a total of 67.6m trips, and for the whole year, we see the market growing to 195m trips, up from 2023’s total of 185m trips. Nevertheless, overall growth momentum across the economy remains somewhat elusive, and this is reflected in: (i) the softening of domestic demand following the expiry of the Easy E-Receipt stimulus program in the middle of Q1; (ii) the transition to the low season in the tourism sector, which over April and May resulted in fewer than 3m foreign tourist arrivals per month; and (iii) the continuing weakness of the Thai manufacturing and export sectors.
May inflation climbed back into the target range for the first time in 13 months, potentially supporting the MPC to hold rates steady at its 12 June meeting. Headline inflation rose from 0.19% YoY in April to a 13-month high of 1.54% in May, staying in positive territory for the second straight month. Price rises were a result of: (i) temporary factors connected to last year’s low electricity bills; (ii) rising diesel pump prices, which touched THB 32.94/liter in late May; (iii) the impact of the drought on agricultural yields, which has fed through into higher prices for fresh foods, most notably for vegetables and eggs. Core inflation, which excludes raw food and energy prices, inched up to 0.39% in May from 0.37% in April. During January to May, headline and core inflation rates have averaged -0.13% and 0.42%, respectively.
Headline inflation climbed back into the target range in May for the first time since April 2023. For the remainder of the year, we expect increases in inflation to slacken on: (i) easing prices for agricultural goods after the worst of the summer heat is gone; and (ii) assistance with domestic electricity bills. However, inflation in the second half of this year should remain within the 1-3% target range, expected to average at 0.7% for the whole 2024.
In light of the above, the chance of a cut in rates is rapidly diminishing. In particular, GDP growth in Q1 was broadly in line with BOT forecasts and inflation is now back on target, while the move by commercial banks and specialized financial institutions (SFIs) to reduce lending rates for vulnerable clients has lessened the need for broad-based rate cuts. We therefore anticipate that the Monetary Policy Committee (MPC) will leave the policy rate unchanged at its next meeting on 12 June, and the rate is also expected to remain flat at 2.50% for the rest of the year.
