Focus on Fed, BOJ, and Europe’s Bank Stress Test – By Reuters

By Balazs Koranyi

FRANKFURT – Central banks around the world, from Washington to Tokyo, will take center stage next week as they navigate the aftereffects of Britain’s surprising decision to exit the EU. Policymakers are expected to exercise caution while waiting for clearer signals regarding the political and economic ramifications of the vote.

Since the June 23 referendum, central banks have largely refrained from taking significant actions, opting instead to provide verbal reassurances to calm market nerves while relying on governments to determine the next steps.

The U.S. Federal Reserve is anticipated to keep interest rates steady on Wednesday. While there are signs of improved economic conditions, the Fed is likely to refrain from giving strong clues about future moves, aiming to avoid the misstep of raising rate hike expectations prematurely.

Experts continue to predict that the next interest rate hike will occur, but as concerns surrounding Brexit diminish, the approaching U.S. elections may delay Fed actions, potentially restricting the central bank to just one rate increase in 2016 instead of the initially anticipated four.

Commerzbank suggested in a recent analysis that the next rate hike is more likely to occur in December, followed by additional increases next year. This outlook could support a stronger dollar and slightly rising yields in the medium term.

Market analysts also expect the next rate adjustment to happen in the fourth quarter, while futures contracts indicate a possible move closer to mid-2017.

Despite uncertainties, the U.S. economy appears to be on stable ground. Preliminary data expected on Friday will likely show an acceleration in annual growth to 2.6 percent in the second quarter, up from 1.1 percent three months prior.

Positive economic surprises and easing financial conditions suggest that the U.S. is entering the third quarter with strong growth potential.

Bank of Japan

For the Bank of Japan, the decision next Friday is critical amid ongoing struggles with low inflation. Speculation is rife regarding potential policy easing, though the bank is expected to only slightly adjust its inflation forecasts. Such adjustments might allow it to maintain the current policy stance for now.

Prime Minister Shinzo Abe, following a significant electoral victory, is also developing a substantial stimulus package, estimated at over 20 trillion yen ($189 billion), which could relieve some pressure from the BOJ, particularly after the criticism it faced for introducing negative interest rates earlier this year.

However, concerns linger about the bank’s ability to meet its 2 percent inflation target, indicating that its upcoming decision will be closely scrutinized.

Investors are increasingly betting on BOJ easing due to Brexit-related uncertainties impacting the real economy and financial markets. Should the BOJ choose to maintain its current policy, it could lead to disappointment in the markets, triggering declines in stock prices and a rise in the yen.

Currently, analysts anticipate an expansion in the bank’s asset purchases alongside a reduction of the key interest rate to -0.2 percent from -0.1 percent.

Europe

In Europe, a major event of the week will be the release of banking stress test results on Friday, particularly focusing on Italian banks, which are perceived as vulnerable due to low profitability and a considerable amount of non-performing loans stemming from the region’s debt crisis.

While the stress test is not designed to be a pass-or-fail exercise, the findings could spur discussions towards a resolution, especially with ongoing deadlock between Italy and the European Commission over state support.

European Central Bank President Mario Draghi has suggested the possibility of establishing a public backstop to assist Italian banks in offloading some of their troubled loans, which have constrained their lending capabilities.

Additionally, GDP figures for the euro zone and the UK from the second quarter will also attract attention, though their significance may be overshadowed by the recent Brexit decision.