After the slightly lower than expected August non farm payroll report last week, the market will receive key CPI data this week, which will have a crucial guiding role in determining the magnitude of the Federal Reserve's September interest rate cut. In addition, the market is also paying attention to the interest rate decisions of the European Central Bank and a series of economic data from China.

The European Central Bank will cut interest rates for the second time

The European Central Bank's interest rate cut cycle appeared somewhat awkward at the beginning of June, as sudden data changes left policymakers with no choice but to push forward with the planned 25 basis point rate cut and present it as a 'hawkish rate cut'.

Fortunately, for dovish and struggling European companies, the reasons for further policy easing have strengthened since the last meeting in July, when interest rates remained unchanged. The overall inflation rate in August fell to 2.2% year-on-year, and the rebound in growth in the eurozone was relatively weak.

The current economic background may lay the foundation for the European Central Bank to lower its quarterly inflation and GDP forecasts, which will be announced on Thursday's meeting. More importantly, European Central Bank President Christine Lagarde may now reduce her emphasis on "data dependence and successive meeting decisions" and confidently point towards further interest rate cuts in the future.

However, there is a problem that the service sector CPI rose to 4.2% in August, the highest value since October 2023. Although this is not enough to prevent the European Central Bank from adopting a more dovish stance at its September meeting, Lagarde may remain cautious at a press conference.

If Lagarde suggests that the path of interest rate cuts is not as far-reaching as investors expected, the euro may resume its upward trend, which was previously hampered by the strengthening of the US dollar.

Will the US CPI support a 50 basis point interest rate cut?

The US dollar has been fluctuating recently due to uncertainty about whether the Federal Reserve will cut interest rates by 25 basis points or 50 basis points at the upcoming meeting. The long-awaited policy shift by the Federal Reserve finally emerged at the Jackson Hole Annual Meeting in August.

Federal Reserve Chairman Powell acknowledges that the labor market is starting to crack, opening the door to a possible 50 basis point rate cut in September. Since then, most of the comments have not supported taking more aggressive action because the data is mostly robust.

The key question is, to what extent will the Federal Reserve prioritize employment tasks over price stability while the risk of inflation still exists? The price indices of the manufacturing and service industries both slightly increased in August by the American Institute of Supply Management, but the employment of the former shrank while the latter showed almost no growth.

Wednesday's CPI report will be the final piece of the puzzle before the September decision, and should bring some clarity to expectations. The overall CPI fell to 2.9% year-on-year in July, and is expected to drop again to 2.6% in August. However, the core inflation rate is expected to remain unchanged at 3.2%. If these data are confirmed, the Federal Reserve is more likely to adopt a 25 basis point dovish rate cut. But in order for there to be a realistic possibility of a 50 basis point interest rate cut, there must be a significant downward shock.

Investors currently expect the probability of a 50 basis point rate cut to be close to 40%, so if CPI data meets expectations or is stronger, it may disappoint the market and push the US dollar higher.

The producer price index will be released on Thursday, and the preliminary survey of consumer confidence at the University of Michigan on Friday is also very important, especially for inflation expectations over the next one to five years.

The decision of the Bank of England is approaching

It is expected that the Bank of England will go against the central bank trend in September and maintain interest rates unchanged at its meeting on the 19th. In the first half of 2024, with a strong rebound in the UK economy and high wage growth and service sector inflation, the Bank of England can temporarily hold its fire after the first interest rate cut in August.

But according to a series of data to be released before the September meeting, the final decision may be much closer than expected. On Tuesday, the employment report for July will receive attention, seeking signs of stability in the UK labor market after significant unemployment at the beginning of the year.

The unemployment rate in the UK fell by 0.2 percentage points to 4.2% in June, but a significant decrease may not be welcomed as wage growth finally begins to move towards a level more in line with the 2% inflation target. The rebound in employment growth may once again drive wage pressures and hinder the Bank of England's efforts to combat inflation.

The focus on Wednesday will be the GDP data for July, including a breakdown of the service and manufacturing industries.

At present, the market expects a probability of about 75% for the UK to remain inactive in September, but if this week's data performs poorly, it may increase the possibility of a 25 basis point interest rate cut, putting pressure on the pound.

Pay attention to Asian data

Amid lingering concerns about China's economic weakness, Monday's CPI and PPI data, followed by Tuesday's August trade data, may attract investors' attention to risk sensitive currencies such as the Australian dollar.

In Japan, this week will be data intensive, with the highlight being Monday's GDP correction data. The GDP growth for the second quarter is expected to increase from the initial 0.8%. If the data is higher than expected, it may enhance market expectations for the Bank of Japan to raise interest rates again this year, driving the yen to continue rising.