Inflation is either running out of steam (the UK) or, in the case of the US, heading in the right direction albeit scrambling through a rocky patch of terrain on its journey back to target.
The strong expectation at the start of this year was that by now the Federal Reserve would be about ready to declare its first cut and that the Bank of England (BoE) would follow suit in May. No one is expecting that timetable now.
This week, two data releases appeared to confirm the tricky task the Fed faces: US consumer prices index (CPI) inflation came in slightly hotter than expected for February at 3.2 per cent, and jobs data showed another surge in employment numbers (although revisions meant the net figure was lower overall, and ING points out that the jobs being created were not in industries you would typically associate with a strong vibrant economy, such as construction and business services).
Still, the fact remains that the jobs market has not yet loosened significantly, and the shock rise in the personal consumption expenditure (the personal consumption expenditures indicator favoured by the Fed) in January is too recent to ignore. That delivered a reminder that inflation might be flattening, not falling. All the signs therefore are that the Fed will continue to mull the data and discuss only how many cuts it intends to make in future at its meeting next week.
Around the same time we’ll also find out if the UK’s CPI inflation rate has dropped again, from 4 per cent in January. A fall to 3.5 per cent would be in line with forecasts from the BoE. Indeed, the Office for Budget Responsibility expects CPI inflation to fall below 2 per cent in the third quarter and to just above 1 per cent early next year. And tightness in the labour market appears to be easing too. Yet as with the Fed, no one is predicting an early cut.
Rates staying on hold in the US may not have much of an impact given the ongoing strength of the economy, but the UK could do with a jolt out of stagnation. While the GDP report this week confirmed the UK economy has already returned to growth from a short-lived and mild recession, economic weakness is putting pressure on earnings growth and borrowing rates for businesses have not been falling the same way as mortgages have.
And even with inflation coming down faster in the UK than in the US and eurozone, and central banks and interest rates moving in lockstep in all three regions, UK stocks are not hitting all-time highs unlike US and EU markets. That difference in market performance, explains Joachim Klement at Liberum, is linked to previous GDP surprises to the downside.
Ultimately, the two main factors keeping the banks pressing on the brakes are the worry that the inflation problem hasn’t been completely cured, and concern about the tightness in labour markets.
Some of the data supports the case for cuts, and analysts believe the US is on track for a June move. There has been some weakening in wage growth there, and the National Federation of Independent Business’s members have been rowing back on hiring intentions. Unemployment has crept up too. Some think a May cut remains a possibility, but only just.
The weight of opinion points to an August cut in the UK, with June a much slimmer possibility. A continuing softening in wage growth here too is an essential prerequisite. Pantheon says the MPC won’t take unemployment data too seriously but will be paying close attention to wages. In the three months to January, Office for National Statistics stats show average earnings, including bonuses, were 5.6 per cent higher than a year earlier. But this was a drop from 5.8 per cent in the three months to December. However, many employers are pointing to April’s 10 per cent rise in the national living wage as an additional pressure and that could increase the risk of a slow easing cycle.
Services inflation is another measure the BoE is watching. Here the data is mixed, with the bulk of the decline since July driven by the energy intensive sectors such as hotels and restaurants, points out Capital Economics, with the non energy intensive services inflation proving stickier.
Revealingly, Huw Pill, the BoE’s chief economist, confirmed in a recent speech that while there are early signs of a downward shift in the persistent component of inflation dynamics, these “remain tentative”. He warned the evidence is not yet conclusive and restrictiveness will need to be maintained “until the risk of inflation becoming embedded above the 2 per cent target dissipates”.
