Coming hot on the heels of yesterday’s labour market and wage data, this morning saw the release of the latest set of CPI prints for the UK. And in this instance we really do mean hot. The upside beat on wages yesterday, a surprise that led markets to price a more than 90% chance of a BoE rate hike in May, was followed up with CPI data that was higher than expectations across almost all readings. YoY CPI printed at 10.1%, down on last month’s figure of 10.4% but above the 9.8% that had been anticipated and only managing to return to the rate of growth seen in the January release. For a BoE looking to cool inflation, the picture did not look much better when switching focus to MoM figures which showed a 0.8% rise, or core numbers which printed flat on February’s release at 6.2%. The one silver lining came in the core services measure that has been highlighted by MPC members as a key indicator for sticky core inflation. This has consistently underperformed the projections of Bank staff in recent months, and did so again today, printing at 6.6% against a forecast of 6.8%. In our view, however, this one bright spot is outshone by the broader picture painted by an accumulation of hotter than expected headline numbers across both wages and CPI prints. With the Bank of England concerned about anchoring expectations and maintaining credibility, this now tips the balance towards a 25bp in May, and we are updating our call accordingly. Markets appear of a similar mind this morning following this news, now fully pricing a May rate hike and leading sterling higher, up around 0.4% against both the dollar and the euro. With that said, we think a hike in May is likely to be the final one. A slowing labour market, alongside signs of underlying weakness in wage growth and CPI all point towards inflation that should fall rapidly over the remainder of the 2023, and the BoE is therefore likely to underperform market expectations that currently foresee 75bp of hiking this year.
Just like the broad dollar, the single currency has lacked direction this week as it continues to trade at the top of its Q1 range and just shy of levels seen last week. Not helping the cause is the lack of economic headlines from the continent. The main news from yesterday’s session came from an impromptu interview with ECB Chief Economist Phillip Lane. Speaking with Bloomberg TV, Lane kept his cards close to his chest when discussing a 25 vs 50 bp hike in May, stating that he wouldn’t commit to the size of a hike just yet but maintained that further tightening was required. What was of note is that he pointed to the importance of the ECB’s quarterly lending survey when discussing such scenarios, which will be released to the public just two days before the ECB’s next decision on May 2nd. Ultimately, Lane’s stance concisely summarised where markets are currently at. With around 30bps of hikes priced in, the debate over the ECB’s next steps is still very much live. But with eurozone inflation data set to be published at the end of the month and the ECB’s lending survey set for release in early May, the debate is unlikely to be settled in the coming week. This should, all things considered, leave the euro in limbo for the time being.
Markets were frothy once again yesterday despite the limited news flow. Front-end Treasury yields continued to climb as markets priced out rate cuts for this year (-43bps vs -49bps at the start of the week), but this time the move in bond markets didn’t equate to further dollar strength as the DXY index almost completely reversed Monday’s rally. The lack of passthrough to the dollar is arguably down to the more limited level of volatility in the fixed income space as Fed speakers have now effectively guided market expectations for their next policy move ahead of their communications blackout which starts this weekend.
The circular price action in most FX pairs at the start of the week may be something of a precursor for what is to come for markets in the coming weeks as the Fed embarks on its communications embargo and no top tier economic data is scheduled for release before the May 3rd meeting. However, although the Fed’s next steps are almost fully discounted by markets with around 22bps priced in, the path beyond the May meeting remains an unknown. The extent to which credit conditions have tightened will be highly influential for guiding these expectations, and on that note, today’s release of the Fed’s beige book will be closely monitored. Back on March 8th, just days before the SVB collapse hit the front pages of financial news outlets, the Fed’s regional report on economic conditions showed credit conditions had already started to materially tighten. Signs that this has been significantly amplified due to banking sector risk will likely feed into the markets base case that US monetary policy is effectively too tight and that cuts will be needed in the second half of this year. In the absence of any other major news today, this could weigh on the dollar as cuts are priced back into the US curve.
The Canadian dollar was flat on Tuesday, lagging behind the EUR and NZD-led rally in G10 FX against the US dollar. The main event of the day was the latest inflation report for March, which showed that headline inflation fell to 4.3% YoY, the lowest since September 2021. While the headline figure seems like a reason to cheer, underlying price pressures were not so favourable. Using 3-month averages of annualised core inflation, we noted that these metrics have scarcely improved in 8 months and are stuck around 3%. While this isn’t enough for the Bank of Canada to immediately start hiking next meeting, we do believe that the risk of a resumption to the hiking cycle has increased, especially with last month’s banking crisis fading into the rear-view mirror. Aside from the inflation data, BoC Governor Macklem testified to Parliament, essentially repeating last week’s message of potentially needing to keep policy “restrictive for longer,” while OSFI officials mentioned that credit conditions in Canada are “quite benign,” but continued to warn that the housing market faces the risk of an “adjustment that may not be completely smooth.” Today, we will get a few mid-tier economic releases from StatCan, including housing starts, industrial product prices, and raw materials prices at 08:30 EST (13:30 GMT).