Inflation Takes a Chill Pill
- U.K., New Zealand, and Canada inflation slow sharply raising the likelihood of more aggressive policy rate cuts.
- BOJ Board Member Adachi signaled the BOJ is in no rush to remove policy accommodation.
- RBA Assistant Governor Hunter hints RBA policy stance could soon turn less restrictive.
USD is up mostly versus GBP. 10-year Treasury yields edged down from a two-month high of around 4.10% to near 4.00% as lower crude oil prices eased inflation concerns. The October New York Fed services business activity index and September import/export price indexes are today’s domestic data highlights (both at 1:30pm London).
Yesterday, San Francisco Fed President Mary Daly (voter) reiterated that “one or two cuts was a reasonable thing” as the U.S. economy is more balanced. Similarly, Atlanta Fed President Raphael Bostic (voter) suggested again the possibility of holding off easing at the next November meeting, pointing out he has one more 25 bp cut penciled-in for this year.
Fed funds futures are pricing-in 25 bp cut in November followed by a 25 bp cut in December. Our base case is for one 25 bp Fed funds rate reduction by year-end because resilient U.S. economic activity and easing in financial conditions are upside risks to inflation.
Interestingly, the U.S. is one of a few G10 economies with annual headline CPI inflation above 2% in September (2.4%). Eurozone: 1.8%, Switzerland: 0.8%, Sweden: 1.6%, U.K.: 1.7%, Canada: 1.6%. The implication is there is greater room for an upward reassessment in U.S. interest rate expectations relative to other major economies in support of a firmer USD.
GBP fell across the board and yields on gilts plunged on slower than expected U.K. inflation. In September, headline CPI fell below the Bank of England’s (BOE) 2% target to 1.7% y/y (consensus: 1.9%, BOE: 2.1%) from 2.2% in August. Inflation is the lowest since April 2021. Moreover, measures of underlying inflation unexpectedly dropped sharply. Core CPI fell four ticks to 3.2% y/y (consensus: 3.4%) and services CPI slumped seven ticks to 4.9% y/y (consensus: 5.2%, BOE: 5.5%). The data raises he likelihood the BOE is more aggressive in cutting interest rates which is a drag for GBP.
Bank of Japan (BOJ) Board Member Seiji Adachi signaled the BOJ is in no rush to remove policy accommodation. Adachi said “what we need to be careful of, in a gradual rate hike process, is that we raise it extremely gradually while keeping financial conditions accommodative.” The looser for longer BOJ policy stance can further weigh on JPY.
NZD is underperforming on expectations the RBNZ cranks-up easing. New Zealand Q3 CPI data largely matched consensus but tracked slightly below RBNZ projection. Headline CPI rose 0.6% q/q (consensus: 0.7%, RBNZ: 0.8%) vs. 0.4% in Q2, while the y/y rate came in as expected at 2.2% (RBNZ: 2.3%) vs. 3.3% in Q2. This was the lowest annual rate since Q1 2021 and nearing the center of the 1-3% target range.
The breakdown showed New Zealand tradeable prices fell -0.2% q/q (consensus: -0.1%, RBNZ: -0.2%), while non-tradeable prices increased 1.3% (consensus: 1.3%, RBNZ: 1.4%). Importantly, the average of annual core inflation (sectoral factor model, trimmed mean, weighted median, and CPI excluding food and energy) is now within the bank’s target band at 2.94% vs. 3.56% in Q2.
Bottom line: the RBNZ has ample room to continue its easing cycle after last week’s 50 bp cut to 4.75%. Indeed, the policy rate is still well above the RBNZ’s estimate for the nominal neutral rate range of 2-4%. Markets have fully priced-in another 50 bp cut for November 27 and imply 37% odds of a 75 bp cut.
RBA Assistant Governor (Economic) Sarah Hunter hinted the RBA policy stance could soon turn less restrictive. Hunter pointed out “there’s no evidence of [inflation] expectations being more persistent than normal…And there’s even some evidence of households and unions extrapolating less from recent inflation.” We expect the RBA to join the global easing cycle later this year because Australia underlying economic activity is weak and points to lower inflation pressures. RBA cash rate futures price-in 40% odds of a 25 bp cut by December. Australia’s September labor force report (tomorrow, 1:30am London) will guide near-term RBA rate expectations.
USD/CAD faces additional upside pressure on expectations the Bank of Canada (BOC) steps up the pace of easing. Canada disinflationary pressures quickened more than expected in September. Headline CPI inflation fell below the mid-point of the BOC’s 1%-3% control range to 1.6% y/y (consensus: 1.8%) vs. 2.0% in August. Meanwhile, the average of the BOC’s core CPI measures (trim and median) printed at 2.35% y/y, same as in August. This was in line with consensus but lower than the BOC’s Q3 projection of 2.5% y/y. Market pricing for a 50 bp BOC policy rate cut next week rose to 80% from about 50% before the CPI data release.
