Inflation Tiger Still Roars

June 26, 2024

Inflation Tiger Still Roars

  • Inflation heats-up in Australia and Canada.
  • Likelihood of RBA rate hike spiked-up, while a back-to-back BOC policy rate cut is unlikely.
  • There are no policy-relevant US, Eurozone, or UK economic data releases today.

USD is holding on to yesterday’s modest gains triggered in part by hawkish comments from Fed Governor Michelle Bowman. Bowman warned “we are still not yet at the point where it is appropriate to lower the policy rate”, adding “I remain willing to raise the target range for the federal funds rate at a future meeting should progress on inflation stall or even reverse.” The risk US inflation proves more persistent cannot be ruled out after inflation in Australia and Canada picked-up.

Meanwhile, Fed Governor Lisa Cook reminded market participants that “with significant progress on inflation and the labor market cooling gradually, at some point it will be appropriate to reduce the level of policy restriction…The timing of any such adjustment will depend on how economic data evolve and what they imply for the economic outlook and balance of risks.”

In our view, the cyclical USD uptrend is intact. First, Fed policy continues to diverge with that of most other major central banks. Second, the favourable US macro backdrop justifies an upward reassessment in Fed funds rate expectations. Fed funds futures continue to price-in about 50 bp of cuts by December 2024 while the Fed has only 25 bp of cut pencilled-in. Third, the June composite PMI prints show growth momentum favours the US economy. Financial markets will ignore today’s US May new home sales data (3:00pm London).

AUD outperformed and Australian bonds sold-off overnight after Australia inflation heats-up, putting an RBA rate hike back in play. The monthly CPI indicator rose more than expected to annual pace of 4% in May (consensus: 3.8%) up from 3.6% in April. The most significant price rises were Housing, Food and non-alcoholic beverages, Transport, and Alcohol and tobacco. CPI ex-volatile items & holiday travel remained stickly at 4% while the more policy-relevant annual trimmed mean inflation surged to a six-month high at 4.4% in May from 4.1% in April.

The swaps market is pricing over 50% odds of a 25 bp RBA cash rate increase between August and September. Australia’s Q2 CPI report, due end-July, will be a key data point shaping the RBA’s August 6 policy decision. Overall, the bar for an RBA rate hike is low as the Board has already been discussing the option of raisings rates further in recent meetings.

RBA Assistant Governor (Financial Markets) Christopher Kent talked about restrictive financial conditions in Australia and did not offer new policy guidance. RBA Deputy Governor Andrew Hauser is up next (11:00am London).

USD/CAD is consolidating around 1.3660. Yesterday, Canada’s May CPI report showed progress on inflation stalled. The market reaction was swift, interest rate futures trimmed odds of a July 24 BOC policy rate cut to 28% from 60%, USD/CAD hit an intra-day low around 1.3626 and Canadian government bond yields rose across the curve.

Canada headline CPI inflation unexpectedly quickened to 2.9% y/y in May (consensus: 2.6%) from 2.7% in April reflecting higher prices for services. The Bank’s preferred measures of core inflation also overshot expectations. Core trim rose a tick to 2.9% y/y in May (consensus: 2.8%) while core median increased two ticks to 2.8% y/y in May (consensus: 2.6%).

We doubt the BOC will deliver a follow-up policy rate cut in July, but a September rate cut remains a strong possibility. There are 3 CPI reports ahead of the September 18 policy-setting meeting. Bottom line: monetary policy divergence between the RBA and BOC suggests AUD/CAD can edge higher.

There are no policy-relevant Eurozone or UK economic data releases today. The ECB and the European Commission issue the Convergence Report (11:00am London). The report is published at least once every two years and describes the progress made by non-euro area Member States towards achieving the criteria necessary for a country to adopt the euro. There are also a handful of ECB speakers today notably Chief Economist Philip Lane (11:40am London).

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