Inflation Watch

March 12, 2024

Inflation Watch

  • UK labour market conditions continue to ease.
  • Financial markets will be guided today by the US February CPI print. Risks to USD and Treasury yields are asymmetric to the upside.
  • JPY was volatile overnight on cautious comments by BOJ Governor Kazuo Ueda.

USD is consolidating above recent lows and 10-year Treasury yields are holding around 4.10%. Today’s US February CPI print (12:30pm London) will help determine whether January’s high inflation reading was noise or a sign that progress on inflation may be stalling.

The Cleveland Fed’s inflation “Nowcasts” model and consensus estimate headline and core CPI to increase by 0.4% m/m and 0.3% m/m, respectively. On a year-over-year basis, the model and consensus project headline inflation to remain at 3.1% for a second consecutive month and core inflation to slow to a 34-month low of 3.7% in February.

In our view, risks to USD and Treasury yields are asymmetric to the upside. Cooler than expected inflation will reinforce the case for a Fed funds rate cut in June, which is virtually fully priced-in, so market reaction should be relatively contained. However, a bigger than expected rise in CPI can trigger an upward adjustment to Fed funds futures in favour of a firmer USD and Treasury yields.

GBP fell slightly against most major currencies following softer than expected UK labour market data. The unemployment rate unexpectedly ticked up 0.1pts to 3.9% in January (consensus: 3.8%) but remains below the Bank of England’s (BOE) medium-term equilibrium level of around 4½%. Total estimated vacancies fell further in February, although they remained 107,000 above their pre-coronavirus January to March 2020 levels. Total and private sector annual average weekly earnings (excluding bonuses) growth both eased to 6.1% in January (consensus: 6.2%) from 6.2% the previous month. Leading indicators point to further growth slowdown in wages and the BOE estimates annual private sector regular earnings growth of 5.7% over Q1.

Bottom line: UK labour market conditions continue to ease to some degree and support the case for looser policy settings from Q3. The UK OIS curve implies almost 75 bp of BOE policy rate cuts in 2024 starting in August. We see more upside for GBP versus EUR because the UK growth outlook is more encouraging than the Eurozone’s. BOE Governor Andrew Bailey takes part in a panel discussion later today (4:00pm London).

JPY was volatile overnight. USD/JPY dipped slightly towards 146.60 after Jiji reported the Bank of Japan (BOJ) could end its negative interest rate policy next week if the Trade Union Confederation (Rengo) wage increase (reported on Friday) “significantly” exceeds last year’s 3.8% rise. Regardless, USD/JPY rallied by almost a full figure to a high near 147.60 following cautious comments by BOJ Governor Kazuo Ueda. Ueda warned about weakness in Japan personal consumption, particularly in non-durable goods. Ueda also noted “we will consider adjusting the negative rate policy, the yield curve control and other various easing measures if the goal is within sight”.

The probability implied by interest rate futures of a 10 bp BOJ policy rate hike on 19 March is around 72% versus a high of 84% late last week. In our view, Japan’s improving inflation backdrop and soft economic activity suggest the BOJ can afford to be patient with policy normalization. In fact, Japan’s all industry/large firms business outlook survey dropped to 0 in Q1, indicative of sluggish economic activity.

AUD/USD is trading on the defensive just above 0.6600, undermined by weak iron ore prices. Australia’s NAB business survey was mixed. Business conditions rose in February back above the long-run average indicative of resilient economic activity, and retail price growth rose sharply suggesting progress on inflation will be slow. Meanwhile, business confidence and forward orders dipped in February remaining below average.

RBA Assistant Governor (Economics) Sarah Hunter cautioned that “inflation is the single biggest drag” to households. In fact, household spending contribution to Q4 2023 real GDP growth was flat after a negative 0.1pts contribution the previous quarter. Bottom line: weak consumer spending activity in Australia justifies money markets continuing to price roughly 50 bp of RBA policy rate cuts this year.

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