US Inflation Dragon Not Yet Pinned Down

• The US February CPI print suggests the Fed can be patient before loosening policy.

• The UK economy is on track to recover quickly from its end-2023 technical recession.

• There are no policy-relevant economic data releases today.

USD is a little firmer and 10-year Treasury yields are up near a one week high around 4.15% underpinned by a modest upward adjustment to US interest rate expectations. Feds funds futures are now pricing-in 84 bp of total easing this year versus 91 bp before yesterday’s US inflation data.

The US February CPI print suggests the Fed can be patient before loosening policy. Annual core CPI inflation slowed less than expected (actual: 3.8%, consensus: 3.7%) and super core CPI (core services less housing, a key measure of underlying inflation) remained high at 4.3% for a second consecutive month in February. Granted, inflation momentum is slowing as the monthly increase in the super core CPI edged down to 0.5% in February after rising by 0.9% in January. Regardless, this is still too high relative to a historical average monthly increase of roughly 0.2%.

We see scope for Fed funds rate expectations to adjust higher in favour of USD because US core price inflation remains sticky, and the economic growth outlook is encouraging. Tomorrow’s US February retail sales data is expected to show robust consumer spending activity. There are no policy relevant US economic data releases today.

GBP/USD is trading heavy near 1.2780. In line with consensus, the UK economy grew by 0.2% in January after shrinking by 0.1% the previous month. Services output was the largest contributor to the rise in GDP (+0.16pts) driven by wholesale and retail trade; repair of motor vehicles and motorcycles. Construction made a small growth contribution (+0.07pts) and production output detracted from growth in January (-0.03pts). Bottom line: the UK economy is on track to recover quickly from its end-2023 technical recession, supporting the case for no immediate Bank of England (BoE) policy rate cuts. A first 25 bp BOE rate cut is more than fully priced-in by money markets for August.

EUR/USD is trading in a narrow range around 1.0925. The Eurozone’s January industrial production data (10:00am London) is unlikely to generate material financial market volatility. Market participants anticipate industrial production to fall by 1.8% in January, which is consistent with the signal from the forward-looking manufacturing PMI.

ECB officials continue to follow President Christine Lagarde’s lead in leaning heavily towards a June policy rate cut (fully priced-in by money markets). This morning, Governing Council member Martins Kazaks emphasised “there is no need to delay the rate reduction too much” adding “the dragon of inflation is pinned to the ground, a little more and it will be defeated”. Meanwhile, Governing Council member Francois Villeroy de Galhau noted overnight “there’s a very broad agreement to cut rates in the spring, bearing in mind that spring lasts until June 21”. And Governing Council member Robert Holzmann warned yesterday that it could be premature to cut in April because “we also won’t have any ECB projections”.

NZD/USD retraced some of its recent losses, trading above 0.6160. RBNZ Chief Economist Paul Conway speaks about the February Monetary Policy Statement later today (6:00pm London). We don’t expect new policy guidance from Conway. Recall, the RBNZ softened its hawkish guidance at last month’s meeting as the updated RBNZ Official Cash Rate (OCR) projections implied a lower probability (40% versus 76% previously) of another 25 bp hike. New Zealand’s OIS curve has more than fully priced-in 50 bp of OCR cuts this year which remains a headwind for NZD.