The overall theme for markets this week continued to be the scaling back of expectations of rate cuts especially in the US as the economy looks stronger, and inflation higher, than expected. However, the change should not be exaggerated. Inflation expectations are well in line with targets and indicators for banking activity in both the US and Europe confirm that the current stance of monetary policy is having a dampening effect on economies.
The latest significant upside surprise to US data was the January CPI. The core price index rose 0.4% m/m, so clearly more than what is compatible with 2% annual inflation. The increase was driven by a broad-based increase in service prices. The so-called “super core” index of services excluding shelter rose 0.85% m/m. This likely reflected higher than normal January price adjustments to make up for past cost increases in businesses and so is not likely to be repeated to the same extent in coming months, but nevertheless feeds into concerns in the Fed and elsewhere that a tight labour market and high wage growth could make it difficult to get service inflation down far enough.
On the negative side, US retail sales declined 0.8% in January and were revised down for December, and industrial production declined 0.5%. Especially retail sales is a highly volatile data series though, and these numbers do not really change the view on the US economy.
In Europe, the economic news has been slightly more positive this week. Employment growth in the euro area actually accelerated in Q4 to 0.3% q/q. The labour market usually reacts with a lack to the economy, so it is perhaps not surprising that the stagnating European economy has not yet produced a decline in jobs, but accelerating outright growth in employment is harder to explain. Surveys continue to show a large, unmet demand for labour among euro area companies. The strong labour market reduces pressure on the ECB to cut rates and adds to concerns about a potential rebound in inflation from high wage growth. The German ZEW index showed a new increase in business expectations in February consistent with the view of a more positive global situation for manufacturing, although assessment of current conditions actually worsened.
Unlike in the US, UK inflation was lower than expected in January, which helped dampen market worries globally. Core CPI increased just 0.16% m/m seasonally adjusted, and service prices dragged down. On the other hand, wage growth declined less than expected in December and stands at 6.2% y/y, while the unemployment rate declined from 4.0% to 3.8%. With core inflation still as high as 5.1% y/y, we still expect the Bank of England to be cautious in cutting rates.
Next week, on Thursday, we will get February PMI data for most major economies. They could show a renewed strengthening in global manufacturing. Regional PMIs published this week in the US point in that direction, as does indicators from several Asian countries that are normally leading in the manufacturing cycle. However, PMIs might also point to continued weakness in services which at least in the euro area seem to be stagnating or contracting, albeit with rising prices.
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