US CPI report supports Fed pause ahead of BoE policy update

USD: Softer services inflation should further ease Fed concerns

The US dollar has continued to trade at weaker levels after initially suffering a sharp sell-off yesterday in response to the release of the latest US CPI report for April. US dollar weakness has been mainly evident against the yen resulting in USD/JPY falling back to an intra-day low overnight at 133.89 down from an intra-day high yesterday at close to 135.50. USD/JPY continues to be the most correlated G10 FX currency pair to US rates. US rates have corrected lower again in response to market participants scaling back expectations for further Fed rate hikes and pricing in more cuts later this year. While the monthly rates of headline and core inflation were broadly in line with expectations in the April US CPI report, the underlying details provided further encouragement that inflation pressures are easing. The Fed has placed more emphasis recently on the measure of core services inflation excluding the cost of housing which slowed more sharply than expected to 0.11%M/M in April. It was the weakest monthly reading since July 2022, and has further slowed the annualized rate

of growth to 4.1% over the last six months down from a peak of 7.8% in the six months to June of last year. Prior to the COVID crisis it was running between 2-3% so it has not yet fully normalized but it should give the Fed more confidence that inflation is heading in the right direction. The Fed’s latest updated policy guidance has stressed that the upcoming policy decisions will be more data dependent. The CPI report supports our and US rate market expectations that the Fed should keep rates on hold in June. However, it was not all good news as the easing of services inflation was offset by a pick-up in goods inflation. Core goods inflation increased by 0.57% driven mainly by a big increase of 4.45% in used car prices. The good news is that auction prices dropped sharply in April so the increase in used car prices in the latest CPI report is unlikely to continue. 

MORE EVIDENCE INFLATION PRESSURES CONTINUE TO EASE IN US

Source: Bloomberg, Macrobond & MUFG GMR

GBP: More persistent inflation risks to support BoE hike

The pound is continuing to trade close to year to date highs ahead of today’s BoE policy meeting. After the release of the US CPI report, cable hit a fresh year to date high of 1.2680 yesterday although it has since dropped back closer to the 1.2600-level. Pound upside over the past week has been more evident against the euro resulting in EUR/GBP breaking back below support from the 200-day moving average at around 0.8740 for the first time since August of last year. The pound is continuing to benefit from the paring back of investor pessimism over the outlook for the UK economy at the start of this year. According to Bloomberg, the economic surprise index for the UK is currently at its highest level since the middle of 2021 with incoming data releases continuing to ease fears over recession in the UK. It stands in contrast to the economic surprise indices for the euro-zone and US. The euro-zone economic surprise index has now moved into negative territory for the first time since last autumn highlighting that initial investor relief that the euro-zone economy proved more resilient than expected over the winter period is now starting to fade. The latest industrial production and retail sales data from the euro-zone has been particularly weak, and could be beginning to weigh more euro performance. The US economic surprise index is still in positive territory but has been falling recently.

The resilience of the UK economy at the start of this year alongside still uncomfortably strong inflation and wage growth keeps pressure on the BoE to keep raising rates. As we highlighted in our latest FX Weekly report (click here), it will hard for the BoE to signal that it is close to pausing their rate hike cycle at today’s policy meeting. We expect the BoE to deliver another 25bps hike in response to the risk of more persistent inflation pressure and to leave the door open to further hikes. We are currently forecasting one more hike that would lift the policy rate to a peak of 4.75% by the summer. The narrowing policy divergence between the BoE and Fed continues to support our outlook for cable to move closer to the 1.3000-level. Inflation has remained more elevated in the UK than in the US as it is taking more time for the impact of lower energy and food prices to feed through to consumers. The energy CPI component has just started to fall back more sharply in the UK while the food CPI index has not yet peaked hitting 19.6%Y/Y in March even as the UN’s agricultural & food price index peaked just over a year ago. The BBC did though report some encouraging news yesterday that UK supermarkets (Tesco, Aldi, Lidl & Sainsbury’s) are starting to cut the price of butter and bread. Consumers have not yet benefitted from the drop in food prices as retailers have contributed to profit-led inflation. It would be good news if this dynamic is coming to an end and food price inflation falls back sharply with a lag in the coming years. 

FOOD INFLATION IN UK HAS NOT YET PEAKED

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
UK	12:00	BoE Interest Rate Decision	May	4.50%	4.25%	!!!
UK	12:00	BoE MPC Meeting Minutes	--	--	--	!!!
UK	13:00	NIESR Monthly GDP Tracker	--	0.0%	0.1%	!!
EC	13:00	ECB's Schnabel Speaks	--	--	--	!!
US	13:30	Initial Jobless Claims	--	245K	242K	!!!
US	13:30	PPI (YoY)	Apr	2.4%	2.7%	!!
UK	14:15	BoE Gov Bailey Speaks	--	--	--	!!!
US	15:15	Fed Waller Speaks	--	--	--	!!
EC	18:30	ECB's De Guindos Speaks	--	--	--	!!

Source: Bloomberg