Global Markets Respond Positively to US Inflation Decline
Global markets welcomed yesterday’s news of US inflation easing for a fourth consecutive month, reaching its lowest level since early 2021. Headline inflation surprised analysts by coming in lower than expected at 2.9% annually and 1.6% on a three-month annualised basis in July. However, the only caveat in the Consumer Price Index (CPI) report was an unexpected 0.4% monthly increase in shelter costs—the largest component of the headline index—as rents are decreasing more slowly than initially anticipated.
Although the details of the CPI and Producer Price Index (PPI) readings, which contribute to the Federal Reserve's (Fed) preferred inflation measure (Personal Consumption Expenditures, or PCE), might cause the index to rise later this month, it is unlikely to hinder the anticipated start of the easing cycle. Generally speaking, price pressures continue to slow, which should provide the Fed with greater confidence to ease policy in the upcoming meetings. The focus has now shifted from whether the Fed will cut rates in September to how much easing is feasible. The answer is likely to depend on the forthcoming jobs report, which has replaced inflation data as the key factor influencing policy decisions in the second half of 2024.
Overall, this week’s inflation data has not significantly influenced markets or the Fed. US equity benchmarks traded slightly lower following the CPI report, while the US dollar and Treasury yields declined. The ongoing decrease in inflation is likely to remain a negative factor for the dollar over the next two to three months. Consequently, the direction of macroeconomic data will be crucial in determining market trends. Today’s retail sales report is the last major release this week; any signs of increasing recessionary risks could further weaken the dollar, while strong consumer spending could cast doubt on whether the expected 200 basis points of rate cuts over the next seven meetings are truly justified.
Modest UK Inflation Rise in July Fuels Expectations of Further Bank of England Rate Cuts
A smaller-than-anticipated increase in UK inflation in July has led traders to believe that additional rate cuts from the Bank of England (BoE) are on the horizon. Markets are now nearly fully pricing in two more 25-basis point reductions this year, compared to 44 basis points before the inflation report. The pound has faced some modest selling pressure, dropping over 50 pips against the euro, with €1.17 proving to be a key short-term resistance level.
UK Consumer Price Index (CPI) rose by 2.2% in July, and it is expected to inch higher as the effect of lower household energy prices fades from the annual comparison. However, this outcome was anticipated and forecast by the BoE. Instead, greater focus is on services inflation to guide policy, which recorded its lowest reading in over two years, standing at 5.2%, down from 5.7% in June and notably below the BoE’s 5.6% forecast. Survey data also indicate that businesses are raising prices less aggressively than before, and with wage growth also cooling, these conditions are likely to enable at least one rate cut, with the possibility of two more before the year’s end.
Why didn’t GBP/USD fall further yesterday? Despite UK yields declining in response to increased expectations of rate cuts, US yields also dropped after headline US CPI reached its lowest level since 2021, allowing GBP/USD to stabilise above its 5-year average of $1.28. The focus now shifts to the UK’s Q2 GDP, which met expectations this morning, having little impact on the pound. However, tomorrow’s retail sales data will provide further insights into the strength of the consumer and the economy in the third quarter.
EUR/USD Hits 2024 High as Softer US CPI Fuels Fed Rate Cut Expectations
EUR/USD climbed to its highest level in 2024 as US CPI figures came in lower than expected, raising hopes for a Federal Reserve rate cut in September. However, traders who were expecting an even softer reading were left disappointed, as the likelihood of a significant 50-basis point Fed rate cut in September now seems increasingly difficult to justify. Despite a rise in short-term US Treasury yields, the euro remained strong, buoyed by improving sentiment that favoured the pro-cyclical currency.
Domestic macroeconomic data was mixed and largely overlooked by market participants. Final estimates showed that France’s annual inflation rate in July increased to 2.3% year-on-year, slightly below the preliminary estimate. The second estimate of Eurozone GDP matched expectations, but employment growth was weaker than anticipated, hinting at potential challenges ahead. Additionally, June industrial production fell by 3.9% year-on-year, surpassing the expected 2.9% decline. In fact, Eurozone industrial production has contracted every month in 2024 on a year-on-year basis. With the manufacturing sector remaining weak and showing little sign of recovery, it is likely to weigh on growth in the third quarter of 2024. As a result, Eurozone growth is likely to rely more heavily on the services sector for the time being.
The Euro Index advanced by over 0.3% on Wednesday, supported by a modest gain against the New Zealand dollar. EUR/GBP rose by as much as 0.3% to £0.858 as UK inflation increased less than expected, boosting short-term Bank of England rate cut expectations. Meanwhile, EUR/JPY approached a two-week high following the news that Japanese Prime Minister Fumio Kishida will not seek a second term.
