The latest data on eurozone inflation showed that both headline and core (excluding food and energy) numbers fell more sharply than expected. However, we do not expect this to result in the European Central Bank lowering its policy rate at its April 11 board meeting. The ECB has made clear that it first needs evidence of moderation in wage settlements.
Eurozone inflation rate was lower than expected in March
Inflation was significantly lower than expected, with headline expectations of 2.4% y/y (consensus 2.6%) and core inflation of 2.9% y/y (consensus 3.1%) (see Exhibit 1).
The decline in key figures is mainly due to a fall in food prices (from 3.9% year-on-year in February to 2.7% in March). The OECD reported last week that food inflation across developed countries had fallen to its lowest level since October 2021. Food prices were soaring due to rising energy costs and reduced trade due to the war in Ukraine. Drought and coronavirus-related supply chain disruptions also took a toll.
Core goods inflation was 1.1% year-on-year, down from 1.6% in February. This reflects the relative weakness of Europe's industrial sector and is partly a result of weak demand from China for German industrial products.
The first inflationary reduction in fixed services will likely occur in June.
The ECB has focused on services inflation. In March, the rate remained at 4.0% compared to the previous year for the fifth consecutive month. This suggests that fairly rapid wage growth is putting prices in this sector under some pressure, but the relatively strong data on services inflation is also partly due to an early Easter effect. This should reverse in April.
The implications for the ECB are not simple in that data offers something for everyone.
- ECB Governing Council dovish faction will highlight significant decline in both headline and core inflation
- Hawks will point out the persistence of services inflation.
Although we cannot completely rule out the possibility that interest rates will be cut at the ECB's policy meeting on April 11, Lagarde has emphasized in recent press conferences and speeches the need to calm service inflation before interest rate cuts begin. The first rate cut in June now seems very likely. To soften policy stance.
Another strong month for U.S. job creation
The U.S. job market remained strong in March, with 303,000 new nonfarm jobs created, much more than expected. Hiring was widespread across the economy, with various sectors such as construction, retail, and health care all performing well.
Labor supply increased in March, reversing some of the unexpected contraction of recent months. There are reports that immigration to the United States is trending at even higher levels than previously thought. In this case, the impact on inflation will be mixed. This could potentially be disinflationary on the supply side (through a potential increase in the labor force), but this would be offset by higher demand for goods and services.
Pay growth, as measured by average hourly wages, was flat at just over 4% in March, down from 4.5% six months earlier, while hours worked edged up after softening in January and February. Net household wages in the United States are growing steadily and above the level of inflation. This is a good sign that consumer spending remains resilient.
However, these employment statistics also suggest that the “last mile'' to eliminating inflation may be bumpy. But if productivity growth continues this year as it has in the past, this report shouldn't be much of a concern for the Fed over the medium term.
Inflation determines the short-term direction of US monetary policy
In our view, the US Consumer Price Inflation (CPI) report due out on April 10 will be more important than the jobs report in determining the outlook for US monetary policy.
If this week's March CPI report shows a modest 0.2% month-on-month increase in core inflation, it will strengthen the case for three 25bp rate cuts this year starting in June. The consensus forecast is for a 0.3% increase.
Yields on the 10-year US Treasury note have risen to around 4.40%, a level that our fixed income team considers attractive over the medium term. However, if this week's CPI report shows that core inflation is stronger than expected, the 10-year Treasury yield will likely rise to test the 4.5% level.
In the long run, the final level of the federal funds rate will depend on the productive capacity of the US economy. Even if inflation slows, constrained labor markets could limit the Fed's scope for action.
Disclaimer
Please note that the article may contain technical language. Therefore, it may not be suitable for readers without professional investment experience. The views expressed herein are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may have different views and make different investment decisions for different clients. This document does not constitute investment advice. The value of an investment and the income it generates may go down as well as up and investors may not recover their initial expenditure. Past performance does not guarantee future returns. Investing in emerging markets or specialized or restricted sectors may be subject to increased uncertainty due to a high degree of concentration, limited information availability, low liquidity, or high sensitivity to change. May be exposed to higher than average volatility. In market conditions (social, political and economic conditions). Some emerging markets have less security than most international developed markets. Therefore, services that perform portfolio trading, clearing, and preservation on behalf of funds invested in emerging markets may involve greater risk.
