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Markets look to UK CPI and Fed minutes

Inflation set to move higher

European markets underwent yet another lacklustre session yesterday, despite a new record high for the DAX, while markets in the US also rolled over, eventually finishing lower after another pretty choppy and directionless session.

Markets appear caught between concerns over rising cases and the spread of the India variant of coronavirus, and optimism over the so-called 'reopening trade', making it difficult to read the direction of the next move. This paralysis of indecision is likely to see markets here in Europe open lower this morning as we look ahead to the latest CPI inflation numbers from the UK and EU.

One of the main worries that has been creating volatility in financial markets this past few weeks has been the potential for a sharp rise in inflationary pressures. These concerns have started to gain ever more traction after big surges in US and Chinese inflation last week. Today it’s the UK economy’s turn to come under scrutiny with the CPI for April.  

Concerns about rising price pressures have served to push UK gilt yields back up towards their recent highs in the past few days, with rising factory gate and commodity prices merely serving to reinforce these concerns. We are already starting to see early evidence of having to pay higher prices, notably in terms of higher air fares and other transport costs, which seem to be merely a symptom of normalisation from the big falls we saw a year ago, when economies went into lockdown, and as such are unlikely to be repeated, which means they are likely to be transitory in nature. Food prices more generally haven’t been showing any signs of upward pressure which is probably the more important narrative.

That’s not to say we won’t start to see sharp upward moves in headline CPI over the coming months. We’ve already started to see it in UK PPI, which has been trending higher since the end of last year when it was at 0.2% and in March hit 5.9%. If this translates into a leading indicator for CPI, we could start to see a move towards 2% CPI in fairly short order. In March, headline CPI came in at 0.7%, while core prices rose to 1.1%.

If the US experience last week is any guide, we can expect to see a similarly large jump in both of these numbers with UK CPI expected to jump to 1.5%, while core prices are expected to edge up to 1.3%. That’s still some way short of the Bank of England’s inflation target of 2%, however the speed of the move might suggest that we could be at 2% in fairly short order, and potentially by the middle of the summer. We also have the final EU CPI reading for April, which is expected to be confirmed at 1.6%, up from 1.3% in March.

Later this evening we’ve also got the latest Federal Reserve minutes from last month' s meeting, which seems quite a long time ago now, and also predates the surprise non-farm payrolls jobs report miss from the beginning of the month. At the time of that meeting the central bank acknowledged the recent improvement in US economic data, but also reiterated that it remained a long way short of the type of outcome-based data needed to alter its current policy stance, nixing any prospect of a taper in the near term. In fact, Powell’s press conference was yet another example of the central bank hedging its bets when it came to outlining the prospect of any sort of near-term policy move.

Given the recent payrolls report miss this caution was well-founded. As Fed chairman Jay Powell indicated when asked at the press conference afterwards, one bumper jobs report does not warrant a policy change, as he referenced the March jobs report, which saw 916,000 new jobs added to the economy, a figure which was subsequently revised lower to 770,000. He went on to say that there were still over 8 million more Americans who were out of a job compared with February last year, and as such the Fed would need to see “substantial further progress” on its full employment goals, for any change in policy to be considered.

The subsequent shock of April's non-farm report at 265,000 only serves to add more weight to this policy stance. The Fed also believes that the recent increase in inflationary pressures is likely to be transitory, and should fall back as the year progresses as base effects fall away. This would suggest that the Fed appears to be on autopilot through the summer, however the recent sharp rise in commodity prices, along with significant base effects, appears to be creating some uncertainty given the recent sharp rise in inflation expectations.

As we get to dissect this week’s minutes, and compare them to the recent utterances of various Fed policymakers over the economic outlook, including vice-chair Richard Clarida's recent comments that a taper is some way off, it’s tempting to suggest that they probably won’t tell us anything that we don’t already know, given how chatty various FOMC members have already been over the past few days. 

Forex snapshot

EUR/USD – breaking to the upside has seen the euro opening the prospect of a move towards the high this year at 1.2345, having broken above 1.2180. Support remains back at the 1.2040 area, with further support at 1.1980.

GBP/USD – still looks well supported, moving above the recent highs above 1.4180, opening up the prospect of a move through 1.4250, and towards the 2018 peaks at 1.4375. The 1.4020 level remains the key support for this move to unfold.  

EUR/GBP – a break through the 0.8630/40 area opens up the prospect of a move towards the April highs at 0.8730. Support currently at last week’s low at 0.8560

USD/JPY – continues to drift lower with trend line support from the January lows now at 108.50. A move below 108.00 opens up the prospect of a move back towards 106.80.

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