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UK inflation and Fed minutes in focus

inflation graph

European markets pulled back some of their recent losses and oil prices dropped sharply yesterday on claims by Russia that they had begun the process of returning some of their troops to their bases, after the completion of military exercises.

While an encouraging development, there was an element of caution all round, with US markets also finishing the session higher, breaking a three-day losing streak in the process. The undercurrent of caution is understandable given the lack of empirical evidence on the ground to support this claim, which means the next couple of days are likely to be key in determining whether the deeds match the claims.

Consequently, European markets are expected to open cautiously higher, as we look ahead to today’s UK inflation numbers, as well as US retail sales and the most recent FOMC minutes. Having seen headline inflation rise to its highest levels since 1992 at the end of last year, moving up to 5.4% from 5.1%, the Bank of England took the decision to raise rates by 0.25% to 0.5% at the start of this month. What was more surprising was that four MPC members wanted to go further and hike by 50bps, which suggests that a similarly strong number today could signal another rate rise next month.

On the RPI measure, prices rose even faster, rising to 7.5%. The most notable takeaway from the December numbers was a sharp rise in food and non-alcoholic drinks, along with increases in the prices of clothing and household goods, as the various supply chain disruptions we’ve been hearing about for several months start to filter down into consumers wallets. This is unlikely to be the end of it given that the Bank of England expects CPI to peak at 7.25%, probably in April, which in turn is likely to push RPI up to over 9%.

Today’s January numbers are forecast to see UK CPI come in unchanged at 5.4%, and core prices to rise to 4.3%. This seems rather conservative, and a touch on the optimistic side, given the trends we’ve seen in the US, and elsewhere. More importantly, we should look for evidence of a subsidence in inflation pressure in the PPI numbers, which tend to be leading indicators for future trends in CPI. Input prices are expected to slip back to 13.4% from 13.5%, and output prices to come down to 9.1% from 9.3%. 

It’s also an important day for US macro data, with the latest retail sales numbers for January as well as the latest FOMC minutes. Starting with US retail sales, expectations are for a rebound of 2%, after the slide of -1.9% in December. This optimism is based on better wage growth, which has been much more resilient and has been rising consistently for two to three months, while jobs growth has also been solid, defying some of the gloom around the spread of Omicron, although consumer confidence has been weak

Nonetheless the decline in December retail sales along with a weaker revision for November of -0.2%, could merely have been a result US consumers purchasing all their Christmas presents early in October, when sales rose by 1.8%, due to concerns about supply chain disruptions. The additional uncertainty caused by the spread of the Omicron variant certainly played a part in December’s slowdown with drops in spending across the whole retail sector.

On the control group measure, which ties into US GDP, the decline was even bigger at 3.1%, while November was also revised lower to -0.5%. This end of year weakness could well translate into a new year rebound, given the resilience in wages with expectations of a rise of 1.4%.

We follow that with the latest Fed minutes, which given the lack of surprises from the most recent Fed statement and the decision to keep monetary policy on hold, could see some market movement. Fed chair Jay Powell’s press conference did show that the thinking of the FOMC was evolving quickly when it came to the pace of rate rises. It’s unlikely that we’ll get much detail on whether they discussed anything more than a 25bps hike, although we might get an insight into how much appetite there is for a faster pace of rate hikes, for example, one at every meeting. Powell went on to say that the FOMC wouldn’t hold back from continuing to raise rates at a faster pace than it did in the last tightening cycle, and that it would be appropriate to start shrinking the size of the balance sheet at the same time.

His admission that there was “quite a bit of room to raise rates before it hurts the labour market”, sent the message of a Federal Reserve appearing ambivalent about the risks of moving too quickly to combat an inflation problem that they appear increasingly concerned about. While some Fed officials were keen to push back on the idea that rates could rise by 50bps in March, the most recent non-farm payrolls report appears to show that the US labour market is much more resilient than first thought. Nonetheless today’s minutes are likely to focus on the appetite among Fed officials for the likelihood of a 50bps rise in March, as well as the prospect of a rise at every meeting.

We could also find out more on FOMC members thinking around the timing of balance sheet reduction, and whether we can expect to see it in the first half of the year. Since the end of last year, market thinking on Fed rate rises has shifted significantly from three rate rises this year, to as many as seven, with the bigger question as to whether Fed officials thinking on the pace of rate rises has shifted as well. 

EUR/USD – reversed off the 1.1270 area and has recovered higher, however we need to get back above 1.1420 to retarget the highs at 1.1485. A move below 1.1270 retargets the lows this year at 1.1120. 

GBP/USD – the pound has struggled for direction over the last few days, with support at the 1.3480 area, and then below that at the 1.3430 area where we have trend line support from the December lows. A sustained move above the 1.3600 area targets 1.3720.

EUR/GBP – rebounded off the 0.8350 area but we need to get back above the 0.8410/20 area, to retarget the 0.8470 area. While below 0.8420, the bias remains for a to a retest of the 0.8280 lows earlier this month.

USD/JPY – currently has support at the 115.00 area but needs to move above the 116.35 area to open up 117.50.  If we drop below the 114.70 area we could slip back to 113.80.

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