18th July 2023
Positive market data sparks optimism
Is the US Federal Reserve’s battle against inflation finally turning the tide?
On Wednesday, data released gave fuel to optimism that the string of interest rate increases may have finally slowed the rise in prices. After increasing by 4% in May, consumer price inflation increased by 3% in the year to June. That is the smallest yearly growth in over two years.
This announcement was welcomed by US markets, which saw the main stock indices reach 15-month highs thanks, in large part, to shares of big tech-related businesses, which are often sensitive to rising interest rates. The worldwide MSCI World Index rose as a result of the US stock market advances and is currently up over 14% for the year. On the premise that the Fed’s rate rises will soon come to a halt, the FTSE 100 posted its greatest weekly performance in over three months.
After reports of weak job growth the week before, positive inflation data suggested that the Fed’s hasty rate increases were starting to cool the economy. However, the unemployment rate is still very near a multi-decade low, and wage growth is still exceeding the Fed’s inflation objective.
Concerns remain as core inflation persists
Core inflation, which excludes volatile costs for food and energy, is proving more resilient and continues to be a cause for concern. Core CPI decreased more subtly, from 5.3% to 4.8%, which is still far above the Fed’s 2% objective.
Chief Economist at Schroders Keith Wade predicts that the central bank will proceed with its well-promised rate increase later this month.
“The labour market is cooling but is still tight enough to accommodate strong wage growth. Such second-round effects have the potential to perpetuate inflation by raising labour costs across the economy, which the Fed will be keen to avoid.”
The US has made comparatively quick headway in slowing price rises compared to other advanced economies like the UK, where inflation is still 8.7%. Former Bank of England (BoE) rate-setting committee member Danny Blanchflower pointed out that the US economy was more agile than the UK’s.
“There’s been a COVID shock for everyone and there’s been a war shock for everybody. The question is what distinguishes the UK from everywhere else and I would say the answer is Brexit, which has made it more difficult for firms to do things like switch supply chains to lower cost alternatives.”
GDP shrinks while salaries rise
The UK economy’s difficulties were highlighted by the announcement that it shrank by 0.1% in May, in part as a result of the additional bank holiday for the coronation. This came after an increase of 0.2% in April and indicates that the UK GDP is on course to increase by about 0.1% in the second quarter.
BoE governor Andrew Bailey fortified its vow to “see the job through” on inflation earlier this week in a speech at Mansion House, but he emphasised that “both price and wage increases at current rates are not consistent with the inflation target”.
As if on cue, official data revealed that UK salaries increased at a record annual rate, increasing by 7.3% between March and May, sparking concerns that inflation will continue to rise. But there were indications that the labour market was slowing somewhat. In the three months leading up to April, the unemployment rate unexpectedly increased to 4% from 3.8%, while the number of open positions decreased.
Investors react to inflation data
Following the latest inflation news, the yield on two-year gilts dropped dramatically, indicating that investors were hedging their bets on how much higher the Bank might raise rates. Since December 2021, the BoE has raised interest rates 13 times in a row; its upcoming announcement is scheduled for 3rd August.
The International Monetary Fund (IMF) provided its analysis of the status of the global economy in advance of this week’s summit of G20 finance chiefs in India. The IMF confirmed that first-quarter growth was marginally above its April projections but maintained its expectation for 2.8% global GDP growth, down from 3.4% in 2022. It was stated that while manufacturing suffered across all G20 nations, demand for services remained high, meaning that “services inflation – which is now the major driver of core inflation – is expected to take longer to decline”.