Economic Data Vindicates Rate Caution By Central Banks

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Eurozone Market Update

With no monetary policy meetings from our three central banks in February, we paid close attention to the economic data that might impact rate decisions at their March meetings. Flash figures show annual eurozone headline inflation came in at 2.6% in February, down from 2.8%, while core inflation of 3.1% was the lowest since March 2022. Services inflation also eased to 3.9% from 4%. The hawks and doves in the European Central Bank (ECB) have expressed confidence in the disinflationary trend but want further evidence of its continuation before embarking on an easing cycle. Wage growth data for the fourth quarter of 2023 showed negotiated wages slowed to 4.46% from 4.69%. The ECB’s chief economist, Philip Lane, commented that 3% wage growth would be consistent with the 2% inflation target, indicating that the ECB is likely to keep rates steady to meet that target. The amount of easing expected by June fell 4.2 bps to 25.52 bps, signalling the first full cut in June, with 75 bps of cuts priced in for the year (see Chart of the Month).

_{Source: Bloomberg, data as of 29 February 2024}

UK Market Update

UK annual headline inflation in January (4.0%) was lower than market consensus estimates and the Bank of England’s (BoE) expectations (4.1% each). Core inflation remained steady at 5.1%. Services inflation ticked up from 6.4% to 6.5% in January but was again lower than anticipated by the market (6.8%) and BoE (6.6%). In a speech, Dave Ramsden, a BoE deputy governor, noted that “key indicators of inflation persistence remain elevated”, and more evidence is required on “how entrenched this persistence will be” when considering how long to leave rates at their peak. This echoed comments Governor Andrew Bailey had made to a Parliamentary Committee earlier in the month. Data showed that the UK slipped into a technical recession in the second half of last year, driven by weak consumption and net trade. This news saw the expected 2024 BoE rate pricing fall intraday.

_{Source: Bloomberg, data as of 29 February 2024}

US Market Update

In January's Federal Open Markets Committee (FOMC) monetary policy meeting minutes, participants flagged concerns over cutting rates too early, with some concerned that inflation progress could stall as the Federal Reserve approaches its 2.0% target. That narrative was further supported in February, where annual headline inflation rose to 3.1% versus the consensus of 2.9%. Core inflation also beat consensus (3.7%), reaching 3.9%. The Producer Price Index (PPI) also delivered strong readings, with the annual headline reading of 0.9% and core PPI of 2.0%, beating consensus expectations of 0.6% and 1.6%, respectively. Real GDP grew at a 3.2% rate in the fourth quarter of 2023, according to the second estimate, which was slightly down on the advance estimate of 3.3%.

_{Source: Bloomberg, data as of 29 February 2024}

Looking Ahead

Given the cautious rhetoric from central bankers, resilient economic data, and stickier prices, the market has pared back the timing of the initial central bank cuts and the total amount of easing expected for 2024. The significant repricing of expectations has moved the market much closer to our expected path and timing for these cuts. As outlined in our previous outlooks, the central banks have been gaining confidence that their tightening cycles are impacting inflation, but they require further information before they can declare victory. The last mile in getting inflation down to 2% is proving stickier than the market expected, leaving central bankers vindicated for erring on the side of caution. We continue to believe that the question central banks face is how long to remain restrictive rather than how restrictive they need to be. Further information on inflation and wages is required before they will be comfortable commencing their cutting cycles.

Chart of the Month

_{Source: Bloomberg as of 29 February 2024}

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