Expectation-Beating Inflation Prints Ratchet Up Pressure on Monetary Policy

Exclusive insight for TMI subscribers! Northern Trust Asset Management share monthly market commentary.

Eurozone Market Update

As expected, the European Central Bank (ECB) left its monetary policy unchanged at April’s meeting. The bank reiterated that net asset purchases should conclude in the third quarter, and rates will likely rise ‘sometime after’ that. The risk has intensified that the ECB will increase its inflation forecast with widespread price increases and inflation expectations above its target (see Chart of the Month). Since the meeting, more hawkish statements have opened the door for a July hike once the Asset Purchase Programme is phased out. Even ECB President Lagarde says there is a “strong likelihood” the bank will raise rates before the end of the year. The market is now pricing 75 basis points (bps) of hikes by the end of the year, with close to 40 bps by September.

UK Market Update

With no Monetary Policy Committee (MPC) meeting in April, key economic data and comments from committee members offered insight into what the Bank of England (BoE) will do next. Economic growth indicators point to a slowdown as high inflation, at 7% in March and above the bank’s estimates, has a negative impact on demand. Retail sales and PMI data showed a larger decline in consumer spending and business sentiment than the market expected. MPC member Catherine Mann raised the prospect of a 50 bps rate hike in coming meetings to get inflation under control. A more balanced speech from BoE Governor Andrew Bailey was not enough to calm market rate expectations of 1.50% of hikes being priced by the end of the year.

US Market Update

Federal Reserve Vice Chair Lael Brainard hawkishly suggested that the Fed could raise rates at every meeting this year to shrink the balance sheet quicker than the last cycle. This was reaffirmed in the Federal Open Market Committee’s (FOMC) minutes, where balance sheet reduction will be up to $95 billion per month. While headline CPI inflation - +8.5% year over year - was the highest in 40 years, a slight core consensus miss forced market participants to re-evaluate their monetary policy forecast. FOMC member James Bullard suggested a 75 bps hike in May may be necessary, while Chairman Powell left the potential for a 50 bps hike. The market has fully priced in 50 bps hikes at the next three meetings, with a total of more than 2% by year-end.

Global Outlook

The Fed continues to play catch-up after taking many months to react to higher inflationary pressures. The hawkish rhetoric throughout the Fed has been a significant change, and we expect a 50 bps hike in May, with a further 75-100 bps of hikes by late July. We believe the BoE will vote in favour of a 25 bps hike, following its concern with economic growth and the risk of a recession in the UK. Hit with a triple whammy of higher inflation, higher rates and higher taxes in April, the cost of living crisis is beginning to appear in economic data. In our view, this will result in the BoE underdelivering on rate hikes this year. In Europe, if inflationary pressure persists, as we believe it will, modest tightening in 2022 may be required.

Chart of the Month: UK and Europe Close in on US as Headline Inflation Upwards Momentum Continues

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