Sticky Inflation Prompts Reappraisal of Fed Rate Cut Start Date

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Eurozone Market Update

As widely anticipated, the European Central Bank (ECB) kept its three key interest rates unchanged in its April meeting. The policy statement noted progress in most measures of underlying inflation, namely, that wage growth is gradually moderating and firms are absorbing some rising labour costs in their profits. However, it also noted that “domestic price pressures are strong” and “are keeping services price inflation high.” The bank maintained its soft guidance for an initial rate cut in June, and investors raised their estimate for the chance of a cut by the June meeting to 87% from 82%, with 83 bps priced in for the end of the year. Inflation data cemented expectations of a June cut, with annual euro area headline and core inflation unmoved from last month at 2.4% and 2.9%, respectively.

_{Source: Bloomberg, data as of 30 April 2024}

UK Market Update

While much of the economic data out of the UK in April was generally in line with expectations, data related to inflation and employment were less encouraging. While annual headline and core inflation figures for March were down to 3.2% and 4.2%, respectively, they missed market expectations. Services inflation, a metric closely monitored by the Bank of England (BoE), is still running strong at 6.0%. The UK’s labour print showed weakness in employment, with an ongoing contraction in the Labour Force Survey of 156,000 through to February, which translates to a 1.9% annualised decline. Payroll jobs dropped by 67,000 in March. The persistence of services inflation reduces the likelihood of the BoE making a move to cut earlier than August. Markets are pricing in a full cut by the August meeting, and 44 bps are priced in for the rest of the year.

_{Source: Bloomberg, data as of 30 April 2024}

US Market Update

The US labour market continued to show strength last month as the March change in monthly non-farm payrolls came in at 303,000, well above expectations of 214,000. Inflation continued to prove sticky, with both headline and core inflation up 0.4% in March, compared to expectations of 0.3%. Economic growth disappointed in the first quarter, with GDP up 1.6% compared to an expected 2.5%. However, it was the core Personal Consumption Expenditures price index portion of the GDP report – which increased 3.7% in the first quarter – that grabbed the market’s attention. This provides little solace for the Federal Reserve regarding the inflationary trend. The month ended with another worrying data point for the Fed, as the Employment Cost Index rose 1.2% in the first quarter, the strongest reading in a year. Combined, these indicators suggest that inflation will remain above target for longer than hoped.

_{Source: Bloomberg, data as of 30 April 2024}

Looking Ahead

Since the start of the year, markets have significantly repriced the expected timing and path of central bank easing. As with our previous outlooks, we have paid particular attention to incoming inflation and wage data and highlighted our view that the last mile of the inflation race would be the hardest. We have stressed that the market’s expectation of easing was premature and too aggressive. Indeed, our views have not been immune to the stickier inflation backdrop. We have now reduced our Fed rate cut expectation from three cuts to two and pushed out the timing of the first cut from July to September. Our starting points for the ECB (June) and BoE (August) cutting cycles are unchanged, but we have revised the pace of their easing cycles to reflect the change in our Fed call. We believe the ECB and BoE can ease policy before the Fed, but the pace of their cycles will be reduced if we see a prolonged pause by the Fed. We view three cuts in 2024 as the base case for the ECB and two for the BoE, with the risk of a further cut if the Fed begins its easing cycle in September.

Chart of the Month

_{Source: Bloomberg as of 30 April 2024}

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