Will US inflation strengthen the case for a Fed pause?

Will US inflation continue to slow?

US inflation is expected to have slowed meaningfully again in May after only a marginal easing in April, offering the Federal Reserve a strong justification for pausing interest rate increases in June.

The Bureau of Labor Statistics on Tuesday will release its latest US consumer price index report, which is expected to show that headline inflation was 4.1 per cent in May, year on year, according to economists surveyed by Reuters.

That would mark a dramatic improvement from the rate in April of 4.9 per cent, after March’s 5 per cent reading. Compared to the previous month, the consumer price index is expected to have risen 0.4 per cent.

The data comes ahead of the Fed’s June rate-setting meeting, which will conclude on Wednesday. The CPI figure is expected to add to the central bank’s conviction that a pause this month in its historic campaign to increase rates is warranted.

The decline in the headline rate is expected to have been driven by weaker energy prices, Bank of America analysts argued, citing data from the American Automobile Association. This shows that average regular petrol prices declined 2.1 per cent month on month.

Core CPI, which strips out the volatile food and energy sectors, is expected to come in at 5.2 per cent year on year, down slightly from the previous month’s rate of 5.5 per cent. The BofA analysts argued that core prices will have been kept high by used-car prices. Kate Duguid

How much higher will the ECB raise interest rates?

Eurozone inflation is falling and the currency bloc’s economy is shrinking slightly. But economists are still convinced that the European Central Bank will raise interest rates by another quarter percentage point when it meets next week.

There is more doubt about how much higher borrowing costs will go in the 20-country zone, so ECB-watchers will be listening closely to what its president, Christine Lagarde, says about likely future rate moves.

Annual inflation in the eurozone has fallen from a peak of 10.6 per cent in October to 6.1 per cent in May. But rate-setters are likely to still be worried that underlying inflation, which excludes volatile energy and food prices, is still too high, even though it dipped to 5.3 per cent last month.

“In essence, data continue to be conducive to the ECB raising rates,” said Andrzej Szczepaniak, an economist at Japanese bank Nomura, pointing out that accelerating eurozone wage growth will keep services inflation stubbornly high.

Investors are betting that the ECB will raise rates this week and again in July before pausing. A key signal on future policy will be whether the central bank lowers its inflation forecast but Szczepaniak thinks it is more likely to raise it.

Dirk Schumacher, an economist at French bank Natixis, expects Lagarde to “stress that an end of the hiking cycle will crucially depend on a further decline in the core inflation rate in the coming months and that additional rate hikes remain a clear possibility”. Martin Arnold

Will UK wage growth add to inflationary pressures?

UK economic data is expected to show an acceleration in wage growth next week, driven by a higher minimum wage and the economy returning to growth in April, which could bolster higher interest rates expectations.

Economists polled by Reuters forecast that total annual pay growth, published on Tuesday, will have accelerated to 6.1 per cent in the three months to April from 5.8 per cent in the previous three months, reflecting around 1.6mn people benefiting from a 9.7 per cent rise in the minimum wage that took effect in April.

“From the point of view of reducing aggregate cost pressures on inflation, higher earnings growth would not be helpful,” said Sandra Horsfield, an economist at Investec. Strong wage growth could support current market expectations that the Bank of England will raise the bank rate above 5 per cent as it tries to bring inflation back down to its 2 per cent target.

The expected acceleration in wage growth comes despite analysts forecasting that the unemployment rate will reach 4 per cent in the three months to April, up from 3.9 per cent in the three months to March.

A stronger than expected rise in gross domestic product, due out on Wednesday, could support the view that the economy will be able to withstand more interest rate increases. Analysts forecast that GDP grew 0.3 per cent between March and April, reversing the 0.3 per cent contraction in March, partially because of fewer strikes in the transport and education sectors.

That would mean that the economy largely stagnated in the three months to April as it has done for the previous six months. Yet “the fact that the UK economy managed to avoid an outright contraction over the winter months considering the many headwinds to growth, particularly from the energy space, is a success story,” Horsfield said. Valentina Romei

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