Key risk events for markets came late in the week via the latest inflation data from the US and the European Central Bank's policy meeting. With the two occurring concurrently, it was not surprising that the former would take most of the attention given the importance of the inflation narrative in the markets, though there were some points of interest arising from the latter. In May, headline inflation in the US overshot expectations in rising by 0.6%m/m to drive the annual pace up to its highest since 2008 at 5.0% (vs 4.7% exp), while inflation on the core rate (ex-food and energy) saw a 0.7% uplift on the month elevating the year-over-year change to its fastest in nearly 30 years at 3.8% (vs 3.5% exp) (see chart below). Though surprising on the upside of consensus, markets largely shrugged the release off in a sign that there is now more alignment with the thesis that global central banks have been putting forward for high inflation readings to prove transitory. Emphasising the point was the move south of 1.5% on US 10-year Treasury yields this week to their lowest since March, which was driven by a rollover in breakeven inflation rates from their May peaks. True that demand for fixed income is very strong (highlighted by this week's US 10-year auction) underpinned by central bank purchase programs, but May's inflation data contained elements pointing to the well-documented supply-side issues that have become evident as economies have reopened.
Chart of the week
About one-third of the rise in headline inflation can be attributed to surging prices for used cars and trucks (7.3%m/m) due to the global semi-conductor shortage and bottlenecks through the supply chain that have constrained the availability of new vehicles. Base effects are also a significant factor driving the uplift in inflation: energy costs in a reopening economy stand 28.5% higher than a year earlier when activity was grinding towards a halt with the lockdowns in place, while gasoline prices are up more than 56% over the period. Shifts in demand patterns due to the pandemic through the rotation away from services into goods at a time of extraordinary stimulus to support spending also help to explain inflation trends. Inflation in durable goods has soared to 10.3%Y/Y (highest since 1980) on these effects, though inflation in services, which tends to be more stable and accounts for a much larger share of the CPI (around 62%), has only just returned to its pre-pandemic pace up 3.1%Y/Y. As consumption patterns rebalance on the back of the continuation of the vaccine rollout and wider reopening, it seems likely to think that this disparity will dissipate and inflation will slow.
Over at the ECB, the decision statement from this week's meeting was nearly identical to that from April as all monetary policy settings were left unchanged. This confirmed that bond-buys under the Pandemic Emergency Purchase Programme (PEPP) would be maintained at their "significantly higher pace than during the early months of the year". Of most significance was that the discussion around tapering will not be taking place until the recovery is back on track after it was derailed by a resurgence in the virus, with the reintroduction of lockdowns leading to a contraction in real GDP of 0.6% in Q4 followed by a further 0.3% fall in the most recent quarter. Progress in the vaccine rollout promises to deliver a strong rebound over the summer based on the signals from the soft indicators (PMIs, mobility and sentiment) and indeed this has been factored into the latest ECB staff macroeconomic projections in which the outlook for GDP growth was upgraded this year (4.6% from 4.0%) and next (4.7% from 4.1%). Adding to the sense of optimism, in the post-meeting press conference, President Christine Lagarde said that the risks around the growth outlook had improved to be "broadly balanced" as opposed to being on the "downside" previously. Upward revisions to the inflation profile rounded out a more upbeat assessment from the ECB with an uplift in the forecast for 2021 to 1.9% from 1.5%, before expected transitory price rises fade in 2022 as the pace slides back to 1.5% (was 1.3% previously). A Reuters article citing ECB sources reported that 3 members had argued at the meeting that the stronger growth and inflation outlook warranted a tapering of PEPP purchases, but the core of the Governing Council remains focused on preserving the current very accommodative financing conditions as the economy opens up again.
In Australia, consumer and business surveys were in focus. Consumer sentiment on the Westpac-Melbourne Institute survey responded to the Victorian lockdown with 5.2% fall in June, taking the index back to its level at the start of the year but still at a strong reading of 107.2. While sentiment fell more sharply in Victoria, it also declined noticeably in several of the other states with the return of virus-related concerns. The broader effects on confidence are an important area to watch given that the recent National Accounts reported that the rebound in household spending slowed across the states in Q1. Also of note, unemployment expectations have come off their best level in a decade after lifting sharply in the month. Whether or not this has much to do with the expiry of the JobKeeper wage subsidy should become clearer in next week's labour market data with seasonal effects from the Easter holiday period out of the way. The May NAB Business Survey was largely taken before Victoria's lockdown and conveyed another robust snapshot of conditions. Business confidence was a little softer at a +20 reading but still very elevated, while business conditions lifted to a new survey high at +37 as all 3 sub-components reset record levels achieved in the prior month (trading +47, profitability +40 and employment +25). But arguably of more importance to the durability of this recovery is that the forward-looking indicators continue to hold up. Both forward orders (+26) and capex (+24) are at record highs, providing optimism that the strength in equipment investment over the last two quarters has further to run, especially since the recent Federal Budget extended the generous asset write-off provisions for another 12 months through mid-2023.
