Inflation data in the US and the UK came in below expectations this week, sparking a bond market rally that finally delivered resistance to the steep rise in yields since the back end of last year. This drove higher equities and a weaker US dollar, with the Japanese Yen boosted further by increased signs that the BoJ is preparing to hike rates next week. The AUDUSD pair lifted from lows dating back to the pandemic; strong Australian labour market data looks to have largely played an auxiliary role in the move as markets continue to price in a strong chance of an RBA rate cut in February.
After last week's very strong US payrolls report lowered expectations for the Fed to cut rates just once in 2025, below consensus inflation data restored pricing for two cuts this year into favouritism with markets. Concerns over robust economic conditions renewing inflation pressures eased somewhat as core CPI printed at 0.2%m/m (vs 0.3% expected) in December - its slowest rise in 4 months - softening from 3.3% to 3.2%yr (vs 3.3%). At the same time, markets looked through a 0.4%m/m rise in headline CPI - its strongest since March driven by higher fuel prices - that lifted the annual pace from 2.7% to 2.9% as both outcomes matched expectations.
The core CPI reading together with producer prices rising by less than expected on a headline (0.2%m/m, 3.3%yr) and core basis (0.0%m/m, 3.5%yr) left markets encouraged that while the economy is strong, disinflationary trends have not been derailed. That narrative was given support by a goldilocks retail sales report for December: headline sales lifted by a solid 0.4%m/m but were weaker than the 0.6% rise expected, while control group sales surprised to the upside at 0.7%m/m against 0.4% forecast.
Softer than expected UK December inflation figures were a welcome circuit breaker to the upward pressure on gilt yields. Headline CPI printed at 0.3%m/m (vs 0.4%) to see the 12-month pace slow from 2.6% to 2.5% (vs 2.6%), while a 0.3%m/m reading saw the 12-month core rate ease from 3.5% to 3.2% (vs 3.4%). The key aspect of the report was a cooling in services inflation, down from 5.0% to 4.4% (a low since March 2022) giving a green light signal for markets to move towards fully pricing in a February BoE rate cut.
Over in the euro area, the account of the ECB's December meeting reaffirmed the Governing Council remains on an easing path. In a dovish tilt, the ECB removed its tightening bias to 'remain sufficiently restrictive' on interest rates replacing it with a line to 'ensure that inflation stabilises sustainably' at its 2% target. That shift reflects increasing confidence in the disinflationary process while also recognising that risks to the growth outlook - particularly from the implementation of trade tariffs under the Trump administration - could end up driving inflation well below target.
The upcoming Q4 CPI report in Australia (due 29 January) has taken on added importance with market pricing remaining heavily weighted towards the RBA cutting rates in February (75% chance) amid the continuation of robust labour market conditions. Employment continually outperformed expectations in 2024, rounded out by a 56.3k acceleration in December - a multiple of the median estimate (15k) and of the outcome in November (28.2k).
The strength of employment growth saw labour market conditions retighten over the back half of 2024. Although the unemployment rate ticked up from 3.9% to 4.0% in December, it averaged 4.0% over the final quarter - well below the RBA's forecast to rise to 4.3%. Meanwhile, the broader underemployment rate closed 2024 at 6.0% - a near 2-year low - with total underutilisation in the labour force holding at lows back to September 2023 at 10.0%. All of this was accompanied by the participation rate returning to record highs at 67.1%. My full review of the December labour force report can be accessed here.
