March inflation data in the US came in above expectations this week, sparking a repricing of the profile for policy easing from the Fed this year. A June rate cut is effectively off the table, leaving markets anticipating only 2 rate cuts at most to be delivered by the Fed over the back half of the year. With the ECB and Bank of Canada signalling that policy easing is on the cards, this has set up a divergence with the Fed, which has sent US yields to fresh year-to-date highs and boosted the US dollar.
The pick-up in US inflation has extended to March as both headline and core CPI surprised on the upside of expectations at 0.4% month-on-month. Headline CPI lifted from 3.2% to 3.5%yr while the core rate was unchanged at 3.8%, but it is the recent momentum that has prompted a repricing of the Fed outlook, with later and fewer rate cuts now expected. Through the first 3 months of the year, headline CPI ran at a 4.6% annualised pace rising from 1.9% at the end of 2023, while core CPI moved up from 3.3% to 4.5% annualised.
Although Fed officials have thought seasonality has played a role in this acceleration, a more cautious tone on policy easing from the Fed may be forthcoming - comments from FOMC members Williams and Collins have indicated less urgency to cut - as the services basket (5.3%yr) has been a key contributor. That said, the most relevant inflation gauge for the FOMC is the core PCE deflator, which is running notably below the CPI outcomes. Taking into account the March readings for producer prices at 0.2%m/m and 2.4%yr, markets are estimating core PCE to come in around 0.3%m/m and 2.7%yr when the data prints on 26 April.
All remains on track for the ECB to start cutting rates in June. ECB policymakers left rates unchanged this week but a new addition to the statement noted that "it would be appropriate to reduce the current level of monetary policy restriction" if the upcoming set of ECB inflation forecasts, wage-price dynamics, and evidence of policy transmission provide increased confidence in a return to sustainable 2% inflation. All that will be needed to give the Governing Council that increased confidence should be available by the June meeting. An unusually candid insight from ECB President Lagarde in the post-meeting press conference revealed that "a few members" had already come to the view that it was time to cut and this forms a base of support to which the consensus is expected to cross to.
President Lagarde was reluctant to discuss policy beyond June; however, a Reuters article referencing ECB sources suggested that the easing cycle will proceed cautiously - potentially with a pause at the July meeting - with this week's US CPI data indicating inflationary risks remain. The ECB continues to see upside risks to inflation from the impact of geopolitical tensions on energy and goods prices, as well as domestic factors associated with the strong labour market and profit margins. Keeping rates at restrictive levels lessens these upside risks but with an increasing trade-off with the ECB describing growth as weak and with risks to the outlook "tilted to the downside".
Survey data in Australia this week remained consistent with economic activity holding up amid weak confidence. Consumer sentiment according to Westpac-Melbourne Institute Index fell more than 2% in April (82.4), with the index little changed over the past couple of years at very pessimistic levels. Notably, however, assessments on the labour market remain upbeat. The NAB Business Survey reported a continuation of below-average confidence among firms in March (+1) but with business conditions remaining robust (+9), supported by strength in trading conditions. In other news, housing finance commitments lifted by 1.5% in February, rebounding from a 3.4% decline over December and January (reviewed here).