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• Gold rallied c. +2% in dollar terms
• Europe was more resilient than other equity regions, falling -0.4% in sterling terms

• Equities broadly weakened, led lower by Japan (-5.6%).
• Bonds also lost ground, with gilts down -0.9%.

While Federal Reserve (Fed) officials may have been worrying about sticky Consumer Prices Index (CPI) inflation prints for some months, there is the possibility that the problem is now manifesting itself across the pond in the UK.

UK inflation data for March showed a more modest drop than expected, after February’s outsized decline. Headline CPI slowed to 3.2% from 3.4%, but was stronger than the consensus expectation of 3.1%. Core CPI slowed to 4.2% from 4.5%, ahead of the consensus forecast of 4.1%. After the print, futures prices indicated that market expectations of Bank of England (BoE) interest rate cuts had fallen back from three to two this year.

Within the inflation print, there was an acceleration in prices across recreation, hotels and hospitality & communications, while housing and utilities, transport, and food price rises all slowed. The early timing of Easter may have had an impact on the print, but this is unlikely to fully explain the strength. CPI is expected to slow markedly in April, when the Ofgem price cap falls by 12%, and this is expected to bring CPI below 2% through Q2 and Q3. However, signs of a persistent acceleration in prices could lead the BoE to hold off on rate cuts.

The Bank’s May Monetary Policy Report will undoubtedly be key. If inflation softens as expected, it is likely that the Bank’s forecast will see CPI, conditioned on the market-implied path of rates, at or below 2% at the end of the three year forecast period. This would open the door for interest rate cuts. The fact that the market implied path has shifted to anticipate a first cut in August, as opposed to June, makes it more likely that the forecast will predict that the price stability mandate will be met, while at the same time delaying the likely timing of rate cuts to August or later.

Other UK data has made the case more clearly for rate cuts. UK unemployment increased more than economists expected, rising to 4.2% in February, from 3.9% in January. Both Labour Force Survey data and payroll data suggested employment contracted in February and March, with March payrolls falling by 67,000. Pay growth also slowed to 6%. A slowing labour market is a key condition for rate cuts to begin.

GDP growth data for the first quarter showed that China’s economy grew by +1.6%, taking annual growth to +5.3%. This was around half a percent stronger than economists had expected.

China’s economy has struggled to regain momentum following the easing of pandemic restrictions, with consumer confidence soft and the real estate sector still struggling after tougher restrictions were imposed on property firms. Despite the continued softness of the property sector, growth recovered in the first quarter, boosted by a surge in infrastructure and manufacturing investment. These areas are likely to continue to be relatively strong, supported by policy initiatives around special bond issuance and an equipment renewal programme. Services also recovered, with IT and communications activity rebounding, likely helped by a more favorable regulatory environment, and an Artificial Intelligence (AI) boom, while transport was also stronger as a likely beneficiary of greater trade activity. However, services sub-sectors exposed to domestic demand, such as retail and hospitality, remained weaker, pointing to continued consumer caution.

While a stronger GDP print now boosts China’s chances of hitting 5% GDP growth this year, it also diminishes the change of a more significant fiscal support package or a regulatory change on real estate. Overall, this means that growth is likely to remain soft in the near term.

The Bank of Japan (BoJ) is seemingly struggling to catch a break. Less than a month after the Bank announced an end to negative interest rates and the Yield Curve Control policy, the yen has weakened against the US dollar to its lowest level since 1990.

The move has perhaps been surprising given the BoJ has recently made clear its intention to tighten monetary policy at a time when most developed market central banks are primed to ease. However, while the BoJ has raised rates and is expected to go further this year, the policy rate is still likely to end the year at around just 0.3%, some 500 basis points below prevailing rates set by developed market peers.

At the same time, expectations of interest rate cuts in the US have been scaled back radically, from over three cuts at the start of April to less than two today.

Combined, these factors have contributed to dollar strength and yen weakness. In the past, the BoJ has intervened to support the yen at times of weakness, but these efforts have not been long-lasting.

 

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