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Beyond low CPI & onto BoE, Fed minutes

by Ashraf Laidi

UK consumer price inflation fell 0.3% in the year ending in January, posting its lowest level since 1960, but both the pound and gilt yields have rallied as the CPI figures were in line with the figures anticipated by the Bank of England’s quarterly inflation report, released last week. And with core inflation – inflation excluding volatile food and energy items — rose to 1.4% year –on-year—suggests that the bulk of the slowdown in inflation is a result of plunging energy prices, which have started to stabilize over the past two weeks. The report remains a short-term positive for the British pound.

The Bank of England predicts CPI will fall below zero on a year-on-year basis, before making its way towards the 2.0% target by the end of the 3-year horizon period. Borrowing from the words of the Federal Reserve, the UK’s low inflation figures are indeed “transitory”. As long as markets are ready for more temporary downside in UK inflation, they can look beyond.

UK CPI slowdown less “transitory” than US

The Bank of England and Federal Reserve are the only major central banks expected by markets to increase rates in the foreseeable future—although I continue to expect both to stand pat. Since both central banks face falling rates of unemployment and inflation, expect the dovish camp to spill more ink on falling prices as a means to delay higher rates.

Yet, the Fed faces a more protracted decline in price growth.Core personal consumption expenditure index, the Fed’s preferred gauge of inflation is at 9-month low of 1.3%, prolonged its decline from last May’s peak.

So how can the Fed be expected to raise rates in June, if the core PCE is displaying no of nearing the Fed’s preferred 2.0% target?

The chart below shows US consumer prices index slumping to 0.8% y/y, the lowest since October 2009 when CPI dropped to -0.2%. US core CPI is at 1.6%, the lowest in ten months.

Looking ahead, we expect UK inflation to begin stabilizing before its US counterpart, mainly due to diverging currency effects as the pound fell 10% against the US dollar from last summer’s peak. With the Bank of England already preparing markets for inflation to fall below zero temporarily, FX traders are already looking beyond this point. This may explain why UK 10-year yields rose by more than 4 basis points to 1.70% despite inflation hitting a 55—year low.In contrast, the Fed continues to describe soft inflation figures as “transitory”, without preparing markets for temporary downside surprises.

On to Wednesday’s Fed & BoE minutes

FX markets will be on watch for tomorrow’s release of the minutes from the Fed’s January 28 meeting. For the first time in over 10 years, the Federal Reserve mentioned “international developments” in its policy statement (released on January 28), as a key element to watch, in addition to the existing list of “labour market conditions, indicators of inflation pressures and inflation expectations”. Wednesday’s release of the minutes will reveal the extent of international factors considered by the Fed. Surely one of them is the prolonged decline in global inflation, about which the bond market is already worried as it sent 10-year yields near the two year lows of 1.6966%.

Any detail on the Fed’s assessment of the negative USD impact on US exporters will be taken by FX traders as a hint of concern, which could diminish expectations of 2015 rate hike expectations to the detriment of the US currency.

And those UK jobs figures

The BoE minutes will be released simultaneously alongside the latest UK jobs figures, with the highest scrutiny placed on December weekly earnings data, expected at 1.7% y/y on the headline series and 1.8% y/y on the ex-bonus series. Both figures are seen matching the November data. As long as the ILO unemployment rate does not rise above 5.9% and decline in jobless claims remains at 20K or more, then GBPUSD shall remain supported for a fresh attempt of $1.5550s.

SPX-Fed-policies-Oct-29

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