The latest data on inflation in the eurozone showed a sharper fall than expected for both the headline and the core (excluding food and energy) number. However, we anticipate this will not lead the European Central Bank to lower its policy rate at the 11 April governors’ meeting. The ECB has made it clear that it first requires evidence of a moderation in wage settlements.
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Eurozone inflation was lower than expected in March
Inflation was significantly below expectations with the headline series at 2.4% year-on-year – versus a consensus forecast of 2.6% – and core inflation at 2.9% YoY relative to a consensus forecast of 3.1% (see Exhibit 1).
The fall in the headline figure is primarily due to a drop in food prices (from 3.9% YoY in February to 2.7% in March). The OECD reported last week that food inflation across industrialised nations has dropped to its lowest since October 2021. Food prices had risen sharply due to higher energy costs and lower trade on account of the war in Ukraine. Droughts and Covid-related supply chain disruptions also took a toll.
Core goods inflation fell to 1.1% YoY from 1.6% in February. This reflects relative weakness in the industrial sector in Europe, which in turn is partly a consequence of weaker demand from China for German industrial goods.
Sticky services inflation means first cut probably comes in June
The ECB’s focus has been on services inflation. In March, it remained stuck at 4.0% YoY for the fifth consecutive month. This suggests that fairly rapid wage growth is keeping prices in the sector under constant pressure, although the relatively strong data for services inflation is also due to some degree to an early Easter effect. This should reverse in April.
The implications for the ECB are not straightforward in that the data offers something for everyone:
- Doves on the ECB’s governing council will stress the significant fall in both headline and core inflation
- Hawks will point to the stubbornness of services inflation.
Although the possibility of a rate cut at the ECB’s policy meeting on 11 April cannot be completely dismissed, a first move in June now appears much more likely given President Lagarde’s focus in recent press conferences and speeches on the need for services inflation to cool before starting to ease the policy stance.
Another strong month for US job creation
The US job market remained solid in March with 303 000 new non-farm jobs created, significantly more than expected. Hiring was broad-based across the economy, with sectors as different as construction, retail and healthcare all showing strength.
Labour supply moved up in March, undoing some of the surprise contraction in recent months. There are reports that immigration into the US has been running at even higher levels than previously thought. If this is the case, the impact on inflation is mixed. It is potentially disinflationary on the supply side (via a larger potential work force), though higher demand for goods and services would offset this.
Pay growth, as measured by average hourly earnings, was static at just over 4% in March, down from 4.5% six months earlier, while hours worked edged up after softness in January and February. US households are seeing solid net pay growth, above the level of inflation. This bodes well for continued resilience in consumer spending.
This sort of jobs report, however, also suggests the ‘last mile’ of disinflation might be bumpy. But provided productivity growth holds up this year, as it has so far, then this report should not be too concerning for the Federal Reserve over the medium term.
Inflation to set the short-term path of US monetary policy
The US consumer price inflation (CPI) report to be published on 10 April will, in our view, be more important in determining the outlook for US monetary policy than the jobs report.
If this week’s CPI report for March were to show a modest 0.2% month-on-month rise in core inflation, it would strengthen the case for three 25bp rate cuts this year starting in June. Consensus estimates are for 0.3% gain.
The yield of US 10-year Treasuries has risen to around 4.40% — that is a level our fixed income team considers to be attractive over the medium term. Should, however, this week’s CPI report show core inflation running above expectations, a rise in the 10-year yield to test the 4.5% level looks likely.
Over the longer term, the terminal level of the Fed funds rate will depend on the productive capacity of the US economy. Even as inflation slows, a constrained labour market may limit how far the Fed can go.
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