18 April 2024: Rail fares and hotel rooms rose in March

The “basket” used to determine headline inflation does not always represent the everyday goods and services concerning the man in the street. While headline inflation fell according to data published yesterday, the fall was less than the market had predicted due to increases in the cost of hotel rooms and train fares.

Although the cost of commuting has grown into a significant factor in many household budgets, very few people stay in a hotel regularly. The cost of accommodation is more of an issue for businesses than individuals.

This is why Jerome Powell prefers to use personal consumption expenditures as a more rigorous guide to the “wider” view of inflation.

The Basket used to calculate CPI is too “narrow” and needs to be updated so often that it becomes unrepresentative for comparative purposes.

Headline inflation fell to 3.2% in March, down from 3.4% in February and less than the 3.1% the market had expected.

The wage increase data published the day before yesterday will have been disappointing for Andrew Bailey.

While wage increases are beginning to slow, similarly to inflation, the fall has become “agonizingly” slow and is deciding to cut interest rates even more difficult to agree.

For the economy to grow, even at the historically low rate it is expected this year, the Bank of England needs to give it the “shot in the arm” that a rate cut would provide.

Despite the painfully slow rate of fall in both inflation and wage increases, Bailey is making “encouraging noises” about the economy. Speaking to the IMF, The Governor of the Bank of England was almost fulsome in his belief that even while interest rates need to remain at a sixteen-year high to combat inflation, the economy is beginning to pick up pace.

The IMF, in addition to publishing its quarterly review of the growth prospects for the major industrialized economies, outlined the dangers and risks it perceives to be a concern in the next two quarters.

The situation in the Middle East is a significant issue, with the wider concern over the disruption to shipping that is currently taking place in the Gulf of Aden. Of immediate concern is the expected retaliation about to be agreed by the Israeli War Cabinet on Iran for its missile and drone attack on it at the weekend.

The G7 has called for restraint from Israel, but its Prime Minister, in thanking the group for its suggestions, said that Israel alone will decide what retaliation is proportionate.

Sterling recovered a little yesterday as the dollar’s recent rise ran out of steam. It reached a high of 1.2482 and closed at 1.2454.

In a speech yesterday, Jerome Powell again “pumped the brakes” on a loosening of monetary policy. He commented that it may take a little longer for interest rates to be cut than previously expected, given the continued strength of the employment market.

The economy added more than 900k jobs in the first quarter of the year. This is significantly more than that predicted, and the jobs market exhibits far more resilience than is normal for this stage of the economic cycle.

There are influences outside the control of the Fed within the wider geopolitical arena currently, which are hitting supply chains both inside and outside the U.S.

The current path of inflation is causing members of the FOMC to take on a far more hawkish stance over monetary policy than is necessary. Continual speculation over “when” rate cuts will begin has been partially replaced by the use of the term “if” cuts are possible this year.

While Powell has been constant in his warnings that the fall in inflation won’t be linear and there will be “bumps in the road,” the lack of progress may have surprised him.

Several members of the FOMC have spoken recently about the fact that the Central Bank does not need to be in a hurry to cut rates, given the level of GDP that has been seen over the past six months, and the prediction for the rest of this year.

Two prominent Wall Street banks have opposite views of the economy. JPMorgan Chase believes that the economy is on the cusp of a significant slowdown which will lead to stagnation, while Goldman Sachs supports the way the Fed is tackling stubborn inflation and believes that a delay in cutting rate won’t affect the eventual soft landing that it still believes is likely.

There is no reason to believe that the next FOMC meeting scheduled for May 1st will do anything other than confirm the view that a cut in rates will be delayed. There will be a concern that the number of rate cuts that are projected to take place that year will be reduced, although such a move will see the dollar continue to make ground.

Over the next week, data for economic output will be published and that is unlikely to blow the FOMC off its newly found hawkish path. PCE numbers will also be released, and this will confirm that inflation remains “sticky.”

Before the self-inflicted blackout on members of the committee begins, there are likely to be further confirmations that any cut in rates won’t take place until deep into the third quarter at the earliest.

The dollar index predictably corrected part of its recent rise, although it is still in an upward trend.

It fell to a low of 105.87 and closed at 105.74.

Just when the market had become close to being convinced that a cut in interest rates would happen at the June meeting of the ECB’s Governing Council, with even the usually cautious Christine Lagarde commenting that she wants rate cuts to begin in “short order”, the most prominent hawk on the committee, Robert Holzman, the Governor of the Austrian Central Bank, highlighted his concerns that the current geopolitical situation, highlighted by the increase in tensions between Israel and Iran is giving him “second thoughts”.

Given that Holzmann is so far a lone concerned voice, a cut in rate on June 6th, is still certain particularly since other hawkish voices have so far remained silent, but the comments have sent mild shock waves through the market.

A lot will depend on Israeli retaliation and how proportionate it is.

When Lagarde spoke yesterday of her desire to “get the first cut out of the way,” even she tempered her remarks by adding the caveat, “barring any major shocks.”

Inflation is continuing to fall which will encourage the market to consider a cut as a “done deal,” but given the historic hawkishness of the ECB, the market will be holding its collective breath until the announcement is made.

Lagarde said her team of economists will be monitoring the oil price very closely over the next few weeks to ensure that no spike could bring an increase in inflation “down the road.”

The worst of all outcomes for the ECB would be to cut rates only to see inflation rise significantly due to an event outside its control. The Credibility of the Bank and its President is at a pretty low ebb currently, and any further delay in a rate cut, or a cut which had to be reversed, would be a disaster.

Bundesbank President, Joachim Nagel, has been willing to join the “rate cut party” recently, but he also sounded a note of caution yesterday.

He believes that there is no guarantee despite the encouraging fall in inflation recently that it will continue that path and reach the ECB’s 2% target early next year and stay close to that level.

He went on to acknowledge the “moderate” level of growth expected for Germany over the rest of this year and next but suggested no “magic potion” to see it increase.

The euro regained a measure of composure yesterday, although its rally was technical and unlikely to last very long.

It rallied to a high of 1.0679 and closed at 1.0672.

Have a great day!