Dollar takes back some ground as US inflation proves sticky

The dollar, which lost ground to the euro over the course of last week, took back some of that in trading on Friday. The dollar rebounded after US PCE data showed that US inflation remains stubbornly elevated and makes it more likely the Fed keeps interest rates ‘higher for longer’. The euro was trading just below $1.07 at close of play on Friday, having touched off as high as $1.0750 in earlier trading. Sterling dipped back below $1.25 on Friday also.  The dollar has lost a touch in early trading this morning to start off the week with the euro and sterling moving back above those Friday close levels right now. Sterling has gained a little on the euro in the past few days and starts off this week at 85.6p. The yen weakened last week, with the Bank of Japan failing to announce any currency market intervention and keeping monetary policy on hold. The Japanese currency very briefly broke through a key level of Y160 to the dollar overnight, a 34-year low, but rebounded strongly to Y155 now prompting some market speculation that authorities may be stepping in though there is no confirmation or denial from the Japanese Ministry of Finance or Bank of Japan.

Government bond yields ticked upward for the most part last week,  but on Friday reversed some of that. US 10-year yields fell 4bps to 4.67% (but up from 4.6% at the start of last week) while German 10-year yields were down 5bps to 2.57% (from 2.5%)  and UK 10-year yields down 4bps to 4.32% (from 4.2%). Yields are dipping lower on the open this morning. The data last week, in the main, showed a little better economic prospects for the Euro area – particularly German data was a touch stronger – and the ECB remains on course for a June rate cut though the path after that remains unclear. The US economic data points to only slightly weaker activity but sticky inflation which points to the Fed pushing out the start of monetary easing until much later this year.

US core PCE deflator rose by 0.3% in March from February, leaving the annual rate at 2.8%, unchanged from February but a touch ahead of estimates. Core PCE is the Fed’s ‘preferred’ measure of inflation and its stubbornness to recede further last month will reinforce views that the Fed needs to hold off on any rate cuts in the near term. Furthermore inflation adjusted real consumer spending rose by 0.5% month-on-month in March, beating expectations, and while headline Q1 US data was weak, household spending was a bright spot, up 0.6% quarter-on-quarter. Combined with a solid labour market, this data all paints a picture for the Fed of households holding up in the face of sustained higher interest rates but that inflation is a bit more persistent than hoped for. The Fed is virtually certain to keep rates on hold at their meeting this week and the market is now pushing out a first rate cut into the final months of this year.

For the ECB, the inflation data on Friday supported the case for beginning easing sooner rather than later. Consumer inflation expectations edged down again in March according to the Bank’s own data. Prices are seen increasing by 3% over the next year, down from 3.1% in February and from a high of 5.8% in October of 2022. Last month’s reading was the lowest since the start of 2022. Price expectations three years out were unchanged at 2.5%. The ECB will get further inflation data this week with the flash HICP for the euro area due. The June meeting remains the key when the Bank will have more data on inflation and wage developments but with each data release, so far, the arguments for a rate cut in June appear to get stronger.

On the agenda today we have European Commission confidence data, German inflation and on the domestic front, Irish retail sales and the preliminary Q1 GDP figure. On the speaker front, ECB Chief Economist Lane and ECB Vice President Guindos are both due.