Fed very much the focus this week
Friday’s inflation data in the US were just slightly ahead of expectations but this was enough to more or less convince markets that the Fed will raise interest rates this week, with about a circa 90% chance of a 25bps hike in the federal funds rate (to 3.75-4%) now priced in, up from around 70% before the data. This firming of rate expectations has provided some support to the dollar, which is trading at around $1.1550 and $1.3495 versus the euro and sterling respectively this morning. EURGBP is a little softer at the start of the play at about £0.8560. The Bank of England also announces its latest interest rate decision this week. The market sees only about a 20% chance of a rate increase on Thursday but has fully priced in a 25bps hike at the following meeting in November, so it will be looking for some signal to that effect from the BoE. Finally, the Bank Japan looks set to raise interest rates at its meeting on Friday, the prospect of which has helped boost the yen recently.
Despite some modest respite on Friday, government bond yield rose sharply across the main markets last week driven by rising oil prices and a marked firmed of central bank rate hike expectations. Short-dated bonds saw the biggest rise in yields, of the order of 25-30bps in the 2-year area, with slightly smaller but still substantial increases further out the curve (of circa 20bps or so in the case of 10-year yields). There was some respite for equity markets too on Friday with the S&P 500 and the Stoxx Europe 600 gaining around 0.9% and 0.5% respectively, though both finished lower on the week overall.
The annual rate of headline CPI inflation in the US was unchanged In August at 3.4% according to Friday’s data, in line with the consensus forecast. Core consumer prices (i.e. excluding energy and food prices) rose by a slightly largely than expected 0.3% on the month, though the year-on-year increase nudged down to 2.4% from 2.5% in July – core services inflation was unchanged at 3% but core goods inflation dipped to 0.7% (from 0.8% in July).
ECB member Nagel says interest rates are now “in the upper bound of neutral territory” following last week’s hike in the deposit rate to 2.5%, while he doesn’t exclude “that we have to go into mild restrictive territory” to ensure inflation returns to the 2% target. The market is currently pricing in a further 75bps increase in the deposit rates over the next nine months or so to mid-2027.
Looking to the week ahead, the central bank meetings, especially the Fed meeting, will be the main focus for markets. On the economic data front, labour market (July) and CPI inflation (August) reports are due in the UK on Tuesday and Wednesday respectively, while US retail sales and industrial production (both for August) are scheduled for Wednesday and Friday respectively.