Strong US Inflation Rate to Keep Fed on Hawkish Track
The United States (US) reported strong inflation rate will keep Federal Reserves on a hawkish track, James Knightley, Chief International Economist at ING Economics said in a note.
Reacting to the inflation figure, analysts said that gasoline prices pulled headline inflation down to 8.3% year on year, but it was a smaller decline than hoped as housing, medical costs and vehicle prices lifted the core rate to 6.3% from 5.9%.
This firmly backs a 75 basis point rate hike next week and the market now anticipates a terminal rate in the 4-4.25% range, but there are still strong reasons for inflation to fall sharply, ING Knightley said. READ: Gold Falls as Hawkish Fed Minutes Boost Bond Yields
It was noted that US consumer price inflation has certainly surprised on the upside and heightened the chances of the Federal Reserve hiking to an even higher terminal interest rate.
The markets were looking for headline inflation to slow from 8.5% to 8%, but for lagged effects of house price gains to push up rents and move core inflation to 6.1% from 5.9%. Housing costs were indeed strong with the rental components rising 0.7%, but utility payments also increased 1.5% while new car prices rose 0.8% and used car prices fell “only” 0.1%.
There had been some talk that new models and promotions would have generated a lower figure while second-hand auction prices had pointed to a larger decline. Other goods and services were also firmer than anticipated, rising 0.7% month-on-month with medical care services rising 0.8%.
The 4.6% month-on-month decline in airline fares and the 10.6% drop in gasoline prices were the main area of softness, reflecting broader energy cost declines.
The Fed has more work to do
Clearly, this outcome throws out any talk of the Fed potentially surprising with a 50bp hike next week, but it isn’t calamitous enough to see a big push for 100bp – at the time of writing the market is pricing 80bp, up from around 72bp before the report’s publication.
It also means the Fed won’t be particularly explicit in any guidance following next week’s Federal Open Market Committee (FOMC) meeting. Nonetheless, the breadth and stickiness of inflation pressure has seen the market shift its expectations for the terminal rate up to 4-4.25% from the 3.75-4% range before the release.
“We are going to stick with the 3.75-4% call for December – a 50bp hike in November and a final 25bp move in December”, Knightley said.
But price pressures will subside
On the activity side, the external environment of a European energy crisis, a China slowdown and a strong dollar combined with ongoing interest rate hikes domestically and a slower housing market raise concerns about the growth story heading into year-end.
On the inflation side, analysts feel that the weaker activity backdrop will dampen corporate pricing power and lead to a squeeze on profit margins. Indeed, the National Federation of Independent Businesses (NFIB) survey released this morning suggests, in the small business sector, that inflation pressures are already softening with a clear drop in the proportion of companies looking to raise their prices further.
Furthermore, the drop in both market and consumer inflation expectations is clearly a positive development as it suggests confidence in the Federal Reserve’s ability to get inflation back to target next year and helps to diminish fears of a 1970s-style wage-price spiral.
Officials repeatedly state that expectations remain anchored and there are clear signs of success here. #Strong US Inflation Rate to Keep Fed on Hawkish Track
