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While headline inflation continued its downward trend in March, a smaller than expected fall reconfirms the message from yesterday’s pay data, suggesting that the BoE should wait until August to begin cutting rates.
Headline CPI growth printed at 3.2% YoY last month, above the 3.1% expected by both markets and Bank staff, and coming in just 0.2pp below the February reading. Granted, the small upside misses to both inflation and wage data this week are unlikely to produce significant forecast revisions in next month’s monetary policy report. But the broad signs of stickier than expected inflation visible across all of this week’s data so far warrants a degree of caution from the MPC, and likely a somewhat more hawkish tone from policymakers than was seen in March. All told, markets have broadly reached a similar conclusion too. The implied odds of a June rate cut now stand at just 25%, having been close to 75% just one week ago.
Looking through the details of today’s report, it is not just headline figures that will likely give the MPC pause for thought. Core CPI growth also fell to 4.2% YoY in March, down from a prior reading of 4.5%, but this again overshot expectations that had looked for a drop to 4.1%. Similarly, the services reading closely watched by the MPC eased only marginally last month, dropping 0.1pp to 6.0% YoY. Not only was this 0.2pp above consensus expectations, but it exceeded BoE forecasts by a similar margin. It is also in keeping with the strength seen in February’s average weekly earnings data for private sector regular pay.
As we noted yesterday, with this having printed at 5.9% YoY, it now looks like a stretch for wage growth on this measure to cool sufficiently to hit Bank staff forecasts for 5.7% 3m/YoY for Q1.
It also suggests that price growth is likely to remain sticky in wage sensitive services inflation in the coming months, particularly with April’s rise in the National Living Wage on the horizon for employers and workers alike, with this set to filter through wages between March and June based on the announced timing of wage rises from major employers. Given these dynamics, it is not surprising to see that price increases were once again notable across restaurants and hotels, up 1.1% MoM in March, and recreation and culture, which recorded increases of 0.9%. To us, this looks like an effort by employers to pass on increased wage costs in advance of the National Living Wage rise. These rates of increase are likely to cause concern amongst the MPC come May, even as base effects mean that both sub-indices will ultimately drop in year-on-year terms.
That said, there is some good news on the horizon for policymakers. We see little reason that inflation across all measures should not continue falling in the coming months.
Headline price growth is set to benefit from energy base effects which will see the rate of price growth fall to roughly 2% in the April figures. Meanwhile services CPI should also ease, albeit more slowly. Signs that labour market pressures are beginning to cool will eventually weigh on wage growth and therefore price increases in upcoming releases, especially from June onwards as the impulse from April’s NLW rise begins to fade. We think this should see the BoE ease rapidly in H2 in line with our long-standing call, even if this is not a focus for policymakers and traders just yet. For the time being, however, with FX markets fixated on the degree of divergence from the Fed and the data corroborating our view that the BoE is unlikely to cut until August, this should see GBP trade more defensive in the next wave of dollar appreciation, resulting in GBP upside on crosses like GBPEUR and GBPCAD.
Author:
Nick Rees, FX Market Analyst