Did the Fed’s preferred inflation gauge ease last month?

Did the Fed’s preferred measure of inflation ease off in July?

The US Federal Reserve’s preferred measure of inflation, the core personal consumption expenditures (PCE) price index, is expected to have cooled in July, following last month’s lower-than-expected consumer price index figures and an unexpected decline in producer prices.

Consumer price growth and producer prices eased in July largely because of lower petrol prices, and Friday’s PCE report is likely to follow that inflation trend.

The core PCE index — which strips out volatile food and energy prices — is forecast to have increased 0.3 per cent from a monthly gain of 0.6 per cent in June, according to economists polled by Reuters.

“Weakness in prices of medical services, airfares, and financial services in July’s PPI notably lowered the translation of July PCE prices from what we had pencilled in after the July CPI,” said UBS analysts in a note. They forecast core PCE inflation to fall to 4.5 or 4.6 per cent from an annualised rate of 4.8 per cent in June.

PCE rose more than expected to an annualised high of 6.8 per cent in June, dashing hopes that headline inflation peaked at 6.6 per cent in March. High petrol prices likely contributed to the worse than expected headline figure, but the core figure jumped to 4.8 per cent in June from the previous year, up from 4.7 per cent in May.

The headline PCE reading has been susceptible to substantial moves this year, given the volatility of the energy and food sectors that has been exacerbated by the war in Ukraine.

Fed governor Christopher Waller said in a speech on July 14 that he expects monetary policy to be restrictive until there has been a “sustained reduction” in the core figure.

The Fed raised its benchmark interest rate by 0.75 percentage points for the second consecutive month in July to tackle inflation. Minutes from the July meeting show Fed officials are planning for more rate increases at future meetings. Alexandra White

Did eurozone business activity decline further last month?

The gloom surrounding the eurozone economy is likely to deepen on Tuesday, when a benchmark survey of businesses is expected to reveal a further decline in orders, output and confidence.

While tourism and hospitality related services have been boosted this summer by the lifting of most coronavirus restrictions, the benefits of this are expected to be cancelled out by a rising number of countervailing factors. 

Russia is squeezing natural gas supplies to Europe, Italy is in the grip of political turmoil and record inflation is eroding household spending and business investment, convincing many economists that the eurozone is heading for recession.

Jessica Hinds, senior Europe economist at Capital Economics, said in a note to clients last week that the economic benefits from easing pandemic restrictions “appear to be fading already and the headwinds to growth are building”. 

S&P Global’s flash eurozone composite purchasing managers’ index is expected to confirm this downbeat outlook on Tuesday, when its reading for the eurozone is forecast to drop from 49.9 in July to 49.5 in August.

This would be the second consecutive month that the index has dropped below the crucial 50 mark that separates growth from contraction — something that until July had not happened in the eurozone since early last year.

“We have had a recession in our central forecasts for a while; this is to say a technical one in the third and fourth quarters,” said Claus Vistesen, chief eurozone economist at Pantheon Macroeconomics, who expects a steeper fall in the eurozone PMI reading to 48. “We think the eurozone economy is now in recession. Germany, at the very least, is.” Martin Arnold

Why haven’t expectations of higher interest rates boosted the pound?

Inflation in the UK reached a 40-year high of 10.1 per cent in July and the rapid pace of price growth has prompted expectations of more aggressive interest rate rises from the Bank of England. 

Higher interest rates tend to boost a country’s currency, as they support foreign investment and demand for a currency relative to those from countries with lower rates. 

But since the latest UK consumer price index data release on Wednesday, sterling has slipped roughly 1 per cent against the dollar.

The pound is down more than 10 per cent against the dollar this year and just under 1 per cent against the euro, despite the European Central Bank only raising rates out of negative territory in July. 

Some analysts say the pound’s poor performance can be attributed to the UK’s gloomy economic outlook. The BoE forecasts the UK will soon enter five quarters of recession. A decline in gross domestic product would, theoretically, lower the appeal of the pound relative to other currencies.

“The currency is dribbling lower because the market sees a negative growth impact [from higher rates],” said James Athey, investment director at Abrdn. “Sterling is latching on to the growth outlook rather than the rate outlook.”

The July CPI data sparked a sell-off in short-dated UK gilts, which are sensitive to interest rate expectations, as the yield on the debt instruments reached heights last seen in 2008. Bond yields rise as their prices fall.

The pound’s weakness has raised questions about the UK’s longer-term economic health.

“Rising rates and a falling currency are more often seen in emerging markets than in developed markets and it possibly [suggests] markets [are] questioning the credibility of UK policy in the longer term,” said Adam Cole, chief currency strategist at RBC Capital Markets. 

The likelihood of more fiscal spending to battle the cost of living crisis, increasing the UK’s borrowing, is likely to drag further on the pound, Cole added. Ian Johnston