A Plague of Inflation
COMMODITY PRICES RISE AGAIN
Rising inflation pressures remain the dominant theme for markets. This week has seen a further sharp rise in commodity prices, led by gas and oil. Gas prices surged in the first half of the week before falling back after Russia offered to boost supplies, while the oil price hit its highest level since 2018. These concerns continue to impact bond markets. Longer-dated bond yields moved sharply higher with 10-year UK gilts reaching their highest level since 2019. US Treasury yields also rose as the September employment report seemed strong enough to confirm a probable announcement in early November by the Federal Reserve that it will start tapering its asset purchases. In contrast, the mood in equity markets has been more upbeat his week. Prices have fluctuated but in a number of cases, markets seem set to end the week up. In currency markets, Sterling performance has generally been mixed. The pound is up modestly against a generally strong US dollar and has risen more sharply against what seems to be a faltering euro. It may be for now at least the possibility of higher interest rates by the Bank of England, in contrast to a continued very dovish monetary policy stance in the Eurozone, is lending support to the currency. Markets remain even more focused than usual on any updates of the future course of monetary policy. The past week has seen much fewer comments from the central bank policymakers than in the previous seven days. However, one notable exception was the new Bank of England Chief Economist Pill. In written comments, he noted that the “current strength of inflation looks set to prove more long-lasting than originally anticipated”, although he also reiterated the currently more typical BoE line that he expected these pressures to eventually prove ‘transitory’. There are further scheduled appearances by Bank of England policymakers next week but none of them look like they will primarily focus on the immediate policy outlook. However, there could of course also be unscheduled comments. A number of US Fed policymakers are also set to speak, including Lael Brainard, who some are tipping to be the next Fed Chair. The minutes of the last Fed meeting may also provide more details around both tapering and the timing of a future hike in interest rates. With less than four weeks now to go until the next set of BoE and Fed updates, both have only a limited window if they want to shift market expectations ahead of the announcement.
US INFLATION TO REMAIN ELEVATED FOR NOW
Given the current focus on inflation, Wednesday’s September update for US consumer price inflation may be the key economic release of the week. The August data provided some tentative indications that inflation was peaking. Annual inflation slipped for the first time this year albeit staying above 5%. However, the recent rise in oil prices points to a risk that inflation may have picked up again in September and the possibility that it will stay above 5% through most of Q1 of 2022. Meanwhile, core inflation continues to show elevated goods price inflation reflecting the impact of rising commodity prices and supply constraints, while services inflation has been more subdued. In August a fall in used car prices, which had previously been one of the biggest contributors to this year’s inflation rise, pushed down goods inflation and it may do so again in September. However, overall core inflation is likely to remain stable and may have edged up modestly. Moreover, near-term trends point to a possible further rise before year-end and remaining elevated at least through the spring. Overall inflation seems, for now, to be continuing to run well ahead of Fed expectations but there is still little evidence that this is causing a shift in expectations that this will be anything but transitory.
UK GDP EXPECTATIONS
In the UK, Wednesday’s monthly GDP data for August are expected to show the economy continuing to grow albeit at a weaker rate than in H1. The July estimate showed growth of just 0.1%, its slowest since January’s lockdown, primarily reflecting various supply constraints. Some analysts suspect that it underestimated the underlying pace of growth and so August could show a slightly bigger gain. However, a fall in manufacturing which seems to be particularly plagued by supply issues is also possible.
The expected August rise would leave GDP only around 1% below its pre-pandemic level. Whether it can move back above that before year-end of course partly depends on how ongoing supply issues continue to play out. Tuesday’s labour market report primarily covers the three months to August. The current forecast for that is for a 250k rise in employment suggesting that the labour market remains buoyant. Unemployment rate is also expected to fall to a new 13-month low of 4.4% and that the level of vacancies in the economy will remain at or close to a record high (of over 1 million).
That all seems to point to reasons for concerns about a shortage of workers with consequent upward pressure on wages. However, over 1 million workers may have re-entered the labour force at the end of September as the furlough scheme ended, and unemployment and inactivity are still some way above where they were pre-pandemic. So, as the BoE has pointed out, the demand/supply imbalance situation in labour market is particularly uncertain at present. Just how it is resolved will be an important determinant of whether wage growth is likely to accelerate sufficiently to add to concerns about inflation. In the meantime, annual wage growth ex-bonuses is expected to have slowed from 6.3% previously to 6.0% but wit should be noted that this probably still contains distortions due to the pandemic that makes the underlying trend hard to gauge.
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