Inflation’s Cooling In The US And UK

Here are some of the biggest stories from last week:

• Wage growth in the UK eased slightly last quarter but remains elevated.
• UK inflation cooled significantly, to a two-year low.
• US inflation fell by more than expected, sending the US dollar tumbling on Tuesday.
• China's consumer spending and industrial output exceeded expectations.
• Japan’s economy contracted more sharply than anticipated in the third quarter

Dig deeper into these stories in this week’s review.

UK

Despite an economic slowdown, Britain's labor market remained resilient in the third quarter of the year, highlighting the challenge for the Bank of England in its efforts to control inflation. Average annual growth in regular earnings, excluding bonuses, was 7.7% in the three months to September, down from a peak of 7.9% two months earlier. Annual growth in total pay, which hit a record high of 8.5% in July, slowed to 7.9%, but that was still well above the 7.3% that economists had expected. Although wage growth eased, the pace of gains in regular and total earnings was still among the highest annual growth rates since comparable records began in 2001. What’s more, the unemployment rate held at 4.2% in the third quarter, defying the BoE’s expectations for a steady drift higher.

The labor market report also showed real regular pay (what workers take home after inflation) rose 1.3% in the three months to September – the fastest increase in two years. This means wages are now growing faster than living costs, which could fuel the BoE’s concerns that it hasn’t yet fully broken the wage-price spiral feeding inflation across the economy. This is where rising prices of goods and services push employees to demand higher wages, which leads to increased spending and higher inflation. This only gets worse as companies raise the prices of their goods and services to offset higher wage costs.

But some of those fears were put to bed this week after new data showed UK inflation sank to a two-year low. Consumer prices rose by a less-than-expected 4.6% in October from the same time last year, down sharply from September’s 6.7% gain and the slowest pace since 2021. The big drop was mainly driven by lower food and energy prices, but even core inflation, which excludes these two volatile components, slowed more than expected to 5.7% last month from 6.1% in September. What’s more, services inflation, which is closely watched by the BoE as a guide to domestic price pressures, also retreated further than expected from 6.9% to 6.6%.

The data added to the markets’ conviction that the BoE has concluded its rate-hiking campaign, with the interest rate futures market fully pricing in a total of three 0.25 percentage point reductions in 2024 (with the first cut in June). The BoE, for its part, wants to see conclusive evidence that price pressures and the labor market have cooled before it contemplates easing borrowing costs. After all, inflation is still running at double the central bank’s 2% target, with economists not expecting the pace of price gains to reach that goal until 2025.

US

Across the pond, new data this week showed US inflation cooled by more than expected in October, declining for the first time in four months. Consumer prices rose by 3.2% in October from a year ago – slightly lower than the 3.3% expected by economists and a marked declaration from September’s 3.7% pace. Core inflation, which strips out volatile food and energy prices to give a better idea of underlying price pressures, was slightly weaker than economists had forecast too, dipping from 4.1% in September to 4.0% last month. On a month-over-month basis, headline and core inflation came in at 0.0% and 0.2% respectively. Both of these figures also came in slightly better than expected.

The better-than-expected CPI report came as welcome news to investors, who had been concerned that robust economic growth might hinder the slowdown in inflation. But despite some bumps in recent months, inflation has come down substantially from the 41-year high reached in 2022. That’s pushing investors to become increasingly confident that interest rates have peaked after the Fed held them steady at a 22-year high earlier this month. Case in point: traders moved to assign a virtually zero chance of another rate hike in December following the CPI data, while also moving up bets of when the Fed will first cut rates to May or June, compared to July before the report. That sent the greenback tumbling by the most in a year, with the Bloomberg Dollar Spot Index falling as much as 1.3% on Tuesday.

Asia

China's consumer spending and industrial output grew more than expected last month, providing a much-needed boost to the world’s second-biggest economy as it contends with a property market slump, sluggish trade, and an uneven recovery from the pandemic. Retail sales expanded by 7.6% in October from the same time last year, beating forecasts of 7% and up from September’s 5.5% increase. Industrial production, meanwhile, grew by a better-than-expected 4.6% – its quickest rate since April and a slight uptick from September's 4.5%.

But take those numbers with a small pinch of salt: they looked good on a year-over-year basis due to comparison with depressed figures from 2022, when the economy was struggling with the final stages of China’s restrictive zero-Covid policies. What’s more, October this year captured the week-long Golden Week holiday period, during which many Chinese traveled around the country and shopped. That could explain why, despite the seemingly strong figures, the Chinese central bank injected the most cash into the economy since 2016 through its medium-term lending facility on Wednesday, in a bid to support funding for growth.

Elsewhere, Japan's economy shrank more than expected in the third quarter, highlighting the vulnerability of its post-pandemic recovery and complicating the central bank's plans to slowly phase out its monetary easing measures. The Japanese economy contracted at an annualized pace of 2.1% last quarter from the one before – much deeper than estimates of a 0.4% fall. The decline, which was the steepest since early 2022, mainly came down to weak consumer spending, falling business investment, and higher imports.

The summer's economic slowdown is likely to further complicate the BoJ’s already difficult task of transitioning away from decades of ultra-loose monetary policy. Persistent higher inflation and a weakening yen, which after decades of deflation has proven more persistent than expected, are intensifying the pressure on the BoJ to scale back its easing efforts. Last month, for example, the central bank made a notable move towards ending its seven-year policy of capping long-term interest rates, announcing that it would allow the yields on 10-year Japanese government bonds to exceed 1%.

Next week

• Monday: Earnings: Zoom.
• Tuesday: Minutes of the Fed’s latest meeting, US existing home sales (October). Earnings: Nvidia, Baidu.
• Wednesday: US durable goods orders (October), eurozone consumer confidence (November). Earnings: Deere.
• Thursday: Japan inflation (October), eurozone and UK PMIs (November), minutes of the ECB’s latest meeting.
• Friday: US PMI (November).