Market View

Does one swallow make a summer

With schools breaking up for the summer holidays, many families will be hoping that the heatwave which has affected large parts of Europe subsides so they can enjoy their summer breaks. For central banks, red hot price pressures have kept them busy over the past eighteen months.

Jeremy Sterngold
Swallows in a field with sunset

While the earlier base effects of the energy shock fade, headline price levels lower across the major developed market economies. However, the picture for core price pressures is what central banks have been focusing on. Core price pressures (or inflation) are meant to strip out the volatile, more commodity-linked components (food and energy) and thus should provide a better sense of underlying drivers. Given that labour markets remain historically tight, the fear is that higher wage costs lead companies to raise prices to compensate, thus elongating this cycle. 

Just how “core” these price pressures are can be debated, central banks have shown limited tolerance for inflation overshoots. This was the focus of one of our previous pieces. These overshoots do not just impact smaller economies like Sweden, although have a more sizeable impact on those. One of the more notable quotes in the most recent “Beige Book”, a document that seeks to capture economic conditions across various Federal Reserve Districts, noted the following: 

Despite the slowing recovery in tourism in the region overall, one contact highlighted that May was the strongest month for hotel revenue in Philadelphia since the onset of the pandemic, in large part due to an influx of guests for the Taylor Swift concerts in the city.1 

The question for central banks is whether these events offer wider insight into consumer sentiment. Concerts of high-profile artists are a classic case of a supply demand mismatch, whereby demand vastly outstrips supply. In a minority of cases, artists put on extra dates. More generally, these events offer opportunities for ticket touts to capitalise on this mismatch and sell tickets at multiples of their face value. In a broader economic context, booming demand for holidays and other experiences/services in the wake of a pandemic has pushed the service sector towards capacity and this more labour-intensive industry is where wages have been bid up. 

Reflecting further on the US CPI (Consumer Price Index) release last week, one we covered in last week’s brief, shelter costs had been a big part of the stickier core price pressures. Shelter is the largest component of core services, and it has been shown to lag the increases and decreases in rent. The timelier US-based rental index, Zillow Rent Index, shows that rental price growth peaked in the first quarter of 2022 and has been declining since. Going back to the June CPI data, if we stripped out energy, food and shelter, it showed that the rest of basket was flat over the month. On an annual basis, this equated to 2.7%2. Bearing in mind that a lagging indicator has been responsible for a lot of these “core” pressures, this most acutely reflects the concerns of overtightening. With a further 0.25% increase expected by the Fed next week, communication around this and the labour market will be key.

In the UK, not only has the weather been cooler, but after months of inflation running above expectations, this week marked the first undershoot in some time. This took the headline number below 8%3 on an annualised basis. The good news did not stop there as core inflation moved lower too, reflecting a moderation in both goods and services. Given that the previous overshoots led the Bank of England (BoE) to opt for a larger 0.5% increase in base rates, this recent inflation print now brings into question whether they go back to rate increase in 0.25% increments. While they admit that the labour market concerns them, the latest data brings price pressures back in line with the May forecast. In that Monetary Policy Report, the BoE had assumed that rates would peak around 4.75%. Given that they currently stand at 5% and are expected to do more, this means the accompanying report will be critical. For mortgage holders, they were facing the terrifying prospect of locking in rates above 6%, the highest in fifteen years. However, the recent data has seen the expected peak in rates decline below 6% which is set to mean a moderate decrease in mortgage rates. Households across the country will be hoping that this last report offers enough signs for the BoE to take a more cautious approach again in its hiking cycle. In that aspect, they do hope that one swallow does make a summer.   

[1] Source: The Beige Book, The Federal Reserve 

[2] Source: US Bureau of Labor statistics 

[3] Source: Office National Statistics

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