Inflation in the US came in slightly below expectations at 4.9% in April, offering a boost to investors’ views that the Federal Reserve is close to its goal of bringing prices under control, and may safely pause its cycle of rate hikes.
But the slow decline from last month suggests the remaining phase of the battle with inflation may prove to be the toughest.
The Consumer Price Index had been expected to land in line with last month, when inflation was an unexpectedly low 5.0%.
Core CPI - which excludes volatile food and energy prices - dipped slightly to 5.5%, in line with expectations but perhaps showing that, after good progress to slow price rises from their peak last year, the remaining part of the fight against inflation will be the most difficult.
“The inflation deceleration simply isn’t fast enough to justify current market expectations for rate cuts later this year,” Seema Shah, chief global strategist at Principal Asset Management, said.
The reading comes as markets widely expect the Federal Reserve to pause its current cycle of interest rate hikes, which are intended to bring inflation down to its 2% target but have created havoc for a number of the country’s mid-sized lenders. Last week, First Republic joined Silicon Valley Bank and Signature Bank as the latest casualties of the worst banking crisis since 2008.
Richard Flynn, managing director of Charles Schwab UK, said the continued progress is proof that the Fed has been successful in bringing prices under control.
“Today’s fall in the rate of inflation is likely to be welcomed by investors, who may speculate that the Fed's tightening in monetary policy appears to be working. Tighter credit conditions for households and businesses are now weighing on economic activity and inflation. The aggressiveness of the rate increases has put increasing pressure on the banking system, with three of the four largest bank failures occurring just in the past couple of months.
Yet while investors believe the Fed has signalled its plans to pause, New York Fed president John Williams yesterday warned against assuming the central bank had made up its mind.
“We haven’t said we are done raising rates,” he said.
Williams may point to April’s jobs report as a reason to consider a rise, as the labour market continued to confound expectations with 235,000 new jobs added, thoough others argue the continued strength of the jobs market shows that a ‘soft landing’ may still be possible.
But - as OANDA senior market analyst Craig Erlam points out - further rate rises will only mean more strain for regional banks.
“The central bank has made it perfectly clear that returning inflation to target over the medium term remains the primary goal whatever the cost but we’ve now likely entered the uncomfortable period in which things are breaking, credit conditions are tightening considerably but the data isn’t quite there yet,” he said.
At the same time, the US economy will face looming questions about the possibility of default amid a standoff over the country’s debt ceiling. Past standoffs have been resolved without default and markets still see the possibility of debts going unpaid as extremely low.
“It would be an act of gross stupidity by Republicans and Democrats alike to let America suffer a ninth government shutdown, let alone default, and as such it seems likely the debt ceiling will be raised for the forty-seventh time since 1980,” AJ Bell investment director Russ Mould said. “But even if common sense does break out, the question of how America will fund and manage its debt going forward will remain.”
But the serious implications of a default will mean investors won’t be ignoring the slim possibility the debt ceiling debate remains unresolved.
“The big worry is that if lawmakers do not crawl back from the precipice and America defaults, stresses in financial markets could turn into a seismic shock,” Susannah Streeter, head of money and markets at Hargreaves Lansdown, says.
