Respite From Hawkish Pressures
There has been plenty of inflation data over the past week, with relatively small fundamental surprises skewing to the downside. Going against the prevailing narrative, this news had an outsized dovish impact on market pricing. The direct policy news was mixed yet significant, with both central bank decisions surprising consensus expectations. Specifically through a surprise hold in Korea and cut in Indonesia.
UK inflation slightly undershot our below consensus call as airfares were even softer than we assumed. The early index date missed the expensive festive period. Airfares distort core and services inflation even more, but 70% reliably unwinds in January. Meanwhile, the monthly median inflation impulse annualised above 3% again. The BoE ignores airfare distortions when convenient, with the lower outcomes fitting its bias to cut rates again in February. Excessive easing may need reversing in 2026 (see UK Airfares Disinflate Before Christmas).
Headline US inflation aligned with the consensus for December, although the core rate was marginally weaker, challenging the prevailing hawkish Fed narrative. Expectations have been repeatedly marked higher in recent months, with the outcome exceeding most previous vintages, except those made during Q2 2024. Persistently excessive inflation data threatens the Fed’s cutting cycle. However, the US economy is not the hawkish outlier often assumed and embedded in market pricing (see US CPI Excess No Worse Than Peers).
The final Euro area inflation print for December confirmed the headline rise to 2.4%, albeit with energy contributing a bit more, offset by even less from food prices. Germany drove the rise amid much higher package holiday prices this year. Its median increase also remained too high, almost matching the UK's above 3% annualised. December still looks set to be the peak. Falls in the following two months may not be enough to regain the target as services inflation persists at uncomfortable heights (see Inflation Peak From Festive Germany).
UK GDP disappointed the consensus again by only rebounding 0.1% m-o-m in November, continuing the stagnation since the election was called and risking a Q4 contraction. The services PMI’s December upturn suggests the recovery could extend. That would also be consistent with residual seasonality, which has been closely followed in 2024. Recent weakness will help the BoE cut again in February. Reversing this dynamic could make it the last, but we expect another cut in May before hikes return in 2026 (see UK: GDP Scrapes Statistical Bottom).
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Ongoing labour market resilience strengthens the conviction in our long-held view that neutral policy rates are high. Rate cuts outside of a recession are usually reversed. Market pricing aligns with our previously contrarian rate view. As the end of the cutting cycle approaches, pricing should embed the possibility of hikes like in 1998-99. We expect at least the Fed and BoE to hike their policy rates in 2026, with the debate beginning in 2025 and potentially crystalising in a move later this year (see 2025: In Like A Dove, Out Like A Hawk).
Meanwhile, on the political front, Alastair Newton highlighted how political uncertainty in Berlin and Paris has created a leadership vacuum in Europe which will not be filled in the foreseeable future. In Germany, investors are getting ahead of the political reality over prospects for reform of the debt brake. France faces another indecisive legislature election in mid-year as Marine Le Pen looks to pressure Emmanuel Macron into stepping down early (see Europe: Chaos ex Machina).