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US inflation data on Wednesday will give investors an indication of how far shockwaves from the Iran war are reaching into the world’s biggest economy.
Economists polled by Bloomberg expect the consumer price index to have risen at an annual pace of 4.3 per cent in May, the fastest rate in more than three years.
But they do not expect surging energy costs to have fed into core inflation, which strips out volatile food and energy prices and which is seen holding steady at 2.9 per cent.
“We continue to think that softer consumer demand with slowing real income will limit the pass-through of higher energy prices to core inflation,” said Citi economists Veronica Clark and Andrew Hollenhorst.
They said headline inflation was in part skewed by rising prices of equities and of computer software and accessories related to AI-demand, rather than everyday goods and services.
They added that, while it was unclear how markets would react to diverging signals on inflation, the Federal Reserve typically uses its policy rate to address tightness in the housing and labour markets, which are not drivers of current inflationary pressures.
Samuel Tombs, chief US economist at Pantheon Macroeconomics, said a tempering in core inflation would reduce the likelihood of interest rate rises during 2026. Markets are currently pricing in one quarter-point rate rise by the end of the year.
May’s data, Tombs said, “should be reassuring enough for most [Federal Open Market Committee] members to signal that the funds rate should be left on hold through the rest of this year”. Michelle Chan
How hawkish will the ECB be?
Traders view it as a near-certainty that the European Central Bank will raise its benchmark interest rate by a quarter point to 2.25 per cent on Thursday, the first rise in nearly three years, as it responds to price pressures fuelled by the Iran war.
Inflation rose to 3.2 per cent in May, above the 2 per cent medium-term target, and ECB chief economist Philip Lane and executive board member Isabel Schnabel have in recent weeks prepared the ground for a possible rate rise with warnings about inflation.
The question on investors’ minds is how hawkish the central bank will be in its commentary accompanying the rate decision, given that the energy shock is also a headwind to economic growth and any rise in borrowing costs will only make that worse.
Goldman Sachs analysts think ECB president Christine Lagarde could repeat her phrase that higher oil prices require “some measured adjustment” in the bank’s stance. But they do not expect specific guidance on where rates will go and will instead “look for her to reiterate that the [rate-setting] council wants to see more data and does not need to rush”.
With swaps markets implying a further one or two quarter-point increases to the policy rate by the end of the year, on top of one next week, it would be difficult for the ECB to “outhawk” the market, said analysts at Nomura.
Although the ECB’s growth projections are likely to be revised down, and inflation to be revised up, Lagarde “will likely want to deliver as neutral a message as possible”, they added. Ian Smith
Is the energy shock catching up with the UK economy?
UK GDP data on Friday will offer investors their latest glimpse of how the economy is dealing with the energy shock triggered by the conflict in the Middle East.
Economists polled by Reuters expected GDP to have contracted 0.1 per cent in April, after growing 0.6 per cent in the first quarter of the year.
While the economy has been fairly resilient so far, unofficial data shows the drag starting to come through.
“Survey data have turned sour, reflecting the ongoing rise in the cost of living and the cost of doing business,” wrote Sanjay Raja, chief UK economist at Deutsche Bank, adding that an “inevitable” wave of inflation “will squeeze real disposable incomes”.
He expects “tepid” GDP growth for the rest of the year.
Lingering in investors’ minds, too, are political risks, as Greater Manchester mayor Andy Burnham prepares to challenge Sir Keir Starmer for the job of UK prime minister.
“We think political uncertainty will rear its head again later this year, adding to economic uncertainty,” wrote Raja.
Traders are almost unanimously expecting the Bank of England to hold interest rates steady at 3.75 per cent at its meeting this month. Further into the year, though, investors remain divided on how many rate rises the central bank will need to deploy to keep inflation under control, with less than two quarter-point moves priced in by the end of the year.
Weaker than expected growth data could tip the balance. Emily Herbert
