What US inflation shock means for markets, politics and the UK

It’s been a lively day in global markets as traders from both sides of the Atlantic reacted to a dire set of inflation data in the world’s largest economy.

The US consumer price index (CPI) jumped 3.5 per cent last month, according to figures released yesterday from the Department of Labor. That’s up from 3.2 per cent in February and higher than the 3.4 per cent Wall Street economists had forecast for March.

Even more worryingly, core inflation – which removes volatile items including energy and food and is considered a better indicator of underlying inflationary pressures – also rose by more than expected last month, to 3.6 per cent. 

The data has all but destroyed hopes that US central bankers would start cutting interest rates as early as June. This, in turn, has triggered a sell-off in financial markets.

Shares fell in New York today while US government bond yields rose sharply. The yield on the two-year Treasury note – which, as Anthony Peters writes in Reaction, is regarded as the yellowest canary in the interest rate coal mine – shot up to levels not seen since last November. 

Prior to yesterday’s release, markets were expecting the Fed to start cutting rates this summer. Today, there has even been talk of things going in the opposite direction – with former Treasury Secretary Larry Summers suggesting rates could rise again before they fall.

Anthony Peters is dubious. There is no need for more tightening unless core inflation pushes back above four per cent, he argues. And a rate hike makes little sense when you look at the factors now overwhelmingly driving these stubborn inflation figures: a jump in fuel and housing rental costs. “Will higher rates make a difference to the price of fuelling the car? No. Do rents come down when the cost of financing a property goes up? You’d have to be joking,” says Peters. 

America will probably avoid further rate hikes. But the start point of easing will likely come later – in the Autumn as opposed to early summer. 

Which is bad news for Biden. The US president would have been hoping to squeeze in as many rate cuts as possible before November’s elections, citing them as progress of America’s strong economic recovery. 

Hence his rival Donald Trump’s overexcited, cap-lock-heavy new post on Truth Social: “INFLATION is BACK—and RAGING!” 

On this side of the Atlantic, there is a very real threat of knock-on effects. 

In Britain, after a bumpy ride to say the least, inflation has fallen steeply in recent months to 3.4 per cent, raising hopes that it could drop below the Bank of England’s target of two per by as early as May. And some economists have factored in a first interest rate cut as soon as June. 

Now, discouraging US inflationary patterns are prompting speculation that a delay in the Fed’s rate cut will result in UK borrowing rates languishing at their 16-year high – of 5.25 per cent – for longer than previously forecast. 

Of course, the Bank of England is under no obligation to follow the Fed. But the Fed’s decisions do impact the value of currency. Higher interest rates in the US lead to a stronger dollar, which, in turn, puts upward pressure on inflation in the UK, requiring a more hawkish position from Britain’s central bankers. 

That said, perhaps Britain’s central bankers should take some encouragement in the fact that their European counterparts don’t appear too fazed by the gloomy US data. 

The ECB opted to hold rates again following its meeting this afternoon. However there was no indication from President Christine Lagarde’s statement that the Bank is shying away from its prior plans to start cutting rates as soon as June.

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