Central bank activity and inflation are not considered exciting dinner party conversation by any stretch of the imagination, although given rising cost of living and fears of mortgage refinancing, these have become a more common topic.
Recently two of the major central banks, the Federal Reserve (Fed) and the European Central Bank (ECB), announced their latest decision. As such, I expected my focus to be around the misnomer of a “hawkish pause” and compare that to the relative outright hawkishness by the ECB. However, the comments from the chief economist for Sweden at Danske Bank, Michael Grahn, on latest inflation print seemed to capture the headlines everywhere, including the title of this article.
Sweden, a country we spend little time discussing in our other publications, has followed a similar path of interest rates to that of the ECB. Even though it started that journey earlier on, policy rates by both central banks now stand at 3.5%. Its housing market has seen some large declines given the rapid shift from the zero/negative interest rate regime. The headlines refer to the inflation data for May, which was released earlier this week. Price pressures were expected to stagnate month over month. However, these increased by 0.3% which may prompt its central bank, the Riksbank, into further rate increases. Looking through the detail of the release, it showed a large jump in restaurant and hotel prices over May, rising by 3.3% in that month alone. This led Mr Grahn to suggest that the Beyonce concerts in Stockholm led to most of this increase given the spike in demand for accommodation and restaurants during that period.
At first glance this headline can be seen a bit as clickbait. I don’t think many people in our industry, or indeed the wider public, were very familiar with Mr Grahn before this week. However, given other information available from other bodies, it does appear that fans from around the world flew in and pricing algorithms captured this demand who were clearly less price sensitive. A rather remarkable development, but Stockholm is a city with a population only of around one million people. Hence, by having two concerts with the attendance for each being 46,000 on a global sold-out world tour seems to have skyrocketed demand. As such, one would expect the trend to reverse the following month. This quirk is also unlikely to be seen in larger markets given Sweden’s relatively small population.
However, as we commented on in our prior brief, central banks seem to have lost patience and want to ensure their credibility is not brought into question. This raises the concern that they are at risk of overtightening if they respond to one-off price shocks. The term “transitory” seems to have quickly become banned in the central banking community. Furthermore, we can argue the notion of the “hawkish pause” by the Fed is an act to retain flexibility should it feel its credibility is under question. In prior hiking cycles, once paused they would keep rates at those levels for some time. This time around they indicated some expectation of future hikes with large caveats around that.
The UK market seems to have been impacted by recent upward surprises in labour and inflation data. We have now seen rate expectation move closer to 6% towards the end of the year, relative to the 5% following the previous Bank of England (BoE) meeting. This suggests the market is pricing quite a bit more ground to cover. Would following this market pricing represent a sensible response? Perhaps by digging deeper into recent inflation data, we can get a better view.
“Can you pay my bills? Can you pay my telephone bills? Do you pay my automo’ bills?”
From Bills, Bills, Bills by Destiny’s Child
In the UK, the release of April inflation data is one print that requires close attention. It is the month we see our phone contracts and water bills rise based on historical inflation data. Furthermore, looking back through history, most increases in rent prices are reflected in the April print. Taking it all together, a lot of upside surprises in the last print were due to calendar effects of contractual price increases, not something one should extrapolate. However, the strength of the labour may mean that as long as price measures remain elevated, this may result in elevated wage pressures for longer. Something BoE governor, Andrew Bailey, has become more vocal about in recent times. While a 0.25% rate hike is expected next week, the prior inflation release could have a larger impact. As such, we should expect tightening beyond this to become more sensitive to incoming data.
All in all, while the odd quirk that is the Beyonce effect seems valid, the state of the labour market means the tolerance for these from central banks has diminished.
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