The week ahead: all eyes on US inflation and UK labour market data

The focus in the coming week will be on macro data from the UK and the US. Central banks are back in wait and see mode, as rate cut expectations get scaled back. In the most recent Federal Reserve and Bank of England meetings, both central banks asked for time: time to assess the path of inflation to ensure that the disinflation trend that we saw in 2023 lasts into 2024. If that does continue, then the Fed and the BOE are likely to cut rates, but if it doesn’t and prices continue to rise in January after they ticked higher in December, then rate cuts could be off the table. Thus, the data released this week are a bit like a zero-sum game, and that could increase volatility in financial markets and impact risk sentiment in the week ahead.

Looking at the US first, the key releases to watch out for are CPI for January on Tuesday. The market is expecting the annual rate of headline CPI to fall back to 2.9% after ticking higher in December to 3.4%. The monthly pace of inflation is expected to rise by 0.2%. Thus, from a headline perspective, the inflation data is expected to be positive and reinforce the disinflation trend. Core inflation is also worth watching. It is expected to rise by 0.3% in the month, the same rate of monthly growth as December. However, the annual rate of growth for core prices is expected to fall slightly to 3.7% from 3.9%. If that happens that would be positive for two reasons: firstly, it suggests that service price inflation, which is driving the bulk of core price growth in the US, is moderating, since goods inflation is very weak right now. Secondly, it would be the weakest rate of growth since 2021.

Is the US’s disinflation trend in tact?

CPI is not the only inflation measure that the Fed looks at. Core PCE is their preferred measure, and they also look at wage growth to try and determine where inflation will go next. However, if core inflation does fall back in January, even at a time when the labour market in the US is so strong, this would suggest that the disinflation trend is in good shape. However, we still doubt that a decline in the core rate of inflation is enough to spur a rate cut from the Fed in March, and the market now expects the first rate cut to come in May.

The US will also release advanced retail sales for January, which are expected to have cooled compared to December. The headline rate of sales is expected to have fallen 0.2% on the month, while the core rate is expected to rise by 0.2%. Producer prices and consumer confidence data is worth watching at the end of the week, although we believe that CPI could dominate risk sentiment, with a good inflation reading potentially helping the S&P 500 to rally beyond the key 5,000 level.

UK inflation expected to rise

Elsewhere, UK economic data that is due for release this week, could be critical for sterling. The BOE would not commit to interest rate cuts at its February meeting because it wants to see more evidence of a fall in inflation. Central bank speak from the BOE has also been on the cautious side, as, on balance, the BOE remains neutral, and this means that rates could go either way. The unemployment data on Tuesday and weekly earnings report will be scrutinized. The UK economy is expected to have created 50,000 jobs in the three months to December, the unemployment rate is expected to be 4% - this will be the first reading of the unemployment rate since the ONS released revisions to the data, which showed a tighter labour market than initially thought in 2023. Overall, the market is expecting a solid labour market report and there is also expected to be a large moderation in wage growth. The annual weekly earnings ex-bonus is expected to have fallen to 6% from 6.8% in the 3 months to December. This is a large moderation, however, it is worth noting that this decline is unlikely to be enough to get the BOE to cut rates, as a 6% average wage rate does not appear to be consistent with a 2% inflation target.

The UK will also release CPI data for January, and the market is expecting a mixed report. The annual core CPI rate is expected to rise to 5.2% from 5.1% in December, while service sector inflation is expected to rise to 6.8% from 6.4%. The headline rate is also expected to inch up to 4.3% from 4%. This is not the CPI report that you want to see if you are a BOE dove, as it does not support rate cuts. The BOE expects some variation in the monthly CPI reports in the next few months, and inflation is expected to fall sharply due to base effects and a lower energy price cap. However, the rise in core service price inflation is worrying, and is well above the BOE’s 2% inflation target. Service price inflation is the bugbear of most central banks right now, who most likely would cut interest rates if price growth in the service sector wasn’t so strong.

The week will end with UK Q4 GDP and then retail sales. The market expects Q4 to register no growth, with the UK narrowly missing a technical recession. Annual growth for 2023 is expected to be a dismal 0.2%. However, the UK consumer is expected to have started Q1 on a high, with core retail sales (ex-auto fuel) rising by 2%, although on an annual basis retail sales contracted and are expected to have fallen by 1.1%.

Sterling will be in focus this week. It is the best performer in the G10 FX space so far this year, registering gains against all the major currencies, most notably the yen, where GBP/JPY has risen by nearly 5%. GBP Is up by 1.48% vs the euro and is basically flat versus the dollar. The reason is interest rate differentials. The BOE is expected to have fewer rate cuts than the Fed or the ECB this year, and the market currently expects just over 3 rate hikes from the BOE, compared to nearly 5 for the ECB and just over 5 for the Fed. UK interest rates are expected to end the year at 4.38%. However, a strong UK labor market report, especially wage data, combined with higher-than-expected core services inflation could see a further recalibration of rate cut expectations for the BOE, and the interest rate differential with other G10 currencies may widen further. Thus, expect GBP volatility in the coming days.