Weekly focus: Will Fed acknowledge rising inflation risks?

Inflation remains the key theme for markets and a surge in Chinese producer price inflation to 9.0% y/y in May on the back of higher commodity prices added to the inflation scare this week. That said, implied volatilities moved lower across assets ranging from equities and bonds to FX and commodities. Inflation prints in Sweden and especially Norway came out lower than expected in May among other things as the currency appreciation seen over the last six months kept imported inflation low. The lower inflation print in Norway does not change our call for a September rate hike from Norges Bank.

In the third paper in our series on global inflation, we focus on the outlook for euro area core inflation. Overall, we see few evidence that core inflation is about to return to the highs preceding the Global Financial Crisis on a sustained basis. However, we have lifted our euro area core inflation forecast for 2022 to 1.2% (1.0% previously), mostly on the back of higher goods price inflation (see Research Euro Area - Mind the inflation gap).

While markets fear a return of inflation, central bankers continue to stay patient. Despite upgrades to its growth and inflation outlook, ECB continued to maintain its accommodative policy stance at the June meeting, with PEPP purchases still to be conducted at a ‘significantly higher pace’ in Q3 compared to the first months of the year (see Flash: ECB Research - ECB turning risk manager). In the US, the May jobs showed moderate jobs growth paired with rising wage pressures due to labour shortages. However, FOMC members downplayed the risk of a wage-price spiral, seeing the wage increases mostly as transitory and due to the enhanced benefits which are set to expire in early September. The May CPI release added another piece to the US inflation puzzle and showed a further rise in core inflation to 3.8% y/y. That sets the scene for some interesting discussions at the upcoming FOMC meeting on Wednesday, which will be the key focal point for markets next week. We do not expect the Fed to send any significant new policy signals, but updated projections will likely show a first rate hike now in 2023, as more Fed policymakers recently have "started talking about when to talk about tapering".

Apart from the Fed meeting, next week also brings US retail sales for May (Tuesday), which will be monitored closely for any signs that the high US goods demand is starting to peak. In Europe, we keep an eye on the EU-US leaders’ summit in Brussels (Tuesday), where discussions will likely centre on rebuilding trade ties and a solution to the Airbus- Boeing subsidy dispute. US President Biden will likely also try to persuade his allies to take a tougher stance on China at the G7 Summit in Cornwall over the weekend, before he rounds off his European tour with a meeting of Russia’s President Putin in Geneva on Wednesday. We expect Bank of Japan (BoJ) to hold policy rates and its QQE programme unchanged on Friday, but in light of the service sector still struggling with a state of emergency in big parts of the country, the BoJ will likely extend its special programme aimed at channelling money to cash-strapped firms. Apart from ongoing trade disputes with the EU regarding Northern Ireland, the biggest theme in the UK remains whether the grand re-opening on 21 June goes ahead as planned or is postponed for another 2-4 weeks due increasing number of new corona cases. Finally, Chinese retail sales and industrial production should start to mover lower, after strong base effects boosted figures in April.

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