Last week was more favorable for investors after the recent turbulence.
After a difficult start to the year, the financial markets experienced a respite last week. Economic and geopolitical developments have supported asset prices; government bond yields fell, corporate credit spreads tightened, and commodity and stock prices rose.
The first positive development came from inflation data in key G7 markets. In the United Kingdom, headline consumer price inflation fell from 2.6% to 2.5% in December, below the consensus estimate of 2.6%, mainly due to inflation in weaker services – a key indicator for the Bank of England (BoE) – which fell from 5% to 4.4%, well below the consensus estimate of 4.8% and the BoE’s projection of 4.7%. Lower prices for airline tickets and accommodation services were the main factor behind this decline.
The UK’s disinflation trend may be short-lived, however, as a further rise in household energy bills is expected in the spring, which could push inflation closer to 3%, well above the BoE’s 2% target.
However, this may not change the Bank’s plans to cut rates, given growing concerns about the UK economy. Last week also saw the release of monthly GDP, industrial production and retail sales data – all below expectations and strengthening the case for a 25 basis point rate cut by the BoE in February (see Chart of the Week, below).
American disinflation back on track?
Meanwhile, US headline inflation rose 0.4% in December – the fastest monthly rise since March 2024 – bringing annual headline inflation to 2.9%. Energy costs were the main cause, with gasoline prices increasing 4.4% (seasonally adjusted) and natural gas prices increasing 2.4%.
However, overall numbers can be misleading. With energy prices largely beyond the control of the Federal Reserve, investors have instead focused on surprisingly low core inflation. Core prices rose just 0.2% in December, after four consecutive months of increases of 0.3%, marking the first decline in six months. On an annual basis, base prices fell by 2.9%. Cheaper hotel stays, lower increases in medical services and stable rent increases have contributed to this development.
The Fed will welcome signs that disinflation appears to be resuming course after stalling in the second half of the year, although it will remain cautious about potential headwinds, including rising energy prices, the impact of wildfires and forest in Los Angeles on housing costs and tariff-induced price shocks. However, investors were encouraged by the price data and raised expectations for two policy rate cuts in 2025, with the next cut now scheduled for June.
Could US tariffs derail China’s recovery?
-In China, growth has been the main concern recently. The government will therefore be relieved that its policy pivot since September helped the economy grow 5.4% in the fourth quarter, the fastest pace in six quarters, enabling it to achieve its 5.4% growth target. % for 2024.
Estimates suggest that about 60% of the rebound is a result of policies to boost consumption and manufacturing investment, with the rest due to rising export shipments. However, China bears are focusing on the front-end concentration of export orders, warning that momentum could fade in the coming months due to the looming impact of U.S. tariffs.
In this regard, it appears that US President-elect Donald Trump has authorized his new economic team to use tariffs as a tool to negotiate favorable trade deals. However, the new administration faces a difficult balancing act between imposing tariffs and mitigating their impact – particularly on the cost of living.
Current reports suggest a preference for a gradual implementation of universal tariffs, with increases of 2% to 5% per month under the International Emergency Economic Powers Act, which would increase the negotiating power of the administration while avoiding sudden price increases for consumers.
Peace sign
Finally, encouraging news came from the Middle East, with Israeli Prime Minister Benjamin Netanyahu announcing that an agreement had been finalized with Hamas to end the conflict in Gaza.
Outgoing US President Biden has stressed his desire for the truce to permanently end hostilities, saying such a resolution would help stabilize the Middle East as a whole and strengthen diplomatic ties between Israel and the Arab States, including Saudi Arabia.
Chart of the Week: Will the BoE cut rates in February?
Source: Bloomberg, ‘Market implied policy rates,’ as of January 17, 2025. For illustrative purposes only.
