European equity markets are expected to open a little higher on Tuesday as traders look toward the CPI data from the U.K. and the U.S. for signs that inflationary pressures are actually returning.
Ahead of the E.U. referendum vote next month, today’s U.K. inflation seems a little insignificant given that in the event of a vote to leave, current inflation levels are likely to have little impact on how the Bank of England responds. Fortunately, while the polls suggest the vote is neck and neck, I think it’s going to be a relatively comfortable win for the “Remain” campaign, at which point the BoE can focus again on returning inflation to target and providing an environment in which growth can accelerate again.
While the CPI number continues to fall short at 0.5%, the core reading which strips out volatile items – most notably energy prices which are still acting as a drag on the headline figure – is at 1.5% which is only just shy of the 2% target. This may be flattered by the weakness in the pound which, in the event of a vote to remain in the E.U., could reverse some of those losses but the trend since it bottomed this time last year has been a gradual rise back towards target. With that in mind, I think the first rate hike from the BoE may come sooner than many think, although as a result of the referendum, we may now have to wait until early next year.
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The U.S. inflation data may be of more interest to traders given that not only is the core reading already above target, the Federal Reserve’s preferred measure also isn’t far off at 1.6%. If we see another month or two of inflation at these higher levels, it may be enough to convince the Fed that it can raise rates again and stick to its plan of raising gradually rather than hold off and risk having to raise sharply.
That said, what the Fed wants to do and what the markets think they will do is two very different things and the central bank is having a tough time getting its message across. Even if we see another uptick in inflation today – core CPI is expected to fall slightly to 2.1% from 2.2% – markets may well just brush this off along with the Friday’s retail sales report and the numerous warnings from different Fed officials.