UK inflation unexpectedly rose in February, with record price increases in food, services and core goods for the month
Ahead of tomorrow’s BoE monetary policy announcement, today’s UK inflation figures for February further supported our view that the majority on the MPC will favour a 25bps hike to take Bank Rate to 4.25%. In particular, consumer prices rose a much stronger-than-expected 1.1%M/M – the most in any February since comparable figures begin in the late 1980s – to leave the annual CPI rate up 0.3ppt to 10.4%Y/Y. While this remains well below last October’s peak (11.1%Y/Y), the average rate in the first two months of 2023 (10.2%Y/Y) is now trending above the BoE’s forecast of a drop to 9.7%Y/Y in Q1. Moreover, prices of core items were also up an above-normal 1.2%M/M in February, to leave the annual core rate up 0.4ppt at 6.2%Y/Y, largely reversing the sharp decline recorded in January.

Within the detail, there was a third consecutive monthly decline in energy prices (-0.5%M/M), driven by a further drop in petrol prices. But each of the other major components of the inflation basket posted record monthly price increases for February. In particular, food prices rose a further 1.7%M/M, to take the annual rate of this component to a new series high of 14.3%Y/Y. Core goods inflation also ticked higher (up 0.1ppt to 5.7%Y/Y), with a pickup in clothing inflation offsetting a further moderation in furniture and persisting deflation of second-hand cars as supply constraints continue to ease. But most importantly for the BoE, services inflation jumped 0.6ppt to 6.6%Y/Y. While this remains below December’s peak of 6.8%Y/Y, when excluding the downwards impulse from airfares, core services inflation ticked even higher in February, led by a jump in hospitality to a record-high 12.1%Y/Y, suggesting some evidence of second-round effects of strong wage growth in this sector.

Later this morning, the latest ONS house price figures for January will be released, while the CBI’s industrial trends survey will offer insights into manufacturing conditions ahead of Friday’s flash PMIs.

All eyes on the Fed with a further 25bps rate hike most likely
All eyes today will be on the Fed’s monetary policy decision this evening. While Chair Powell had just two weeks ago suggested that recent stronger than expected economic data meant that a 50bps hike might be on the table at this meeting, the sudden escalation of financial instability in the wake of the failure of SVB and Signature Bank, as well as stress at First Republic, effectively took an accelerated hike off the table. Indeed, given the net tightening of financial conditions that might result from the recent turmoil, it can’t yet be ruled out that policy-makers will pause their tightening cycle to access the economic impact. But with US authorities having taken swift action to try to restore financial stability, the Fed appears free to do what’s required to tame inflation. Indeed, several former Fed Governors have argued that a pause would send a signal that underlying conditions were worse than initially feared and therefore might risk increased financial instability. And markets our now pricing a roughly 80% probability of a 25bps hike today. Certainly, economist colleagues at Daiwa America still expect the FOMC to press ahead with a hike of 25bps in the federal funds rate target range to 4.75-5.00%.

A key focus today will also be the FOMC’s updated economic projections, including its new dot plot. Earlier this month, Fed Chair Powell signalled that the new plot would show a higher level of rates than the December plot, which presented the median FFR forecast for year-end at 5.125%. Despite risks that financial conditions will now tighten significantly, the new plot still seems likely to signal higher rates. Our colleagues in Daiwa America would not be surprised with a median dot for end-23 of 5.625% (i.e. a target range of 5.50-5.75%). However, the range of FOMC member projections might be expected to be significantly wider than in December, reflecting the heightened uncertainty.

Watchers’ Conference to give clues on future path of ECB rates
Following last week’s ECB monetary policy announcement, which offered no guidance on the path of euro area rates ahead, President Lagarde, Chief Economist Lane and dovish Executive Board Member Panetta are all also due to speak publicly in Frankfurt at the annual ECB Watchers’ conference. Lagarde suggested that we might hear a more thorough assessment from her of how recent financial market developments might affect the transmission of monetary policy, which could offer a little clarity on the likely next steps from the Governing Council.