UK inflation again exceeds all forecasts with broad-based intensification of core pressures
Once again, the latest inflation data provided a nasty shock to the BoE, surprising significantly to the upside – and exceeding every single forecast on the Bloomberg survey – to raise the likelihood of further rate hikes into the second half of the year. While headline CPI inflation fell 1.4ppts to a 13-month low of 8.7%Y/Y, that was 0.3ppt above the BoE’s forecast published less than a fortnight ago. And the decline was more than fully accounted for by base effects associated with the jump in energy prices a year ago following the Russian invasion of Ukraine. Indeed, electricity and gas prices alone subtracted 1.4ppts from headline inflation with motor fuel prices also lower. Food inflation also turned down marginally, falling 0.1ppt to 19.1%Y/Y, albeit with prices of such items rising further to cause continued grief for consumers. But all other major components rose.

Government policy contributed to the latest rise in inflation via the first increase in tobacco duty for 18 months. More notably, within the core items, pressures in recreational goods, children’s clothes and second-hand cars among others pushed non-energy industrial goods inflation up by the most in more than a year (0.9ppt) to 6.6%Y/Y. And services inflation rose 0.3ppt to a series high of 6.9%Y/Y, with additional impetus coming from a diverse range of items including telecoms, housing rents, car maintenance and repair, and water and sewerage. So, the core CPI rate also exceeded all forecasts on the Bloomberg survey, leaping 0.6ppt to 6.8%Y/Y. Make no mistake, these are dreadful figures for the consumers and the BoE alike. And so, the MPC now seems more likely than not to keep hiking into the second half of the year.

Reuters Tankan survey signals acceleration in Japan’s economic recovery in May
Consistent with the improvement in yesterday’s flash PMIs – which saw the composite output index jump 2pts to 54.9, the highest since October 2013 – today’s Reuters Tankan survey signalled an accelerated recovery momentum in the middle of Q2. Like with the PMIs, firms in the services sector remained the most upbeat, with the headline sentiment diffusion index up for the third consecutive month in May, by 1pt to 25, matching December’s 41-month high and leaving the average so far in Q2 trending more than 5pts above the Q1 average. Reflecting the ongoing recovery in domestic demand and return of overseas visitors, retailers recorded a marked improvement in optimism, with the respective index up to its highest since ahead of the consumption tax hike in October 2019. Sentiment among construction firms also matched a pandemic high.

Like with the PMIs, today’s survey also hinted at a change of fortunes for the better for Japanese manufacturers. Indeed, the Reuters Tankan index rose 9pts to +6, suggesting that optimists outweighed pessimists in the sector for the first time since December. The improvement was broad-based across sub-sectors, with the index for firms producing precision machinery the strongest for a year, while sentiment in basic materials, oil products, metal products and electrical machinery rose to the highest since December. Admittedly, the respective autos index slipped back slightly in May, down 1pt to 8. But this still left it trending so far in Q2 some 19pts above the Q1 average. Overall, the manufacturing DI was trending 6pts above the Q1 average and was forecast to rise marginally further over the coming three months too.

German ifo business survey to point to further improvement in services
In the euro area, the focus today will also remain on economic sentiment surveys with the publication of Germany’s ifo survey for May. Yesterday’s flash PMIs suggested that conditions in the euro area’s largest member state improved slightly this month, with the sectoral breakdown likely to point to stronger sentiment in services, even if the manufacturing indices point to stagnation or worse.

FOMC minutes in focus today
In the US, today will bring the minutes from the latest FOMC meeting, when the Fed raised rates by a further 25bps but Powell also signalled that it might well be appropriate to pause the current tightening cycle to take stock of the recent tightening of credit conditions. Certainly, the minutes will be closely analysed to see to what extent members supported the decision to signal an impending pause in rate hikes and for further insight into the Committee’s views on whether the current target range of 5.00-5.25% is a sufficiently restrictive level to bring inflation back to target.