U.S. inflation slows. Is a rate cut in the cards?

Executive summary:

  • U.S. consumer price gains eased during May
  • The Bank of England could start cutting rates in August
  • Inflation remains subdued in China

On the latest edition of Market Week in Review, Investment Strategist BeiChen Lin and Product Operations Analyst McKenna Painter discussed the latest U.S. inflation data and how it could impact U.S. Federal Reserve (Fed) policy. They also assessed when the Bank of England (BoE) could begin lowering borrowing costs and concluded with an update on economic growth in China.

Encouraging inflation reports suggest Fed may cut rates in September

Painter and Lin began by reviewing the U.S. consumer price index (CPI) and producer price index (PPI) readings for May, both of which were published by the Labour Department the week of 10 June. In both instances, inflation came in softer than anticipated, Lin said—an encouraging sign after a string of hotter-than-expected inflation reports in the first few months of the year.

Starting with the CPI, he said that core consumer prices—which exclude the more volatile food and energy sectors—rose just 0.2% on a month-over-month basis, compared to expectations for a 0.3% increase. Likewise, annual price gains eased to a rate of 3.4% in May—below both consensus expectations and April's CPI reading of 3.6%, Lin added. Meanwhile, the core PPI—which measures what producers pay for their goods and services—came in flat for May on a month-over-month basis, he noted.

“The CPI and PPI numbers are both good news, as they suggest that U.S. inflation is back on a downward trend toward the Fed’s target rate of 2%,” Lin remarked. He noted that the central bank left interest rates unchanged at 5.25-5.50% at its June meeting, with Chair Jerome Powell stressing that the Fed wants to be more confident that inflation is on a sustainable downward trajectory before cutting rates. That said, Lin believes an initial rate cut may not be too far off in the future.

“Based on how the data has been evolving so far this year, I think Fed officials will likely be in a position to deliver the first rate cut of the cycle in September,” he remarked.

When could the Bank of England begin lowering borrowing costs?

Expanding the conversation beyond the U.S., Lin noted that many other developed-market central banks have also seen inflation cool significantly from its peak. This includes the European Central Bank and the Bank of Canada, both of which recently announced initial 25-basis-point (bps) rate cuts in response to easing price pressures, he said.

Lin added that he believes other central banks will follow suit later this year, including the Bank of England (BoE), whose benchmark rate currently sits at a 16-year high of 5.25%. Due to a higher-than-anticipated inflation report in April, he doesn’t expect the BoE to cut rates at its upcoming 20 June meeting, but thinks that a rate cut later in the summer is possible. “May’s inflation report for the UK will be released soon, and if the numbers are in line with or softer than consensus expectations, I think the BoE will be on track to lower rates at its August meeting,” Lin explained.

Ultimately, he said most developed-market central banks will probably be able to start normalising interest rates soon, which would bring down the cost of capital and be welcomed by plenty of investors around the globe.

Is China’s 2024 growth target still attainable?

Painter and Lin finished by unpacking the latest inflation numbers from China, which Lin said came in relatively subdued. Broadly speaking, consumer prices were largely flat on a month-over-month basis, he remarked, noting that this makes the country’s economic growth prospects a bit uncertain. That said, Lin stressed that the Chinese government still appears very committed to achieving its 2024 GDP (gross domestic product) growth target of 5%.

“I believe that in order for China to meet this target, it will need to continue rolling out more stimulus measures. The government has stepped up its fiscal stimulus efforts this year, but I think more still needs to be done,” he stated. The fact that price pressures remain relatively muted means that Chinese leaders have the room to do so, Lin added.

“At the end of the day, I’m cautiously optimistic that China will be able to hit its 5% growth target for the year, but I’ll be watching closely for additional stimulus announcements,” he concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.