Kerry Craig

Macroscope | Surprising inflation data lends weight to market hopes of a soft economic landing

Markets are cheering the combination of economic deceleration and disinflation that reflects economies’ resilience in the face of rising interest rates

In particular, US inflation drawing unexpectedly closer to the 2 per cent target suggests an end to rate rises after July, which would support a market rally

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A woman shops at a supermarket in Monterey Park, California, on October 19, 2022. The US disinflationary trend has cut the year-over-year inflation rate by more than two-thirds over the past 12 months. Photo: AFP

Kerry Craig

Published: 4:30pm, 21 Jul 2023

The positive surprises on the growth and inflation outlook have created a Goldilocks tilt to markets, adding weight to the soft-landing scenario being reflected in rising equity indices.

The resilience of the US and global economies in the face of sharply higher interest rates has illustrated just how far economies can bend without breaking. The activity data has hardly been robust, particularly from China and Europe, and does not suggest a re-acceleration in economic momentum, but the combination of weaker growth and lower inflation is being cheered by markets.

The June consumer inflation report for the United States came in better than expected. Prices in the US rose by 3 per cent compared to a year ago, with core inflation, which excludes food and energy prices, rising by “only” 4.8 per cent. While these are still high, they are a marked improvement on last year’s peak inflation rate of 9.1 per cent in June, with core inflation rising by a high of 6.6 per cent for September.

The disinflation momentum in consumer prices was corroborated by the continuing decline in producer prices. The producer price index (PPI) recorded an increase of just 0.1 per cent in June compared to a year ago.

Similarly, the inflation figures out of the United Kingdom surprised by coming in softer than expected for both the headline and core rates. This diminished market expectations of just how far the Bank of England may need to push the official cash rate.

As always, there are many moving parts when it comes to what is driving the change in prices. The comparison of prices over time means it’s not just today’s prices that matter, but where they were a year ago – this is known as the base effect. Often, something that is strongly inflationary in one year will become disinflationary in the following year as there are few products or services that can justify sharply higher prices year each year and the base effect comes into play.

Shoppers pass a souvenir store in Oxford, UK, on July 19. UK Inflation fell unexpectedly to 7.9 per cent in June, after hitting 8.7 per cent in May. Photo: Bloomberg