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The Future of Inflation Remains Uncertain

ECONOMYThe Future of Inflation Remains Uncertain

It is now possible that this year, the Federal Reserve (Fed) may not cut interest rates, aligning in this respect with the actions of Poland’s National Bank (RPP). However, this is not yet the base scenario for the Fed. Meanwhile, Poland maintains the highest interest rates among European countries.

Based on December expectations, we should have already experienced the second consecutive rate cut by the Fed this year. However, investors are increasingly wondering whether there will be any rate cuts at all this year. This is due to a series of inflation data publications that did not show the further expected decrease, particularly in the service sector. For three consecutive months, inflation in the USA has been rising at a rate higher than analysts anticipated.

The Fed has just emphasized the lack of further progress in combating inflation, and at the moment, this signals a lack of expected rate cuts in the foreseeable future. Hence, the market is not short of opinions about a “hawkish pivot” that Fed Chair Jerome Powell is said to have made.

The Fed had set such a firm course for cuts in December that any change now would be a reluctant admission of error.

– The Fed is in a situation where it is caught between the scenario outlined by the Federal Reserve Chairman at the December meeting, where he claimed that inflation had been conquered without negative effects on the economy, and this year’s economic data, which now do not fit this vision, says Dr. Przemysław Kwiecień, chief economist at XTB, in a conversation with MarketNews24. – However, I expect that if the next economic data turns out to be better, the Fed will eagerly return to the narrative of interest rate cuts.

The April reading of the ISM indexes for American industry was among the uglier ones. Why? Until now, the market narrative was that the economy was doing fine despite high rates, and inflation would fall further when the Fed cuts rates. Hence, such high valuations for many companies (PE > 30). Now it may turn out that high rates are beginning to harm the economy, and the Fed does not have room to cut them. This was approximately shown by the ISM, i.e., weak orders (not dramatic, but a day after the absolutely tragic Chicago PMI) and a further and significant rebound in the price component.

So far, macroeconomic data has been somewhat ambiguous. Some showed a rather surprising economic rebound. However, now matters are getting complicated because cuts are becoming more distant, and the last thing markets want to see is weak data at the same time. To weak activity indicators, data on consumer sentiment has joined, which in terms of expectations fell to post-COVID lows. Could it be that high rates are finally starting to leave their mark?

– The Fed is very closely monitoring labor market data, and that’s because it’s the labor market that shows with the greatest delay whether something bad or good is happening in the economy, comments an XTB expert. – The data from the US economy is not bad, but it may still turn out that the price to be paid for fighting inflation will be a recession.

Reducing the quantitative tightening (QT) program is a step towards easing (the Fed will reduce QT from 95 to 60 billion USD per month). However, this move has been communicated since the beginning of the year. The Fed had already suggested that this could bring the balance sheet total even lower. And since cuts are not yet on the horizon, this sounds even credible.

In this situation, European banks become somewhat isolated in the perspective of interest rate cuts. The Swiss Bank and the Bank of Sweden have already made cuts, and the ECB has announced such a decision for June. The Bank of England has just communicated readiness to cut interest rates also in June.

Although inflation data from Europe for April turned out to be slightly higher than expected, the ECB is likely not to change its mind. However, if there is a perspective of maintaining pressure in service inflation, this cut may be “signal” and not immediately followed by others.

– The ECB usually tried to copy what the Fed did, but it is now almost certain that now it will go its own way, assesses P.Kwiecień from XTB. – There is now hardly any sense for the ECB to be fixated on what the Fed will do.

For now, however, it seems that between the Fed and the ECB we have continental drift, which should favor declines in the EURUSD pair and will be a factor not necessarily good for the złoty. The receding decision about cutting interest rates in the USA is favorable for the dollar. At the same time, it should be unfavorable for gold prices, which have significantly risen this year.

– I expect that this year the RPP will not cut interest rates, however, the Fed may still decide on a cut, especially significant have become falling oil prices, which may be decisive – summarizes the expert. – It will be important for oil prices to be below 90 USD per barrel. Poland currently maintains the highest interest rates among European countries (excluding, of course, Russia or Turkey). Moreover, also in terms of the real interest rate, Poland is among the leaders, not only in Europe but also globally.

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