USD holds on to gains driven by inflation fears from Trump’s tariffs

USD: Evidence of inflationary impact of tariffs helps to lift USD

The US dollar has continued to trade at stronger levels after extending its recent rebound yesterday following the release of the latest US CPI report for June. US dollar gains have been most evident against the yen amongst the FX majors lifting USD/JPY back above up above the 149.00-level as it moves closer to the 150.00-level ahead of this weekend’s Upper House election in Japan. The US dollar has strengthened despite the fifth consecutive monthly downside surprise for core inflation which increased by 0.23%M/M in June coming in below the Bloomberg consensus forecast of 0.3%M/M. Instead market participants have focused more on evidence in the CPI report showing that higher tariffs are beginning to lift goods prices. Core goods prices excluding autos increased by +0.5%M/M in June which was the biggest monthly increase in three years. Unsurprisingly the biggest price increases were for goods that are mainly imported such as appliance prices which jumped by 1.9%M/M, sports equipment prices up 1.8%M/M, toy prices up 1.8%M/M and video & audio product prices up 1.1%M/M. The inflationary impact of tariffs is expected to increase further in in next month’s CPI report for July. The outlook for inflation beyond is more uncertain as we wait to see whether President Trump will follow through on plans to impose higher “reciprocal” tariffs from 1^st August. In contrast, core services inflation remained more modest increasing by +0.25%M/M in June. Fed Chair Powell’s favourite measure of core services inflation excluding shelter similarly increased by +0.21%M/M. It is too early to expect higher prices from tariffs to feed through significantly into service sector inflation. There was also good news showing that shelter inflation continued to slowdown meaningfully increasing by just +0.18%M/M.

Overall, the report suggests that the Fed’s preferred measure of core inflation the core PCE deflator is likely to have increased by +0.4%M/M in June although that estimate could change depending on the release of the PPI report for June. Building evidence of the pick-up in inflation from tariffs supports the Fed’s caution over resuming rates cuts in the near-term despite the barrage of criticism from the Trump administration. Chair Powell has already signalled clearly he wants to wait to assess incoming data in the coming months to better assess the economic outlook for the US economy. A rate cut as soon as later this month was already judged as off the table after the stronger NFP report for June, but there are now more doubts over whether the Fed will cut rates at the following meeting in September especially if President Trump follows through with plans for higher “reciprocal” tariffs on 1^st August. On that front, President Trump announced yesterday that another trade deal has been reached with Indonesia. Under the trade deal imports from Indonesia will be subject to a 19% tariff down from the 32% rate threatened in last week’s letter. Indonesia has also agreed to purchase USD15 billion in US energy, USD4.5 billion in US agricultural products and 50 Boeing Jets. It follows the recent deal for Vietnam where the tariff rate was set at 20%. Along with the first trade deal with the UK which set a tariff rate of 10%, the trade deals signed so far support expectations that the likely range for tariffs on major trading partners is likely to settle between 10% and 20% once trade deals as put in place. We still believe it is premature to abandon our call for a Fed rate cut in September.                   

GOODS INFLATION IS PICKING UP LIFTED BY TARIFFS

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Stronger UK CPI report provides temporary relief for GBP

The pound has also temporarily boosted this morning by the release of the stronger than expected UK CPI report for June. It has helped to lift cable back above the 1.3400-level  at the start of the European trading session  after it fell to a low yesterday of 1.3379. Similarly, EUR/GBP has fallen back to a low of 0.8663 after moving to within touching distance yesterday of the 0.8700-level. The latest UK CPI report revealed that headline inflation unexpectedly picked up to 3.6% in June from 3.4% in May. Core inflation picked up by a similar amount by 0.2ppts to 3.7%. It was the third consecutive monthly upside surprise for headline inflation. While service  sector inflation held steady at 4.7% in June, it was expected to slow to 4.5%.

Our European economist has highlighted that the biggest contribution came from housing, utilities and other fuels which added +0.95 ppts to the annual headline rate. Transport contributed +0.25ppts as well. The BoE have been expecting CPI inflation to “remain just under 3.5% for the remainder of the year, with a brief increase to 3.7% in September”. The report will dampen expectations for the BoE to speed up the pace of rate cuts in the 2H of this year although is unlikely to prevent the BoE from sticking to the current quarterly pace of cuts by delivering another 25bps cut in August. There are still 22bps of cuts priced in for the August MPC meeting and 43bps in total by the November MPC meeting. Market participants will be wary of pricing in a more hawkish outlook for BoE policy so close to the release tomorrow of the latest UK labour market report. BoE officials including Governor Bailey in a recent  interview with The Times has indicated more unease over weakening labour market conditions which are viewed as the main potential trigger for a faster pace of rate cuts. We still expect the pound to underperform against the euro (click here).

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com