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[Quick Facts]

1. It's premature to declare victory against inflation, with one more rate hike possible.

2. Former BOC Governor says wage gains do not automatically mean higher inflation.

3. The dollar's weakness is just a correction, so the Fed needs to further tighten the policy.

4. The ECB is likely to pause rate hikes, but it doesn't mean the end of the tightening cycle.

5. The CPI strengthens tightening expectations.

[News Details]

It's premature to declare victory against inflation, with one more rate hike possible

U.S. September CPI data also exceeded expectations, but the core CPI growth has slowed. The Wall Street Journal correspondent Nick Timiroas wrote that despite the progress bringing inflation down made by the Federal Reserve, it's premature to declare victory. And recent progress stalled in September, offering the latest sign that the path to fully extinguishing price pressures remains bumpy. If there is stronger evidence that price pressures and economic activity are cooling, officials may feel more comfortable with the decision to keep rates steady. But now we're in a position where a December rate hike can't be ruled out because the labor market remains strong. The Fed is unlikely to pause rate increases indefinitely this year.

Former BOC Governor says wage gains do not automatically mean higher inflation

In the field of economics, the traditional view is that wage increases will inevitably lead to higher inflation. Former Bank of Canada (BOC) Governor Stephen Poloz, however, believes that a variety of factors affect the relationship between wages and inflation. One of the factors is productivity growth. If firms are able to produce more goods and services with the same amount of labor, they can absorb higher labor costs without raising prices. This may lead to higher wages, but not to higher inflation.

Supply and demand dynamics also play an important role. In a tight labor market, firms may need to raise wages to attract workers. However, if consumer demand is weak, firms may not be able to pass on higher labor costs to consumers through higher prices. As a result, wage increases may not be inflationary in this scenario.

The dollar's weakness is just a correction, so the Fed needs to further tighten the policy

Ahead of the CPI data release, the dollar was holding steady around 105.720. After the release, the dollar index has retraced about 38% from its gains made from August to October. But the current dollar's weakness is essentially a correction. Putting aside current safe-haven flows and the Fed's dovish stance, nothing has changed at all and there is no reason to believe that the dollar's uptrend is over.

The U.S. economy continues to grow at an above-trend level, and last Friday's jobs data confirmed that the U.S. economy is still heating up and needs further policy tightening.

The ECB is likely to pause rate hikes, but it doesn't mean the end of the tightening cycle

While the vast majority of policymakers supported the decision to raise interest rates at the time, the views advocating an immediate pause strengthened, according to the minutes of the European Central Bank's (ECB) September monetary policy meeting released on October 12. Moreover, the rate hike supporters believed that the September rate hike could reduce the possibility of future rate hikes.

In the minutes, some members of the ECB Governing Council warned that further rate hikes could lead to a repeat of the situation in 2011 when the euro area experienced a severe sovereign debt crisis. The Governing Council's interest rate decisions need to take into account the economic and social costs of a possible hard landing.

A growing number of ECB officials have recently argued that inflation will stabilize at 2% in the medium term and further rate hikes are unlikely. For the time being, while there is still considerable disagreement within the ECB, a pause in rate hikes after two weeks should be most likely. However, there is still great uncertainty about when the current tightening cycle will end, and there is still the possibility of further rate hikes in the future.

The CPI strengthens tightening expectations

Following the PPI, the U.S. September CPI growth also exceeded expectations, continuing to accelerate the growth momentum over the previous month. The MoM growth of core CPI in September was flat from in August due to the high cost of housing. The services CPI excluding housing, the other core inflation indicator grew by 0.61% MoM, the highest level in a year, highlighting the stickiness of inflation.

The unexpected CPI growth reinforced the market's tightening expectations that the Fed is going to keep interest rates high for longer and will raise rates one more time during the year. Swap contract pricing showed investors expect about a 50% chance of another Fed rate hike within this year, a sharp pickup from Wednesday's 30%, with the first-rate cut next year expected to be delayed to July from June.

After the CPI release, U.S. Treasury yields rose. The U.S. benchmark 10-year Treasury yields picked up by more than 10 basis points, and the interest rate-sensitive 2-year Treasury yields quickly rose back up to 5.0%, up more than 10 basis points compared with the one-month low recorded on Wednesday. The U.S. dollar index, which has hit new intraday lows for more than two weeks for two consecutive days, quickly moved higher, driving many non-U.S. currencies weaker.

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