Euro area inflation in the spotlight

In focus today

Today, focus is on euro area inflation for April. Inflation has declined significantly in recent months but the underlying momentum in service inflation has picked up. We expect inflation will remain unchanged at 2.4% y/y due to food inflation and rising energy inflation while core inflation should decline to 2.6% y/y. This call is further supported by the fact German and Spanish inflation both came in aligned with expectations yesterday (read more on this below).

The most important thing to look out for is service inflation which has gained momentum recently and remains sticky on the back of recent wage increases. We expect to still see strong momentum in service prices for April, but given how Easter spanned both March and April, we will now be able to see the momentum more clearly without the influence of Easter in the seasonal adjustments. This will be very important for the rates outlook for the ECB as recent communication has suggested that the ECB is worried about the strong domestic inflation.

Today, we also get the first GDP release for the euro area for Q1 2024. We expect that the economy grew 0.2% q/q driven by the service sector while the manufacturing sector declined slightly as indicated by industrial production data and PMIs. The German Bundesbank estimated GDP grew 0.1% q/q in the first quarter so the aggregate euro area print will likely be higher than that.

From the US, Q1 Employment Cost Index is due for release. The recent annual growth pace of around 4% remains uncomfortably high for the Fed, but recent declines in hiring and job openings indicators could point towards some moderation in today's release.

Economic and market news

What happened overnight

In Japan, markets reopened after a bank holiday on Monday. As of this morning the yen has been trading around 156.80, after reaching a 34-year low yesterday morning crossing 160 against the dollar (USDJPY). The yen rose sharply in the early hours of the Asian afternoon, with the USDJPY cross suddenly reverting to around 155 in less than one hour, fuelling suspicion Japanese authorities had intervened. Sources had told the Financial Times that Japanese Ministry of Finance officials had been told to stand by yesterday, and not take the day off. The Wall Street Journal later said sources had said Japanese authorities had intervened. Speaking to Reuters, the top foreign exchange diplomat in Japan, Masato Kanda, refused to comment on whether authorities had intervened. He merely stated that they were always ready to deal with foreign exchange matters.

In China, the Caixin PMI rose to 51.4 in April up from 51.1 in March. The numbers thus indicate that the Chinese manufacturing activity expanded at the fastest pace seen in 14 months. The expansion was driven especially by new export orders as they expanded at the fastest rate seen in three and a half year. The PMI reading is thus in alignment with the Q1 GDP growth numbers which earlier this month beat forecasts coming in at 5.3% y/y.

The official PMIs out of China showed a somewhat muddier picture dropping to 51.7 from 52.7 in March. This drop was mainly driven by the services PMIs which fell to 51.2 in April compared to 53.0 in March, undershooting expectations of 52.3. This reflects continued weak private demand. As for the manufacturing PMI it came out above at 50.4 above consensus expectations, albeit falling from 50.8 in March.

What happened yesterday

In Germany and Spain, inflation numbers came in as expected. German headline CPI stood at 2.2% y/y, whereas core CPI came in at 3.0% y/y (prior 3.3% y/y). As for Spanish inflation, CPI stood at 3.2% y/y, and core CPI came to 2.9% (prior 3.2% y/y). With both German and Spanish core inflation declining 0.3pp we are on track for the same decline today in euro area core inflation to 2.6% y/y from 2.9% y/y as we and consensus both expected. The same goes for the expectation of an unchanged headline inflation at 2.4% y/y in April.

In Sweden, GDP figures for the first quarter came in below expectations, as monthly activity figures for January and February both saw large downward revisions. The Q1 GDP figure thus stood at -0.1% q/q (-1.1% y/y). This is roughly aligned with the Riksbank forecast of -0.2% q/q.

In the Middle East, the US and the UK both encouraged Hamas to accept a truce proposal from Israel. US Secretary of State Anthony Blinken said that it was now only Hamas who stood in the way of peace, as well as the release of the remaining Israeli hostages.

Market movements

Equities: Global equities rose yesterday, despite a marginal downturn in Europe. The positive tone was primarily driven by mega-cap news and earnings. Notably, in the U.S, consumer discretionary outperformed communication services by nearly 5%. The VIX index declined further below the 15 level, and various volatility measures have also lowered over the past week, reducing the risk of volatility-driven funds, such as risk parity, being forced to sell risky assets, particularly equities. Yesterday in the U.S., the Dow was up by 0.4%, S&P 500 by 0.3%, Nasdaq by 0.4%, and Russell 2000 by 0.7%. Asian markets are generally higher this morning, with Japan improving after yesterday's close and China's mainland shares lagging. Futures in Europe and the U.S. are mixed this morning.

FI: Global yields retraced, reversing part of the sell-off on Friday. Initially French bonds caught a bid as it was not put on negative watch on Friday, which lead to a spread tightening of 2bp to Germany in the 10y point by the end of the day. The lack of outlook change supported semi-core European bonds in general. 10y German bund yields dropped 4bp to 2.53% yesterday. European inflation data was overall balanced and do not seem to change the outlook for the June rate cut. We are looking for an EA flash inflation at 2.4% (unchanged from March) and core at 2.6% (from 2.9% in March) when released today. We also get the advance GDP figure.

FX: Extreme fluctuations in USD/JPY persisted as a central focus in the FX market yesterday. FX intervention appeared to successfully arrest the rally that initiated last week. EUR/USD, EUR/SEK, and EUR/NOK remained stable, reflecting the general market's cautious stance ahead of tomorrow's FOMC meeting.