Bond Watch: US inflation drops to 5%, but one more rate rise expected

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

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Here’s what you need to know this week.

Inflation in the US falls to 5%

Inflation in America cooled faster than expected, with prices rising 5% year over year in March, the lowest increase in nearly two years. Prices rose just 0.1% from February to March.

This compares with a 6% annual price increase in February.

However, core inflation, which strips out volatile food and energy costs, rose by 5.6% for the year, suggesting inflation may take longer to subside than many hope.

Gurpreet Gill, fixed income strategist at Goldman Sachs Asset Management, says the battle to rein in inflation is not completely over in the US.

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“Overall, we think the latest inflation data — combined with a still tight labour market — continue to support the case for one further interest rate hike in May.

“The US economy added more than a million jobs in the first quarter, something unseen in a three-month period since 1997, and inflation remains more than double its 2% target. We therefore expect the Federal Reserve to maintain a somewhat hawkish stance even as it pauses on rate actions, absent a material deterioration in either economic or credit conditions,” she said.

Stock and bond markets reacted positively to the US inflation figures.

In a sign of what may come in the US, the Bank of Canada left interest rates unchanged in its April meeting, but warned that “demand is still exceeding supply and the labour market remains tight”. 

UK economy in the slow lane

The International Monetary Fund (IMF) predicted that the UK economy would contract by 0.3% in 2023, the worst growth rate of any G7 economy.

While an improvement on its previous forecast of a 0.6% decline in GDP this year, it shows that the outlook for the UK economy is tough. Even in 2024 the IMF only expects a 1% economic growth rate.

Data out this week showed that the IMF is right to be pessimistic about the UK. GDP was unchanged between January and February, according to the Office for National Statistics (ONS).

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Charles Hepworth, investment director at GAM Investments, said: “After beating forecasts in January, UK GDP stalled in February showing zero growth. While technically true that this is better than what was feared some quarters ago, Chancellor Jeremy Hunt claiming that the ‘economic outlook is looking brighter’ is quite some suspension of disbelief.”

Hepworth says inflation data will still be the driver for Bank of England policy, with inflation set to remain above developed market peers. Higher inflation and interest rates would spell bad news for bond prices.