Summary
- UK inflation came in higher than expected at 3% year-on-year, driven by VAT on private school fees and rising food costs, though underlying price pressures may still be gradually easing
- The UK 10-year bond yield rose 0.07% to 4.57% and equities fell with the FTSE 100 index down 0.8% and FTSE 250 down 1.4%
- Japan’s economy showed resilience, with stronger-than-expected GDP growth and moderate inflation overshoot supporting a gradual move away from ultra-loose monetary policy
- European equities edged lower despite cautious optimism, with PMI data indicating fragile business activity and defence spending discussions weighing on bond yields
- US equities saw volatility, falling 1.9% in GBP terms, as weak consumer sentiment and a contraction in services activity raised concerns over economic resilience
- Investors will be watching Germany’s political landscape take shape as the Christian Democrats (CDU) emerge from the election 2025 as winners with right-wing Alternative for Deutschland (AFD) coming second, Olaf Scholz’s Social Democrats finished third (its worst result since World War II) but will likely be part of a coalition government
- We also anticipate US PCE inflation data this week, with potential implications for Fed policy.
Markets last week
UK
Last week’s focus was on January’s inflation report, which came in hotter than expected at 3% year-on-year, up from 2.5% in December. The main drivers of the acceleration were education and food. In education, the introduction of VAT on private school fees at the start of the year pushed prices higher, while food inflation continues to climb as firms pass on rising labour costs stemming from the increase in employer national insurance contributions and the minimum wage hike.
Despite the stronger-than-expected headline figure, policymakers may find some reassurance in signs that underlying price pressures are gradually easing. Excluding airfares, package holidays, education, and volatile accommodation services, annual services inflation, which the Bank of England (BoE) closely monitor as a core measure to determine the underlying trend, slowed slightly to 5.1% from 5.2%. A more refined gauge that strips out both volatile and indexed components cooled to 4.1% from 4.4% on an annual basis.
While these figures suggest that underlying inflation pressures could gradually ease over the year, upside risks remain and headline inflation persists above target, reinforcing the BoE’s cautious stance on rate cuts. Traders reacted with the UK 10-year bond yield rising 0.07% over the week to close at 4.57%. UK equities also fell with the large cap FTSE 100 index falling 0.8% and the more domestic focussed mid-cap FTSE 250 index falling 1.4%.
Global
Global markets faced some modest headwinds, though Japan’s economic backdrop offered some encouraging signs. Japanese equities fell 0.8% in local currency terms but rose 0.9% in GBP terms. Stronger-than-expected GDP growth and a moderate inflation overshoot suggest the economy is on a more solid footing. Japan’s core CPI inflation rose 3.2% year-on-year in January, slightly ahead of expectations, reinforcing the case for the Bank of Japan to continue with their gradual move away from its long-standing ultra-loose policies. Fourth-quarter GDP growth surprised to the upside at 0.7% quarter-on-quarter. As a result, 10-year Japanese government bond yields climbed to 1.43%, the highest level since 2009, as markets priced in the prospect of further policy normalization – a necessary step to restore more balanced financial conditions over the long term.
European equities edged lower amid a continued sense of cautious optimism. Although mixed data highlighted fragility, European equities remain up over 12% year-to-date. The eurozone’s flash Composite PMI held at 50.2, suggesting business activity remains in expansionary territory, but with weak new orders and rising input costs weighing on sentiment. Meanwhile, European bond yields underperformed as discussions over increased defence spending gain traction in response to geopolitical uncertainty.
In unusual fashion the US seems to have taken a backseat from a market perspective so far this year. US stocks experienced some volatility amid a holiday-shortened week with early gains erased by concerns over consumer sentiment and spending as well as particularly weak flash PMIs. S&P Global reported that services activity fell into contraction having shown remarkable resilience in recent years. The Services PMI reading of 49.7 marks the lowest level in over two years. The US equity market fell 1.9% in GBP terms while US treasury yields fell slightly.
The week ahead
Monday: German election results
Our thoughts: Investors will be closely watching Germany’s political landscape take shape following election results. Friedrich Merz’s conservative-leaning CDU emerged victorious, while the right-wing AfD outperformed Olaf Scholz’s left-wing Social Democrats. As no party secured a majority coalition negotiations will be crucial in shaping Germany’s policy direction. With the CDU having ruled out a coalition with AfD the party will most likely form a government with the Social Democrats, despite their worst election result since World War II.
Friday: US PCE inflation
Our thoughts: The US Federal Reserve’s (Fed) favoured inflation gauge, core PCE is expected to tick up to 0.3% month-on-month while the annual measure is anticipated to soften to 2.6%. The Fed have adopted a wait and see approach to further policy easing and will be looking for signs of further disinflation before considering future rate cuts.
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Markets for the week**
Sources: FTSE, Canaccord Genuity Wealth Management