Investors scale back bets of May rate cut on strong US inflation figures

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Investors scaled back bets that the Federal Reserve will begin cutting interest rates in May after data showed US inflation eased less than expected in January to 3.1 per cent.

Following Tuesday’s release, the likelihood of a rate cut in May implied by futures markets fell from 50 per cent to 30 per cent, while the chances of a cut in March were almost fully eliminated.

The two-year Treasury yield, which moves with interest rate expectations, rose 0.13 percentage points to just under 4.6 per cent. The benchmark 10-year yield increased 0.11 percentage points to 4.28 per cent. Yields rise as prices fall.

The S&P 500 share gauge dropped 1.4 per cent after the New York open, while the technology-heavy Nasdaq Composite fell almost 2 per cent.

The figures come as the Fed considers when to start cutting interest rates from their current level of 5.25 to 5.5 per cent after a lengthy campaign to tame persistent price pressures.

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“This is inconvenient data for the Fed and [a] plan to cut rates relatively soon,” said Dean Maki, chief economist at Point72 Asset Management. “I think this takes a March rate cut off the table, and it makes a May cut unlikely.”

Economists polled by Bloomberg had forecast annual consumer price inflation of 2.9 per cent, down from 3.4 per cent in December.

Core inflation, a closely watched measure that strips out volatile food and energy prices, was 3.9 per cent year on year in January, in line with the previous month.

The dramatic overall fall in inflation over the past year has prompted central bankers in the US, Europe and the UK to rule out further rate increases and start discussing the possibility of cuts.

Last month, Fed chair Jay Powell said the Federal Open Market Committee expected to cut interest rates three times this year, but he signalled it was unlikely to begin doing so until more progress had been made towards its 2 per cent inflation target.

The dollar, whose movements are influenced by changes in rate expectations, traded 0.6 per cent higher on the inflation data release.

Housing, vehicle insurance and medical care all contributed to January’s price pressures. Shelter, the largest component of which is rental costs, was the biggest influence on core inflation, with the index increasing 0.6 per cent in January.

Tuesday’s figures showed that while the ongoing trend of deflation in core goods continues, inflation in services remains strong, thanks in part to an increase in medical care costs.

The Fed’s preferred measure of inflation is the core personal consumption expenditures index, which has slowed more drastically than CPI. The core PCE index was up 2.9 per cent in January on an annual basis, the first reading of less than 3 per cent in about three years.

Monthly headline inflation rose 0.3 per cent, surpassing the 0.2 per cent forecast.

The Fed’s next policy meeting is scheduled for March 19-20, at which it will release its latest “dot plot” survey showing officials’ projections for interest rates, inflation and unemployment.