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In what should temper the concerns of some Fed officials, consumer prices rose 0.4 percent in August. Core prices posted a 0.2 percent increase, but the trend remains tepid relative to the start of the year.

Headline and Core Inflation Strengthen

After three months of lower-than-expected inflation readings, the CPI index came in higher than what markets forecasted. Consumer prices rose 0.4 percent in August, which was the largest monthly jump since January.

Leading the charge was a 2.8 percent rise in energy costs. Prices for gasoline had already been inching higher ahead of the Harvey-related surge late in the month. With gas prices typically falling in August, prices rose 6.3 percent after seasonal adjustment and accounted for half of the headline's gain. Food prices ticked up 0.1 percent as a 0.3 percent increase for food away from home more than offset the 0.2 percent decline at grocery stores. To what will likely be a relief to Fed officials, core inflation rose 0.2 percent in August, which was the largest month gain since February. What's more, the increase has a relatively "high" 0.2 percent, coming in at 0.248 percent before rounding.

The strength can be traced to a rebound in core services. Shelter prices rose 0.5 percent amid a pickup for primary residences (both rented and owned) as well as a full reversal in last month's 4.9 percent drop in hotel prices. Prices for medical and transportation services also advanced. Core goods prices posted another monthly decline of 0.1 percent amid further weakness in vehicle prices.

On a year-over-year basis, core inflation continues to look rather anemic. Ex-food and energy, prices were up just 1.7 percent over the past 12 months. Following the August gain, however, the recent trend looks stronger; over the past three months, the core index has risen at a 1.9 percent annualized pace.

Fed Will Still Be Cautious Interpreting Inflation's Recent Trend

August's strong gain should help alleviate concerns among Fed members that the slowdown in inflation that began in the spring is set to continue. That said, with some components like gasoline and hotel prices getting a boost late in the month from storm activity, we suspect Fed members will continue to be cautious in interpreting recent movements.

FOMC members have continued to telegraph that they are set to announce the start of balance sheet normalization at next week's meeting. We do not expect the inflation data to get in the way of that plan. What is likely to be affected, however, is the Fed's Summary of Economic Projections. There will be three more readings on CPI and PCE inflation before the FOMC's December meeting, but the soft patch hit in prior months is likely to lead to lower estimates of year-end core inflation. That could be enough for some officials, worried about inflation's persistent shortfall from the Committee's target, to push out their projections for the timing of the next rate hike.

Central bank meetings dominated today's European session, while US CPI was the main data in focus. The pound soared to a fresh one-year high against the dollar after the Bank of England signalled rates could go up within months. The US dollar also shined as the greenback was lifted by stronger-than-expected inflation data. In contrast, the Swiss franc ended up as one of the worst performers after the Swiss National Bank slightly altered its view on the Swissie's value.

The pound returned to the top of the performance league for the second time this week as the British currency jumped more than 1% after the Bank of England strongly hinted at a rate hike in the near future. At the end of its two-day monetary policy meeting, the BoE kept policy unchanged as expected, with two MPC members dissenting to vote for a rate hike as anticipated. However, in the meeting minutes published immediately after the announcement, the bank said a majority of MPC members thought "some withdrawal of monetary stimulus is likely to be appropriate over the coming months" if underlying inflationary pressures continue to rise.

Sterling powered ahead to fresh highs against both the dollar and the euro, hitting $1.3371 and 0.8876 pounds to the euro. It was also up sharply against the yen, reaching a nine-month high of 148.12.

Earlier in the session, the SNB kept its key rates unchanged as expected but toned down its verbal warning of the exchange rate. In its statement, the bank said the franc remains "highly valued", slightly less strong language to the "significantly overvalued" term used in previous meetings. Pressure on the franc has eased substantially following the euro's 7.5% appreciation against the Swiss currency this year. However, the SNB reiterated that it will remain active in the forex markets as necessary.

The Swissie weakened after the SNB's decision, with dollar/franc climbing to 0.9660 and euro/franc firming to 1.1480 in late trading.

The euro was mostly swayed by the movements of its peers in the absence of any major Eurozone data today. There was little reaction to remarks by ECB board member, Bostjan Jazbec, who said the central bank needs more data before deciding on reducing the size of its asset purchase program, but added that a decision was inevitable. The single currency recovered from a two-week low of $1.1836 touched earlier in the day, to rise to around $1.1880 in late session.

Meanwhile, the dollar was boosted after US inflation rose by more than expected in August. Annual CPI beat estimates of 1.8% to rise to a three-month high of 1.9%, up from 1.7% in July. Prices were driven higher by a jump in gasoline prices and housing costs. The core rate, which excludes volatile food and energy prices, was unchanged at 1.7% in August, though this was above forecasts of 1.6%.

Other data out of the US today included the weekly jobless claims. Initial claims for unemployment benefits rose by 284k last week, an improvement on the prior week's 298k and lower than the expectations of 300k.

The greenback surged to a more than one-month high of 111.02 against the yen, before retreating to around 110.70 at the US open. The dollar index was slightly down however at 92.30, weighed by the stronger pound. The US currency appeared to backtrack as some analysts said Hurricane Harvey may have skewed the CPI numbers at the end of August, while reports that North Korea may be preparing to launch another missile test also unsettled some traders.

The Canadian dollar was unable to benefit from better-than-expected house price data out of Canada today. The loonie was last trading 0.25% down on the day at C$1.2200 to the greenback.

In commodities, base metals continued to slide, with copper prices falling to a one-month low of $2.9180 per tonne. But crude oil extended yesterday's gains, following the IEA's upbeat assessment of the oil market. WTI crude was last up 1.2% at $49.90, while Brent crude was 0.8% higher at $55.61 per barrel.

Highlights:

• The all items index rose 0.4% in August, slightly ahead of market expectations. That pushed the year-over-year rate up to 1.9% from 1.7% in July.
• A 6.3% jump in gasoline prices was partly responsible for the headline increase.
• It is likely a bit too soon to attribute rising gasoline prices to Hurricane Harvey-related supply disruptions. That will be a larger factor in September's CPI reading.
• Consumer prices excluding food and energy rose 0.2%, breaking an unusually long five-month stretch of more modest increases. However, the year-over-year rate of core inflation was unchanged at 1.7% for a fourth consecutive month.
• The shelter index was a big contributor to rising services prices. A 0.5% increase in that component was the largest monthly gain in more than a decade.

Our Take:

August's CPI report provided more of the same: steady core inflation alongside an energy-driven move in the headline rate. As the BLS noted, core inflation has been in a 1.6-2.3% range for six years now. Although some transitory factors are responsible for keeping the current rate at the lower end of that range, it is hard to argue we are seeing much in the way of inflationary pressure. Our diffusion index shows only 30% of CPI basket components are rising at or above a 2% year-over-year rate. That is despite clear signs of limited economic slack, including an unemployment rate that is 1/4 percentage point below the Fed's longer run estimate.

Today's inflation readings don't alter our expectations for next week's Fed meeting. We already saw little chance of a rate hike, with policymakers instead focusing on implementing their plan to start shrinking the Fed's balance sheet. Our long-held view has been that December would be the timing of the next rate move although markets remain skeptical of even that. Given some FOMC members' concerns about low inflation, we'll likely need to see higher CPI readings in the coming months to raise the odds of one more rate hike this year.

The headline consumer price index (CPI) ticked up 0.4% in August, slightly above market expectations. Inflation on a year-on-year basis moved up to 1.9% in August.

Delving into the details, a 2.8% pop in energy prices on the month and a 0.5% increase in shelter costs were the main culprits lifting headline inflation in August. Food inflation remained fairly tame, up just 0.1% on the month, and a mere 1.1% year-on-year.

Core inflation finally broke out of its 0.1% funk, rising 0.2% on the month – and a strong 0.2 at that given the 0.248 print to three decimal points. Still, that left core inflation at 1.7% year-on-year, a pace that has been steady for four months now.

The core measure, along with shelter price increases, was led by motor vehicle insurance (+1.0% m/m), medical care (+0.1% m/m) and recreation (+0.2% m/m). Shelter is highly important for inflation, accounting for one third of the CPI basket. As such, the 0.5% rise carried some weight. Within shelter prices, all categories gained momentum including rent, owned housing and lodging away from home.

The tug of war in core inflation between soft goods prices (-0.1%) and rising services prices (+0.4%) continued in August, with services gaining speed as of late. Still, it wasn't enough to lift the annual pace of core services, at 2.5% y/y in August. Meanwhile core goods prices remain in deflationary territory, down 0.9% from a year ago – a pace that has been reasonably steady over the past year.

The BLS cited that Hurricane Harvey had a very small effect on survey response rates in August, with price collection disrupted in 2 of 87 collection areas.

Key Implications

Phew! The sigh of relief among economists forecasting the U.S. economy is surely audible. Analysts have been increasingly worried that the Phillips curve, or the relationship between the unemployment rate and inflation, might be dead, or at least on life support. August's CPI report provides some reassurance that it may be unwise to write it off yet. However, with core inflation still below 2% it will take more than a month of good data to convince the FOMC that inflation is well on its way to target. Moreover, there may still be poorly understood structural forces restraining inflation.

That said, the uptick in services inflation was most encouraging, as it is most closely tied to conditions in the domestic economy. While goods inflation is still feeling the effects of a stronger U.S. dollar in recent years. We expect those exchange rate impacts will ebb, and goods prices should help lift inflation higher over the coming two years.

Next week, the Fed is expected to starting the process of balance sheet normalization. The likelihood that the Fed would raise rates once more in 2017 had been looking increasingly iffy as the softness in inflation dragged on. Today's CPI report provides some reassurance that there are signs of life in price pressures in the U.S. economy, and makes a December rate hike look more likely.

• Risk sentiment on European stock markets soured around the US opening as Japanese newspapers report that North Korea shows signs of preparing a missile launch. Main US stock indices open up to -0.5% lower (Nasdaq).
• The Bank of England signaled that officials are preparing to raise interest rates within months to restrain accelerating inflation, a fresh sign that a decadelong era of ultraloose central-bank policy is slowly drawing to a close. EUR/GBP lost more than one figure, dropping from 0.9020 to sub-0.89 area.
• US CPI beat forecasts in August, ending a 5-month run of misses. Headline CPI rose by 0.4% M/M and 1.9% Y/Y. "Increases in the indexes for gasoline and shelter accounted for nearly all of the seasonally adjusted increase in the all items index," said the Labor Department. Core inflation rose by 0.2% M/M to stabilize at 1.7% on a yearly basis.
• The Swiss National Bank kept its policy rates unchanged, but changed its tone on the franc. The SNB ditched its nearly three-year mantra that the franc was "significantly overvalued", but still thinks that it is "highly valued". The central bank reiterated its commitment to "intervene in the foreign exchange market as necessary".
• Donald Trump has tied a deal to protect undocumented workers who arrived in the US as children with his campaign promise to increase security along the Mexico border, denying he struck a deal with Democrats on legislation legalising the status of so-called "Dreamers".
• North Korea has threatened to destroy Japan with nuclear weapons and "reduce the US mainland to ashes and darkness" in response to the countries' effort to ramp up sanctions on the isolated east Asian nation. "The four islands of the [Japanese] archipelago should be sunken into the sea by the nuclear bomb of Juche".
• Another prolonged bout of wrangling over the debt ceiling in the US could prompt Fitch to review the country's AAA credit rating with "potentially negative implications", the agency said.

Rates

North-Korea limits downside US T's after BoE and US CPI

Global core bonds lost ground as the Bank of England signalled policy normalisation in coming months and after higher-than-expected US CPI data. Reports in Japanese newspapers about a possible near term North-Korean missile launch erased part of core bond losses via safe haven flows. US Treasuries nevertheless still underperform German Bunds, especially at the front end of the US yield curve. At the time of writing, the US yield curve bear flattens with yield changes ranging between +3 bps (2-yr) and flat. The German yield curve trades 1 bp higher across the curve. On intra-EMU bond markets, 10-yr yield spread changes versus Germany range between +2bp and -2bp.

Core bond trading again started on a lethargic footing with small movements in the European session. Things changed as the Bank of England indicated that "some withdrawal of monetary stimulus is likely to be appropriate over the coming months". (see FX). UK Gilts lost significant ground (UK 2y yield +8 bps) and dragged the US Note future and German Bund slightly lower as well with some investors rethinking their dovish stance/positioning. The sell-off in the US Note future accelerated after higher US CPI data. The front end of the curve underperformed as the market implied probability of a 2017 Fed rate hike moved back above 50% for the first time since early July. Reports in Japanese media (Nikkei,…) about a possible near term North Korean ICBM launch created safe haven flows and volatility immediately after the CPI release. However, as the US trading session gets going, investors favour again the downside in US Treasuries.

The Irish Treasury ended this week's scheduled EMU bond with successful taps of two on the run bonds (€0.55B 1% May2026 & €0.45B 1% May2037). The combined amount sold was the maximum target with a good auction bid cover of 2.19. With the completion of today's auction, the NTMA has issued €10.5B benchmark bonds, from its stated target range of €9B to €13Bin the bond markets this year.

Currencies

North Korea threat prevents further USD gains

The dollar couldn't extend sustained gains today. The Interest rate context and the data were supportive. Interest rate markets prepared for a BoE interest rate hike on hawkish BoE speak and the US CPI was higher than expected. However, the positive impact from the eco/monetary news was countered by a flaring up of geopolitical tensions as Japan saw signs of North Korea preparing new offensive actions. This threat prevented the dollar to fully profit from the positive eco news. EUR/USD trades in the 1.1875 area. USD/JPY is changing hands in the 110.75 area in volatile trade.

Asian equities traded mixed. China and Japan mostly showed modest losses. Other regional indices traded with a slightly positive bias. USD/JPY settled in the mid 110 area, nearing 110.67/95 resistance. EUR/USD set a minor correction low in the 1.1865/70 area.

There was hardly any high profile news to guide USD trading during the European morning session. Core yields drifted sideways to marginally higher ahead of the BoE's policy decision and the US CPI release. EUR/USD returned to the 1.19 area. USD/JPY failed to try a real test of 110.67/95 resistance. USD bulls took a more cautious approach after recent gains.

The BoE left its policy rate unchanged but signalled that a rate hike in the near future has become a real possibility. The subsequent rise in core yields also helped to put an intraday floor for the dollar. The US August CPI rose more than expected from 1.7% to 1.9%. Core inflation was stable at 1.7%, while a decline was expected. US/core yields rose further and the dollar spiked higher. EUR/USD filled bids around 1.1840. USD/JPY tested the 111 area. However, the USD soon lost part of the post-CPI gains, just to try another comeback. The volatility in the dollar (and in other markets) was due to headlines on North Korea preparing a new missile launch in the direction of Japan. North-Korea press reports also said the country was ready to use a nuclear weapon. This geopolitical uncertainty partially countered the positive impact of stronger US CPI for the dollar. Currently, the dollar trades quite close to the levels that were on the screens going into the start of European trading this morning. EUR/USD is changing hands in the 1.1875 area. USD/JPY is changing hands around 110.70.

Sterling jumps as BoE sees strong case for a rate hike

Sterling trades were keen to see the BoE's policy assessment as inflation rose sharply in August. The BoE didn't want to shock the market and as expected left its policy rate unchanged. The vote for an unchanged policy rate was 7-2 as was the case in August. However, a majority of the MPC members judged that if the economy continues to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target. So, the BoE's assessment might be considered as hawkish even as the vote remained 7-2. Sterling started a new upleg EUR/GBP declined more than one big figure and is falling below the 0.89 big figure. Cable also set a new ST top north of 1.33 (currently 1.3350) despite overall USD strength after higher than expected US CPI data.

The currency pair has resumed the upside movement and seems poised to jump much higher after the good United States data. The pair has retreated a little because the traders were a little surprised by some US data.

USD/JPY is trading in the green and should resume the upside movement because is expected to reach some important resistance levels. We'll see what will happen because the dollar index is still located under some very important resistance levels. The USDX is now pressuring the 92.49 static resistance, a valid breakout above could confirm a further growth in the upcoming period.

The dollar received a helping hand from the United States data, the Unemployment Claims dropped unexpectedly in the previous week, from 298K to 284K, even if the traders have expected to see an increase to 303K. Moreover, the CPI rose by 0.4%, beating the 0.3% and the 0.1% growth in the former reading period, while the Core CPI surged by 0.2%, matching the 0.2% estimate.

USD/JPY continues to move in range on the short term, remains to see how will react when will hit the warning line (WL3). We'll see if will have enough energy to reach the confluence area formed at the intersection between the 38.2% retracement level with the WL3. Only a valid breakout above the WL3 will confirm a further increase, while a rejection will send the rate tumbling.

The price is strongly bullish on the short term and seems motivated to jump above the second warning line (WL1) of the ascending pitchfork. A valid breakout will confirm a further increase towards the upper median line (uml) of the minor descending pitchfork. Resistance can be found at the 0.9787 horizontal resistance.

The price continues to increase on the short term and could close the above the 1.2200 psychological level. The rebound could be only temporary because is hard to believe that will have enough directional energy to make a broader rebound without another decrease. Resistance can be found at the median line (ml) of the minor descending pitchfork and at the lower median line (LML).

EURGBP - The cross continues to hold on to its downside pressure selling off on Thursday and opening the door for more weakness. Support lies at the 0.8850 level where a violation will turn focus to the 0.8800 level. A break will expose the 0.8850 level. Resistance resides at the 0.8900 level where a violation if seen will turn risk towards the 0.8950 level. Further up, resistance resides at 0.9000 level followed by the 0.9050 level. Its daily RSI is bearish and pointing lower suggesting more weakness. All in all, EURGBP remains biased to the downside on further weakness

BOE sent a hawkish message at the September meeting, noting that the majority of the members agreed that some withdrawal of stimulus should be appropriate in coming months. The key reason for the upcoming tightening is strong inflation which the central bank expects to rise above +3% in October. The market interpreted this as a signal that the historically low interest rate would be raised soon. Sterling rallied to a one-year high against the US dollar and a two-month high against the euro after the announcement. The market has now priced in over 54% chance of a rate hike in December. On the monetary policy this month, the BOE voted 7-2 to leave the Bank rate unchanged at 0.25% and unanimously to keep the asset purchase at 435B pound.

Added in the meeting statement was a hawkish reference: A majority of MPC members judge that, if the economy continues to follow a path consistent with the prospect of a continued erosion of slack and a gradual rise in underlying inflationary pressure then, with the further lessening in the trade-off that this would imply, some withdrawal of monetary stimulus is likely to be appropriate over the coming months in order to return inflation sustainably to target. Yet, it stressed that any rate hike "would be expected to be at a gradual pace and to a limited extent".

On economic developments, BOE acknowledged UK demand is "growing a little in excess of this diminished rate of potential supply growth" and spare capacity has been "eroded". It also noted that "underlying pay growth has shown some signs of recovery, albeit remaining modest". As the unemployment rate has plunged to a 4-decade lower of 4.3% in the 3 months through July, pay growth is expected to pick up in coming months. On inflation, policymakers suggested that "remaining spare capacity in the economy is being absorbed a little more rapidly than expected at the time of the August Report, and that inflation remains likely to overshoot the 2% target over the next three years". Headline CPI surprisingly rose to +2.9% y/y in August, from +2.6% a month ago. The market had anticipated a milder increase to +2.8%. BOE expects inflation to rise to above 3% in October.

Michael Saunders and Ian McCafferty continued to dissent, suggesting that monetary policy at 0.5% (up +25 bps) would still be "very supportive". Yet, the rest of the Committee, including new member Dave Ramsden preferred to " undertake a full assessment of recent developments and the data released over the next couple of months, in the context of its November forecast round".