UBS On-Air: Paul Donovan Daily Audio 'Inflation bonanza'

Good morning, this is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's six o'clock in the morning London time on Wednesday the 10th of June. US May consumer price inflation data is assuming increased importance for investors.

The headline data is expected to rise because the costs of the US war in the Gulf are being passed through relatively quickly to domestic consumers. Sometimes an external price shock will be passed through with a delay or a more muted impact when, for instance, companies along the supply chain are prepared to take a squeeze on profit margins. However, the very dominant narrative of this particular shock means everyone is very aware that prices will rise.

The recent history of the pandemic supply shocks and then the additional costs of US tariffs have made consumers more used to the idea of price increases. Not happy about them, but not surprised by them. That combination has allowed the higher energy costs to be passed through rapidly and completely, which means in turn that as long as demand does not weaken, companies are much less likely to take any hits to their profit margins.

The core inflation rate will reflect some higher energy costs too, but these will be less significant. The higher US headline inflation rate is why consumers have had to tap into their savings. Nominal consumption is growing faster than nominal income at the moment, and inflation is also growing faster than income.

The stability of the US labour market has allowed consumers to do all of that. So far, the main questions around inflation in the States are less about the potential for demand destruction and more about the policy response and the political consequences. On the policy response, the issue is not passing through oil prices, but whether there are any signs of other prices picking up, the second round inflation effects.

These have been largely absent from the data. Areas like service sector inflation will be a focus in the details of today's numbers in this regard. The political consequences focus on the approval rating of US President Trump, which for economic management and inflation management specifically has slumped in recent weeks.

Even Republicans are moving beyond partisanship to blame the President for the affordability crisis. That may already have some consequences. The exemptions to the latest wave of proposed tariffs US consumers are being asked to pay or the attempts, so far ineffective, to try and extricate the US from the Gulf War.

China's inflation is much, much less relevant to the global economy. The world does not tend to hold its breath in anticipation of the next People's Bank of China decision, and China's domestic consumer price inflation is a parochial affair with little relevance beyond its borders. May consumer price inflation was slightly weaker than had been anticipated, with collapsing pork prices a part of the drag on the overall index.

That is not something of global relevance. It says little about domestic demand in China, though domestic demand is not strong, and it's more about specific supply side issues. The oil price in China is a fiscal burden, not a consumer burden, with fiscal subsidies keeping the consumer insulated from the shock.

Producer prices are somewhat more relevant globally. There was a pick-up here, led by the technology sector, in turn reflecting international demand for AI-related stuff. The AI price impulse is global, though technically it's more a relative price change than an inflation shock.

Exceptional demand in a narrow set of sectors is pushing up prices in those sectors, rather than creating an economy-wide imbalance. The relative indifference of the oil price to the latest ceasefire breakdown in the Gulf War is not really that surprising. Markets are generally being cynical about all the positive pronouncements that come from the US administration on the progress of talks, etc., and are instead focusing on the realities on the ground and what signals come, generally indirectly, from the Iranian government.

The exchange of fire is only a deterioration if viewed in the context of earlier US social media posts. That's all for today. Have a good day.

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