Inflation shocks test global economic resilience

Headline inflation jumped as energy prices surged, while core inflation stayed contained. Weak sentiment and uneven global signals leave policymakers navigating rising uncertainty.

• US: First stagflationary impulses show up
• CA: Labor market remains sluggish
• Japan: Mixed signals
• Spotlight on next week
  

Weekly highlights

US: Stagflation signals

The first inflation report since the start of the Iran war showed the anticipated stark rise in headline inflation alongside contained core inflation.

Overall consumer prices rose 0.9% MoM, lifting the headline inflation rate by 0.9 percentage points (ppt) to 3.3% YoY, the twin‑highest since May 2024. Core prices (excluding food and energy) rose 0.2% and the core inflation rate increased just one tenth to 2.6% YoY. Gasoline prices rose 21.2% MoM, food prices were unchanged, airfares increased 2.7% MoM, medical care declined 0.2% MoM and shelter rose 0.3% MoM. Overall, service prices increased 0.2% and goods prices jumped 2.0%.

None of this was surprising. What is surprising to us is the ongoing disinflation in used car and truck prices; these declined yet again even as auction price data from Manheim suggest a rise in auction prices in recent months.

This ongoing divergence poses the risk of a catch‑up increase in coming months, possibly worsening the inflation prints even as the upward impetus from energy fades. Alternatively, it could be that dealer margins in the used car market are being compressed as consumers become more price sensitive and unable to accept higher prices.

To be sure, real disposable income growth slowed quite dramatically to just 1.1% YoY in February. Aside from the big Covid‑related gyrations in 2022, this marked the slowest gain since 2014.

The implication is that pricing power must weaken in the context of weaker income growth. The inflation squeeze will hit real income further in March, although tax refunds will offer a cushion. This, in turn, suggests an eventual slowdown in real consumption.

Consumer sentiment is already taking a hit as a result of the energy price spike. The Michigan consumer sentiment index plunged another 5.7 points in March to a multi‑decade low while inflation expectations rose.

Short‑term (one‑year) inflation expectations rose one percentage point to an eight‑month high of 4.8% while long‑term inflation expectations ticked up two tenths to 3.4%.

Canada: Labor market remains sluggish

The latest job report aligns with expectations, underscoring the persistent challenges within the labor market. Unemployment remains elevated, hiring activity is subdued, and ongoing economic uncertainty suggests continued modest job growth and stable unemployment rates in the foreseeable future.The unemployment rate held steady at 6.7% following an increase in February. The labor force expanded by 15k in March, while participation remained constant at 64.9%.

Layoff rates are consistent with pre‑pandemic norms, suggesting that sluggish hiring, rather than increased layoffs, accounts for elevated unemployment.

Employment gains were primarily seen in the “other services” sector and natural resources. Wage growth accelerated, with average hourly earnings rising 4.7% YoY in March, compared to 3.9% in February.

However, adjusting for workforce composition, wage increases stood at 3.6%, in line with figures from January and February 2025.

The economic prospects remain uncertain due to the ongoing energy shock and uncertainty around Iran’s conflict duration. Continued disruptions are expected to impact inflation; however, subdued demand may mitigate some effects, enabling the Bank of Canada to refrain from immediate intervention.

Japan: Mixed signals

The past week’s data suggest a marked deterioration in sentiment among consumers and economy watchers. Consumer sentiment fell sharply, with the February index dropping 6.4 points in March to 33.3, the largest decline since April 2020 at the beginning of the first Covid emergency.

At the same time, one‑year‑ahead inflation expectations jumped by a full percentage point to 4.67%. The Economy Watchers’ Survey echoed this weakness: the current conditions index fell 6.7 points to 48.9, driven by a 10.1‑point plunge in food and beverage‑related activity, the lowest reading since early 2022, while the household index declined by 7.1 points.

Inflation concerns appear to be building in the pipeline. Domestic CGPI rose 0.8% MoM in March, a sharp acceleration from the previous month and sufficient to lift the annual rate by 0.5 ppts to 2.6%.

Import prices in yen terms also surged, rising 3.3% MoM after just a 0.1% increase in February, underscoring renewed cost pressures from the weaker currency and higher commodity prices.

Against this backdrop, wage data delivered a more constructive signal. Nominal cash wages grew 3.3% YoY, up from 2.5% in February. While the jump largely reflects the introduction of a new survey sample, it nevertheless supports the argument that wage dynamics are gradually strengthening.

Regional intelligence from the Bank of Japan (BoJ) broadly reinforces this picture. Branch managers continue to describe regional economies as recovering moderately, with some localized weakness, consistent with the BoJ’s March macro assessment.

However, the April meeting also surfaced growing concern about spillovers from Middle East tensions, including lower operating rates due to higher input costs, raw material constraints, and the risk of broader supply chain disruptions.

Demand conditions remain mixed, with resilient spending on special occasions and inbound demand offset by ongoing consumer thriftiness, while business investment sentiment remains positive.

Wage plans for FY2026 are broadly aligned with FY2025 levels, though firms flagged the risk of a more cautious stance if geopolitical and commodity price pressures intensify.

Most importantly, the BoJ’s Consumption Activity Index delivered a downside surprise in February (‑0.4%) alongside a large downside revision for January (‑0.7 pp to ‑0.3%).

The data rhyme with the deterioration in sentiment, but we continue to believe that the conflict in the Middle East is weighing heavily on an otherwise resilient domestic consumption story backed by improving wages.

If the conflict persists, we believe the economy could shift into a slower lane but still avoid a recession.

Taken together, the data leave markets highly sensitive to geopolitical developments, particularly the outcome of negotiations between Iran and the US.

In an optimistic scenario of sustained progress, we still think the BoJ could proceed with a rate hike; otherwise, a pause would be the more likely outcome, one that we lean on.

Spotlight on next week

• Japan’s machinery orders to have weakened in February. 
• Australia’s consumer sentiment to have weakened dramatically.