13th BoE hike due; 25 or 50 basis points?
The impact on the pound after yesterday’s hotter-than-expected UK inflation print was an interesting one, as questions over the persistent inflation problem and unfavourable comparisons with both the US and the Eurozone gain momentum. The risk of a larger 50-basis point rate hike by the Bank of England (BoE) today has increased, but as has the risk of a deeper economic slowdown, which is weighing on the pound.
Economists and investors expect the Monetary Policy Committee to push ahead with another 25-basis point increase in Bank Rate to 4.75%, however, money markets place a near 50% chance of a half point increase to 5%. This is due to the shock inflation print yesterday, driven mostly by the outperformance in services inflation, which the BoE pays close attention to. Traders also lifted expectations for the terminal rate to 6%, which would be the highest since the turn of the century. The pound remains softer as the rate decision draws nearer though, reflecting concerns that higher interest rates will rattle the UK housing market and trigger a recession. GBP/USD dropped below $1.27 for the first time since last Thursday before bouncing off its 10-day moving average, whilst GBP/EUR looks primed for its first weekly loss since mid-April.
So, rather than the pound benefiting from a more attractive yield appeal and GBP/USD climbing towards $1.30, it is the possibility of higher borrowing costs increasing recession risks that traders are currently focusing more on. Therefore, the pound, as it typically has done in this tightening, may be primed to weaken whether we see a 25- or 50-basis point hike today.
Powell pushing for more hikes
Federal Reserve (Fed) Chair Jerome Powell sent a strong signal to markets in his testimony before congress yesterday, confirming his bias towards continuing to raise interest rates. The recent string of better-than-expected data releases for the US economy – especially the recovery of the housing market – seem to have put the July hike back on the table, with markets pricing in a 77% probability of a rate increase. European equities are set to begin the day on weaker footing, after the S&P 500 recorded its fourth consecutive daily slump, following Powell’s comments.
Strong consumer spending and a resilient labour market have pushed out recession calls for the US and have put the possibility of a soft landing back into some investment outlooks for the second half of 2023. Retail sales have hovered around all-time highs and are currently around 15% above their pre-pandemic levels. However, the data would have to hold up until September for the Fed to consider moving a second time after its pause in June. With all three stimulus checks (2020, 2021) having been depleted and total savings back below a $1 trillion – a $1.27 trillion shortfall from the trend line – spending might face some headwinds going forward. It is interesting to see how the growth rate of retail sales has slowed at the same time that savings bottomed around Q3 last year. The consumer, labour and housing markets will be key factors determining if the recession occurs and how shallow or deep it will be and how far the Fed will have to go.
The US Dollar Index is currently following risk sentiment more so than yields. While rates have tended to slowly price in the higher for longer narrative, stocks have enjoyed a significant rally in recent weeks. This positive risk taking has come to the detriment of the Greenback, which has fallen three consecutive weeks. The triangle formation that has formed since October now gives us a trading range between 101.60 and 104.50 with DXY currently trading at 102.10.
EUR/USD below $1.10 as stocks turn south
The European Central Bank (ECB) raised interest rates by 25 basis points last week to a 22-year high against the backdrop of stickier than expected core inflation and a resilient labour market. However, the June hike was the first time in history that the ECB tightened policy during a time when the Eurozone was in a recession. The mix between inflation and economic data will be key in determining how high the terminal rate in Europe will have to rise.
Different members of the Governing Council have different opinions on that matter. French governor Francois Villeroy de Galhau warned investors and economists last week not to jump to any conclusions regarding the next rate hike. While markets have gone ahead in pricing in two more rate increases from the ECB, with the terminal rate now at close to 4%, Villeroy emphasized the important of the duration and not the peak of the tightening cycle. Against the backdrop of headline inflation falling, holding rates constant should be enough to produce a positive real rate. Bundesbank chief Joachim Nagel had a more hawkish agenda in his latest speeches, calling a premature pause a first order error.
Both the ECB, BoE and Fed have shown their hawkish side in recent weeks. The euro has therefore been more driven by positive risk sentiment and the Fed pausing its tightening cycle in June. While talking about raising rates is easy, markets still seem to be unconvinced of rate hikes occurring in the US beyond July, in contrast to pricing in the Eurozone and United Kingdom. EUR/USD is inching closer to the first resistance at $1.1000-$1.1050, defined by the downward trend line that started in May 2022. However, with stocks falling this week and Powell set to continue his senate testimony today, upside could be limited in the short term.
Pound stumbles as recession fears grow
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: June 12- June 16
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
