Shane O'Neill, Head of Interest Rate Trading
Sterling markets took focus over the last month with inflation and central bankers surprising markets. Inflation figures continue to be a concern – headline numbers came out higher than expected (8.7% vs. 8.4%) but perhaps even more worryingly, core inflation climbed to 7.1% vs. 6.8% expected. The UK is now an outlier amongst the US and EU where inflation figures have started to regulate. The figures came out the day before the BoE meeting, and heaped pressure on the MPC.
Going into the BoE meeting, market expectations were still skewed toward a 25bps hike but the MPC surprised markets with a 7-2 vote in favour of 50bps, taking the base rate to 5%. In his press conference, Bailey acknowledged that the price pressures would likely take longer to dissipate than they did to emerge . The larger than expected hike, the 7-2 split and Bailey’s comments made this an unequivocally hawkish meeting and as such rates expectations jumped.
Before the meeting, peak rates were expected to reach just under 6%, we are now looking at rates of 6.15% and staying comfortably above 6% well into 2024. It wasn’t long ago that this same MPC were all but guaranteeing that rates above 5.5% were unlikely due to the effects on the economy but here we are – as we discussed earlier this week (Bank of England Surprises) rate expectations over the last couple of years have continually shifted higher and with core inflation still climbing, it is increasingly difficult to say this is the peak.
In the US we saw headline inflation fall to its lowest level since March 2021, coming in at 4%. But core inflation remains stubbornly high at 5.3%. This slightly mixed bag of numbers may have led to the slightly mixed messaging coming out of the Fed meeting.
As expected, the Fed paused their hiking cycle, leaving rates at 5.25%. But in the press conference, Powell came across more hawkish – commenting that two further hikes this year may be required. These two hikes would bring us in the territory implied by the Fed’s own dot plot but would surprise markets, which are currently only pricing one more hike.
The ECB also came to market in the last month – as was widely expected they chose to hike by 25bps and bring the base rate up to 3.5%. Inflation data out of the Eurozone has shown positive signs over the last couple of months, with headline falling back to 6% from highs of over 10% and core inflation also showing signs of falling.
However, at her speech during the Central Bank Forum in Sintra, Portugal, Christine Lagarde laid out in very clear terms why pausing the hiking cycle at this juncture would be a bad idea. She gave a clear and concise description of the stickiness of inflation and suggested that hikes would indeed continue. A hike in July now seems all but assured and only in the meetings following this is there disagreement. Markets are pricing one more hike after July taking us up to 4%. Though if rates are to stop there it is evident Lagarde and her supporters would need to see significant improvements in the inflation situation
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