A hawkish ECB – Sterling Update

GBP

The bank of England raised UK rates yesterday by a further 50bps, moving the base rate to a 14-year high of 3.5%. Whilst the 50bps move was completely priced into markets, the 9-member BoE voting pattern was a surprise to markets, given that there appears to be a fairly broad opinion amongst MPC members. Six members voted for the preferred 50bps move, with two opting for no hike and one member thinking that 75bps would be the right choice. In his post-meeting conference, BoE head Andrew ‘honest’ Bailey said that ‘I know raising interest rates has a real impact on people’s lives, but by raising interest rates we can bring inflation down sooner and help the economy begin to grow and prosper once more.’ The majority of MPC members also suggested that further hikes were likely ‘for a sustainable return of inflation to target.’

The current market-implied terminal (or end) rate from the BoE is at just over 4.5%, a level that has been on the decline of late, as markets re-evaluate the impacts of a weakening UK economy, and (thankfully) softening inflation, albeit at the margin for now.

The pound also declined after the BoE, with GBP/USD slipping from a 6-month high at over 1.2440, back to 1.2200. However, we were at that level just this Monday, so the move may well have been driven partly by position squaring as markets reduce risk and portfolio exposures into the holiday season. Next week is dominated by the latest growth figures, with Q3 GDP expected to have declined by 0.2%, as the UK slips into a recession. Indeed, this week’s data highlighted a slight increase in the overall unemployment rate from 3.6 to 3.7% combined with an unexpected jump in the claimant count of 3.5K. With average private sector earnings also increasing sharply, there is a lingering fear that companies will pass on higher wage costs through price increases, which could keep unwanted pressures on inflation. Next year therefore looks a tough one on paper for the UK economy, even if the pound continues to take its lead from broader dollar moves.

EUR

The ECB may have replicated the moves of the BoE, Fed and SNB this week, when raising Euro area rates by a further 50bps to 2.5%. However, the accompanying language from ECB Head Lagarde was far more hawkish than that of the Fed or BoE, as Lagarde & Co doubled-down on the ECB’s commitment to continue hiking rates, in order to combat surging inflation in the region. Lagarde stressed that ‘we judge that interest rates will still have to rise significantly and at a steady pace.’ She went on to say that further hikes of 50bps should be coming for ‘a considerable amount of time.’ That last line really caught our attention.

Markets were themselves caught slightly off-guard by the brazen hawkishness of Lagarde, just as much as Lagarde & Co were caught out by the surge in Euro area inflation earlier in the year. However, those who turn-up late to the party are often the last one’s dancing, and the ECB will take our honesty award from the BoE, as they look to continue with their hiking cycle, even though recent data has reflected a slight drop in Euro area inflation. Saying that, both German (11.3%) and Spanish (12.6%) inflation remains sticky, and that may have played a part in the ECB’s rather forceful language yesterday.

The market reaction to the ECB was fairly swift, with yields rising in key Euro area bonds and EUR/USD briefly moving over 1.0700 for the first time since the middle of June. Indeed, the gains for

the single currency were fairly broad-based, with GBP/EUR succumbing to Euro strength, and slipping back under 1.1500.

Interestingly enough, the latest Euro area inflation data is due out later today. Next week will be a combination of position-squaring heading into the holiday period, combined with mostly less-sensitive data releases, so expect the single currency to be driven by the broader dollar moves.