The BoE raise the stakes – Sterling Update

GBP

The decision by the BoE to hike UK interest rates by 50bps to 5% yesterday surprised many in markets and beyond. Markets had priced in a 25bps hike, and the fact that the BoE had given no forward guidance on a potentially larger hike, had many analysts settling on the 25bps move. However, the BoE decided to go bold now given evidence of persistent inflation, news of which had been confirmed just a day before. In fairness to the BoE, they hardly had much of a window to flag a larger hike. Understandably, the BoE also said that they are likely to hike rates further moving forward. The BoE’s terminal rate is now expected to move over 6%. Tough times ahead.

Whilst the likes of the EU and especially the US, have seen much bigger declines among inflation of late, the latest data confirmed that UK headline inflation remained stuck at 8.7% during May, the same level as last month and considerably higher than the 8.4% that had been expected among analysts. Worse still, Core inflation (which removes food and energy prices) rose from 6.8% in April to 7.1% last month.

Prior to the inflation report, markets had already been primed and somewhat rattled by the sudden growth in wages highlighted in the latest unemployment report last week. Higher wages feed through to higher inflation as consumers spend more (see the bottom of the GBP section for evidence), with wage growth in particular being further impacted from the impact of Brexit on labour shortages, as companies have been forced to pay more for workers.

Even before Thursday’s big BoE move, interest rates had already been having a materially damaging impact on the UK property market. With this in mind, Jeremy Hunt called for a meeting with major lenders today (Friday), to assess the state of the mortgage market, after a recent surge in borrowing costs. His move came after the average two-year rate climbed above 6% on Monday. However, Hunt ruled out government help on mortgages and suggested that ‘we won’t do anything that will prolong the inflationary agony that people are going through,’ given that pumping more money into the system would likely just help to accelerate inflation. Therefore, it seems unlikely that Hunt will be unable/unwilling to offer any form of assistance as it stands.

Ordinarily, higher interest rates also feed into higher currencies, but the pound wobbled after the big 50bps move, with markets seriously questioning whether the newly aggressive stance from the BoE will send the UK economy into a tailspin and a potentially damaging recession. GBP/USD had traded as high as 1.2840 as the news broke from the BoE, but quickly slipped back to below 1.2750. Likewise, GBP/EUR slipped further away from the 1.1700 region, a move further impacted by the surge in EUR/USD beyond 1.1000 (see EUR).

Whilst the data had clearly been obtained before the BoE hike, the latest GfK Consumer Confidence survey (up from -27 to -24) and Retail Sales data highlight a more robust consumer. Retail Sales increased by 0.3% during May, following on from a 0.5% rise during the previous month, and well ahead of a -0.2% decline.

EUR

EUR/USD rallied over 1.1000 earlier in the week, albeit temporarily, for the first time in roughly a month and a half. Aside from the US side of the pair, helping to drive Euro gains have been the constantly hawkish outlook on rates among key ECB members. Christine Lagarde suggested that a July hike is likely, and although inflation has declined to Around 6% in the region of late, the ECB are still a country mile away from their 2% target level, hence the ECB’s commitment.

As we have highlighted on many occasions beforehand, the regional economy looks to be struggling against higher rates, with Germany and the region as a whole recently slipping into a recession. Whilst a little on the thin side this week, incoming data has hardly helped to change that dynamic, as Construction Output declined (once again) over the past month, although there was a slight beat in Regional Consumer Confidence, which improved from -17.4 to -16.1 on a preliminary basis during June. Today’s (Friday) PMI surveys among the region should give evidence of ongoing manufacturing weakness. Next week sees the release of the inflation data throughout the region, as well as key German Retail Sales and the latest IFO survey. As always, inflation is the big one to watch.

Back to the single currency, and further attempts at a more sustainable break over 1.1000 could be forthcoming if the ECB maintain their hawkish narrative and we see evidence of improving European data combined with the possibility of a broadly weakening dollar.