Pound reverses losses against euro and dollar as hawkish tips scare shorts

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The Monetary Policy Committee (MPC) of the Bank of England (BoE) raised interest rates by 25 basis points to 1.25% at the last meeting.

This is the fifth consecutive rate increase and the highest level since the start of 2009.

There was a 6-3 vote for the policy decision, with Haskel, Mann and Saunders voting for a bigger 50 basis point hike to 1.50%. These three had also backed a bigger rate hike at the May meeting.

The MPC signaled that further rate hikes were coming and, potentially, at a faster pace.

After the meeting, market expectations changed, with money markets signaling that rates will rise to 3.0% next year.

The yield on 10-year gilts also rose to over 2.60%.

The British pound initially fell sharply on the announcement and decision not to rise by 50 basis points, with the pound-dollar exchange rate (GBP/USD) sliding to lows just below 1, 2050. The exchange rate between the pound and the euro (GBP/EUR) also fell sharply to reach lows below 1.1600.

However, the pound quickly rallied as more hawkish forecasts triggered buying. Short coverage was also in evidence with the move exacerbated by very negative market sentiment in the decision.

GBP/USD made sharp gains above 1.2200 against the USD with a peak near 1.2250 before fading while GBP/EUR strengthened to 1.1720 in lows. volatile trading conditions.

bannerThe exchange rate between the pound sterling and the Swiss franc (GBP/CHF) was still significantly lower on the day at 1.1915 as the Swiss National Bank raised its rates.

The extent to which markets believe the BoE will be more aggressive in raising rates, as well as upcoming UK data releases, will be crucial for the direction of the pound.

Growth fears, but tight job market

There were reservations about the growth outlook, with bank staff now expecting GDP to contract 0.3% in the second quarter, weaker than expected at the time of the May report.

The MPC noted that the labor market is still tight with upward pressure on wages. He noted; “Recruitment challenges remained high and labor demand remained strong. Underlying growth in nominal earnings has also remained strong, and Bank officials report that bonuses have been used to address recruitment and retention issues.

The government’s fiscal support program will have a limited impact on the economy with a 0.3% increase in GDP and a 0.1% increase in inflation in the first year.

Inflation concerns escalate

Regarding inflation, the bank noted that there are significant risks from Ukraine, soaring energy prices and global supply difficulties.

The bank however added; “Not all of the excess inflation can be attributed to world events. Interactions with domestic factors also played a role, including the tight labor market and corporate pricing strategies.

The bank expects CPI inflation to be above 9% in the coming months and to rise slightly above 11% in October when the next increase in energy prices comes in. in force.

Substantial Hawkish change in BoE guidelines

Regarding orientation, he noted; “The magnitude, pace and timing of any further Bank Rate increases will reflect the Committee’s assessment of economic prospects and inflationary pressures. The Committee will be particularly attentive to indications of more persistent inflationary pressures and will act forcefully in response if necessary.

This was a significant change from the May meeting, when some members doubted rates would need to rise again.

A key question for the bank is whether domestic inflationary pressure will continue even if the downturn begins to open up in the economy.

The majority of the committee considers the data to be relatively limited since the May meeting and would like to take a stable approach at this stage.

Dissenters wanted a more aggressive stance with the minutes stating; “These members also felt that monetary policy should lean heavily against the risks that recent trends in wage growth, corporate pricing decisions and inflation expectations in the broader economy become more firmly entrenched. .”

Charles Hepworth of GAM Investments was skeptical of the directions; “Their commitment to act ‘with force if necessary’ seems a little laughable. The need is already there, with inflation expected to peak at 11%, but the Bank knows growth is slowing, so it cannot act as forcefully as it claims.

JP Morgan Asset Management’s Karen Ward says the Bank of England should have gone further to limit inflation expectations; “What he needed to do today was send a clear message to other price makers in the economy that 10% price increases are not an acceptable new normal. It had to show that it had not softened inflation or, in economic terms, to anchor inflation expectations.

She added; “In our opinion, a 50 basis point hike would have sent this signal instead. It is possible that by acting with caution today, he will have to do more later.

AJ Bell analyst Laith Khalaf added that markets would “no doubt take this as a sign that the Bank of England has bottled it up.”

Paul Dales, chief UK economist at Capital Economics, said the Bank of England should focus even more on inflation.

He notes; “By raising interest rates by 25 basis points today, from 1pc to 1.25pc, rather than the 50bps or 75bps announced last night by the Fed, we believe the The Bank of England places too much emphasis on the slowing economy and not enough on soaring inflation.

He added; “It hinted that it could still raise rates faster in the coming months. But either way, we think the Bank will have to raise rates to 3%.”

Vivek Paulat BlackRock Investment Institute We think market expectations for future UK rates will ultimately prove to be overdone. By the Bank’s own figures, recession is a real risk – and recent government initiatives to ease the cost of living crisis may prove insufficient to offset weak UK consumers.

He also pointed to the UK’s debt problems; “At the end of the day, the Bank has less leeway for hikes compared to the United States. The neutral interest rate – one that does not excessively stimulate or restrain economic growth – is lower, and the country’s high debt-to-GDP ratio implies greater sensitivity of debt servicing costs to rate hikes.

ING also considers that market expectations are too high; “The hawkish twist in the policy statement suggests a 50 basis point hike is entirely possible in August. But the most important signal here is that pricing a terminal rate near 3.5% l next year, markets are overestimating the tightening ahead.”

Less aggressive than the Fed

The BoE started raising interest rates earlier than the Federal Reserve, but the US central bank was much more aggressive in raising rates during the second quarter.

After Wednesday’s 75 basis point hike, US benchmark rates are at 1.75%, compared to 1.25% in the UK.

Chris Beauchamp, Chief Market Analyst at IG Group commented; “Once again, the BoE looks like the timid cat next to the Fed’s roar on inflation, with only a 25 basis point hike.”

He added; “The BoE board’s 6-3 vote in favor of a 25 basis point hike means that sterling bulls won’t have much to back any attempt to push the pound higher. against the dollar, and $1.20 will likely be tested one more time.”

Hetal Mehtaat of Legal & General Investment Management pointed to global pressures for more hawkish action and a bigger hike next time around; “The Bank of England finds itself between a rock and a hard place. Yesterday the Fed set a marker that inflation was its main concern, and the pressure facing the Bank of England will only increase from here as other central banks continue to act forcefully and inflation expectations soar.

Vanda FX Analyst Viraj Patel Maintains Bearish Pound Stance; “The BoE sees growth as a risk, so it didn’t rise this time. And if they need to rise further in the future, it’s because inflation is sticky and bigger rises are pushing up the risks of a recession in the UK. The UK is the archetypal stagflation trade.

TD Securities doubted there was a change in sterling sentiment; “We fear that higher rates will have a perverse reaction on FX. GBP weakness looks excessive but difficult to mitigate.

Marshall Gittler, Head of Investment Research at BDSwiss Group, commented; “The pound has tended to weaken after recent Bank of England meetings. It’s probably because of the caution some members have been showing. I expect them to be more aggressive during of this meeting and therefore the pound could shake this pattern.

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