US markets finished the session lower after the Federal Reserve raised rates by 50bps as expected while adjusting up its expectations for rate rises next year. Despite the hawkish slant the market reaction has been fairly measured.
Asia markets have also slipped back with the latest Chinese retail sales and industrial production numbers painting a dire picture of the Chinese economy last month. Retail sales declined by -5.9%, much more than expected, as Covid measures hammered consumption patterns, while industrial production also disappointed, coming in at 2.2%, with the focus for European markets today on the Swiss National Bank, Bank of England and ECB, where we can expect to see 50bps rate hikes across the board.
When the Bank of England last met in November, they raised rates by 75bps then spent the entire press conference undermining that decision by expressing concern about the prospect of surging mortgage costs.
Behind all of that was the fact that the fallout from the UK gilt market volatility may have made them slightly more cautious about being too hawkish.
This seems a long time ago now, with the pound now much stronger since that decision was made. The key messaging in November was that rates were unlikely to go anywhere near as high as markets were pricing at the time, although they were still expected to rise, and that the UK economy was likely to face a 2-year recession. With inflation still well above 10%, falling back to 10.7% that seems a bold statement to make given the central bank's inflation target of 2%.
Given that a weak currency helps make the process of controlling inflation much more difficult the bank appears to have been let off the hook in the last few weeks by the weakness in the US dollar which has pushed the pound sharply higher to six-month highs this week.
This rebound of almost 20% from the recent lows will make the central banks job that much easier to help keep a lid on prices, assuming that they don’t blow it by being too dovish when they meet later today.
Unlike in the US and the EU there are fewer signs in the UK that inflation is near to a short-term peak, even as the economy slows sharply.
The weak economic outlook will play a part in today’s decision with the real possibility of a three-way split on policy, which will make the prospect of a clear message much more difficult.
We could see some policymakers argue for a 25bps hike as opposed to a 50bps move, while we could also see some push for a move of 75bps in order to front load the hiking process.
The odds favour a move of 50bps in line with the Federal Reserve last night, who while they dialled down to 50bps indicated that more rate hikes were on the way, with a hawkish outlook of at least another 75bps of rate hikes in 2023.
This probably shouldn’ t have been unexpected given the markets interpretation of this week’s inflation numbers. The Fed needs to keep market interest rate expectations in check, even as the data continues to support a slowdown in the pace of rate hikes, and while the Fed painted a hawkish outlook the move in yields suggest the market isn’t buying the narrative.
Soon after the Bank of England announces its decision we are followed by the European Central Bank, who are expected to follow suit in hiking rates by 50bps.
Last month ECB President Christine Lagarde went to great lengths to suggest that as far as they were concerned inflation probably hadn’t peaked.
While she could well be right, recent data suggests she probably isn’t.
In October we saw big falls in German and Italian PPI, while headline CPI in the EU also fell back sharply from the record highs seen in October of 10.6% to 10% in the recent flash CPI numbers for November.
A lot of ECB policymakers have expended a lot of capital in pushing the case for another 75bps rate hike this week, despite it being self-evident that the eurozone economy is slowing sharply in Q4.
While the likes of the Bundesbank and other northern European countries are pushing the case for more aggressive hikes, it’s more likely that we’ll see a slowdown from the ECB from the 75bps hikes we saw at the last two meetings to 50bps when they meet later today.
It’s unlikely that there will be a big enough consensus for anything more than 50bps over concern of what a more aggressive posture might prompt, particularly when it comes to the borrowing costs of countries like Italy.
It’s also difficult to see how much more the ECB will be able to do in 2023, given these same concerns, however as a sop to the hawks Lagarde might be slightly more hawkish in an attempt to push down inflation expectations.
What might save the central banks next year is that inflation does appear to be peaking, although we can still expect the weather to play a part as it has in recent days, where we’ve seen some bitterly cold weather push up demand and create energy usage spikes.
EUR/USD – continues to edge higher as we look for further gains towards 1.0800. Needs to hold above the 1.0520 area for this to unfold, with further support at the 1.0340 area.
GBP/USD – pushed through 1.2300 as well as the 1.2400 level as we look to head towards 1.2750. Still have support at the 200-day SMA at 1.2110, with interim support between 1.2260 and 1.2280.
EUR/GBP – slipped back to support just above the 200-day SMA but continues to hold above it. A break below 0.8540 opens up further losses towards 0.8480. Resistance at 0.8650.
USD/JPY – feels like we could be on course for a retest of the lows this month at 133.60, on the way to the 130.00 area. A move above 138.00 negates.