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Central bankers take markets by surprise

With political uncertainty still rippling through UK markets and economic data coming in on the weak side, the Bank of England caught everyone on the hop yesterday despite its decision to keep interest rate policy unchanged.

The consensus expectation was for an almost unanimous decision to keep rates unchanged, however in an unexpected development we got a significant split among policymakers about whether to hold or hike rates.

Three policymakers (all external members) voted to raise rates, after Michael Saunders and Ian McCafferty joined Kristin Forbes. Kristin Forbes is leaving at the end of the month, which means that the dissenters should drop back to two at the next meeting, but that does tend to assume that any new candidate will vote with the status quo. That is by no means certain given that there does seem to be rising concern on the committee about the recent jump in inflationary pressure.

UK index markets slump

As a result of this unexpected turn of events, the FTSE 250 underwent one of its worst one-day fall since last year’s Brexit referendum, sliding back sharply, with the FTSE 100 following suit on a day when equity markets across Europe also slid back.

Investors had already been digesting the fact that, despite recent weak US data, the US Federal Reserve appeared unconcerned about a slowdown in the US economy, as they announced another 25-basis-point rate rise, while at the same time outlining their latest plans to reduce the size of their balance sheet, potentially as soon as September, and their expectation that we would also see another rate rise this year.

These two factors combined, along with further weakness in the US tech sector, played into the risk-averse mood among equity investors, as they began to mull the possibility of tighter policy, not only from the Federal Reserve but also the Bank of England, not to mention the prospect of a discussion on tapering from the European Central Bank before the end of the year.

The main concern would appear to be the belief that central banks, and the Federal Reserve in particular, may be misreading the signals from the US economy at the precise moment that it might be starting to show signs of a slowdown, while equity markets are showing increasing signs of starting to roll over. For some time it has been suggested that the Fed could well be behind the curve in respect of its rate-hiking cycle, and it does appear to be a message that the Fed is worried about, to the point that they refuse to consider the possibility they may be acting too hastily.

US tech stocks under pressure

Bond markets certainly aren’t buying the latest narrative, even if the US dollar did move higher yesterday, with the line of least resistance still towards the downside for US yields. US stock markets also had a disappointing day, with the NASDAQ once again coming under pressure and on course to close lower for the second week in succession, as tech stocks saw further profit taking.

In Europe, the big news overnight is that Greece appears to have come to an agreement with its creditors on the next tranche of bailout money, as it looks to service a large chunk of debt which becomes due next month. Under the fudged deal agreed yesterday, the subject of debt relief appears to have been deferred on the basis of an agreement in principal to outline the type of measures that might be considered towards that end, and that these measures on the debt relief would also be linked to Greece’s growth rate.

Crucially the details of any debt relief measures would only become clear after the German elections, and that the IMF had agreed to participate on that basis, a classic fudge that avoids the problematic scenario of Germany having to take a decision that could cost Angela Merkel dear in terms of credibility, ahead of this September’s vote. The IMF appears to have ceded the principle that the primary surplus targets are unsustainable, as these are left unchanged at 3.5% a year for five years, and then 2% a year from 2023 until 2060.

Forex snapshot

EURUSD – a move below the 1.1100 area could well signal a double top reversal which could signal a potential move towards 1.1020 in the short term, and then 1.0900. Resistance remains back up at the 1.1300 area.

GBPUSD – while the pound remains below the 1.2820 area and the 50 day MA we remain susceptible to further losses. It currently remains corralled between this resistance area and support just above the 100 and 200 day MA’s as well as the 1.2635 area. A move through 1.2830 argues for a retest of the 1.2920 area.

EURGBP – we saw the euro slip back to the 0.8720 level after the bearish reversal earlier this week. This needs to hold to keep the uptrend intact. A move below here could well see a retest of the 200 day MA at 0.8615. Rebounds need to hold below the 0.8820 area.

USDJPY – the US dollar has moved back above the 200 day MA and could well return to the 111.60 area, and this month’s high. This still remains a key resistance area and as such we could still slip back towards this week’s lows at 108.80.

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