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RBA raises cash rate by 0.5%, as inflation concerns return to the fore

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European markets started the week very much on the front foot as did markets in the US, after a positive lead from Asia markets which were boosted by the continued relaxation of covid restrictions in Chinese cities, which for over two months have acted as a brake on sentiment.

As the US session progressed, the move above the 3% level on the US 10-year yield, saw the gains in US stocks start to slow, as we got a pull back from intraday highs. This pullback has translated into a softer European open, as once again investors fret about how high rates might go.

Once again, the sensitivity of US stocks relative to US yields above 3%, has served to temper upside momentum, with markets once again sensitive to the inflation narrative, and how central banks are likely to react to more persistent inflation pressure.

Earlier this morning the RBA followed up on its decision to hike rates in May by 25bps to enact a further increase in borrowing, raising the headline cash rate by 50bps, in a move that beat consensus expectations.

General expectations had been for a 25bps move which always seemed a little half-hearted. It’s been clear for some time the RBA is behind the curve, especially since the RBNZ has been so aggressive, in its attempts to curb inflation, so today’s move by 50bps to 0.85%, shouldn’t have been a surprise and sends a message that they are concerned about that, and are determined to get out in front of it. The Australian dollar jumped, along with yields.

Today’s move also reinforces the determination of Governor Philip Lowe to get the cash rate up to 1.5% by year end.

There was little in the way of a reaction by the pound to the outcome of yesterday’s confidence vote in Prime Minister Boris Johnson. Markets are more concerned about the direction of the UK economy and the Bank of England’s attempts to address it.  

Economic activity in the UK services sector plunged in May after the flash reading slipped to a 15-month low, from 58.9 in April to 51.8, a number which is set to be confirmed this morning. It doesn’t take a magician to work out why, as the combined effect of surging energy prices, and tax rises starts to curtail economic activity.

The increase in energy prices by 54% would have been bad enough, but the decision to raise taxes was also very much a self-inflicted wound on the part of the government.

The decision to restore VAT rates on business to 20% from their covid-reduced rates would have been difficult enough under normal circumstances, while supply chain issues are adding to the problems facing businesses in the UK.

These problems have been compounded by the inexplicable decision to go through with the decision to increase NI tax rates, thus adding further to the burdens being faced by the UK economy.

The decision in May by the Chancellor of the Exchequer to add further fiscal support could mark the low water mark for the services sector in this regard, while the platinum jubilee celebrations could also add an uplift in the June numbers.    

EUR/USD – currently struggling below trend line resistance from the highs this year at 1.0760.  A move below support just above the 1.0640 area, which while it holds keeps the potential for a move towards 1.0850. A move below 1.0640, opens up the 1.0530 area.  

GBP/USD – rallied off support at the 1.2450 area and the lows last week. A break below 1.2450 argues for a move towards 1.2320. While above support from last week lows, we can see a move back above 1.2550 towards 1.2630.  

EUR/GBP – slipped back from resistance at the range highs near 0.8600 yesterday. We have trend line support from the April lows currently at 0.8480. A move below 0.8470 retargets the 0.8420 area.  

USD/JPY – moved above the recent highs at 131.35, putting us on course for a move towards the 2002 peaks at 135.00. Only a move below the 50-day MA, undermines upward momentum and argues for a move lower towards the 123.00 area.

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