As expected, the US Federal Reserve raised rates by 50 basis points (bps), pushing the upper bound of the funds rate to 1%. There had been talk that some on the committee were keen on a 75bps move, however these concerns came to nought with all on the FOMC agreeing to a 50bps move.
Moreover, the central bank laid out the start of the balance sheet reduction programme, starting with $47.5bn in June, rising to $95bn a month after three months. This could be construed as being on the dovish side, given that they were starting the programme from a lowish base and then ramping up, rather than going for $95bn straight out of the gate.
At the press conference Fed chair Jay Powell put some flesh on the bones of the announcement by insisting that the Fed had no intention of going faster than 50bps in a single month, firmly burying any prospect that the Fed would be much more aggressive in subsequent months. He specifically made the point that a 75bps hike wasn’t something the FOMC was actively considering.
This policy stance was much less aggressive than some of the more hawkish scenarios that the markets had feared, helping to act as a drag on the US dollar, pulling it back sharply from its 20-year highs, while yields also fell back sharply, especially at the short end. Banks are likely to welcome this as the yield curve steepens.
We also saw US equity markets rally strongly in the aftermath of the press conference, with the S&P 500 and Nasdaq 100 both finishing 3% higher, which in turn is likely to see markets here in Europe open strongly higher this morning, despite a plunge in Chinese economic activity in the services sector as the Caixin services PMI plunged in April to 36, a two-year low.
With the Fed decision firmly in the rear-view mirror, Fed policymakers now have the freedom to start articulating their own version of last night's events, with some of the more hawkish members like St. Louis Fed president, James Bullard, likely to pour cold water on some of last night’s positive narrative.
Until then we can look towards the Bank of England later today, with the hope that they won’t derail the rebound we saw in the pound last night as the US dollar slid back. With UK inflation already at 7% in March and set to go even higher, the Bank hasn’t got an easy task, especially given the plunge seen in retail sales during the same month.
We already know that some on the MPC are concerned about the negative impact a further rise in interest rates might have on demand in the UK economy, and fragile consumer confidence. This was a factor cited by Jon Cunliffe at the last meeting, when he voted to keep rates on hold, but it’s also hard to ignore the impact rising prices also has on those factors.
Rising prices are becoming embedded in the price of clothing, furniture, food, drink and restaurants, while a sinking pound has served to add to that upward pressure on prices. Cunliffe can worry about a rise in interest rates all he likes, but if the pound continues to fall, the upward pressure on inflation will increase further. Raising rates may be the least bad option, nonetheless Cunliffe could well be a dissenter, along perhaps with Silvana Tenreyro, to any decision to hike today.
With input prices at 19.2%, further upward pressure in headline inflation is coming, and the Bank of England is likely to be faced with little choice but to raise rates, if only to keep pace with the Federal Reserve to maintain rate differentials, and help to push the pound back up to $1.3000.
Some may argue that the Bank of England could get away with raising rates by 25bps incrementally, and that might work given the dovish reaction to last night’s Fed decision, but it would need to be combined with firm forward guidance, along with a commitment to continue raising rates in subsequent months, along with a timetable for quantitative tightening. A tentative and weak approach would not work, and would only send a signal that the central bank is weak in undertaking to meet its inflation target.
The bigger risk for today is if the UK's central bank does nothing, with a minimum expectation of a 25bps rise to 1%, but an outside chance we could see a 50bps move to 1.25%.
Before the Bank of England decision, the April services purchasing manager index (PMI) for the UK is expected to be confirmed at 58.3, a sharp slowdown from March’s 62.6. US weekly jobless claims are expected to come in unchanged at 180,000.
EUR/USD – still above the lows of last week at 1.0470, with the next target a potential retest of the 2017 lows at 1.0340. To alleviate the risk of a move towards parity we need to see a move back above the 1.0820 area.
GBP/USD – holding well above the 1.2412 lows of last week for now. We need to see a move back above 1.2630 to suggest a retest of the 1.2830 area, or risk a move towards 1.2250.
EUR/GBP – still has resistance at the 0.8470/80, with support at the 0.8360/70 level. Still in the wider 0.8200/0.8500 range with support also at 0.8320.
USD/JPY – appears to have run out of a bit of steam at 131.25 but is now on course for a potential test of the 135.00 area, and 2002 highs, while above 129.20.