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Is the Bank of England set for a hawkish tilt?

Bank of England set for hawkish tilt

It turned out to be a rather disappointing session for markets in Europe yesterday, falling back for the first time this week. US markets also had a lacklustre session, although the Nasdaq and Russell 2000 finished the day higher.

The market tantrums of the last few days still appear to be tempering the upside and introducing an element of caution, as investors start to look towards the end of the quarter and the outlook for employment, as well as inflation.

Today’s European open looks set to be a similarly cautious affair with the main focus today set to be on the latest weekly jobless claims data, and the latest decision from the Bank of England.   

In light of recent events and the slight shift in the Federal Reserve’s stance on the timeline of a possible rate rise, today’s Bank of England meeting could have the potential to mark a similar shift in timing with respect to the withdrawal of its own monetary policy emergency measures.

When the MPC last met in May the mood was notably more upbeat than was the case at the start of the year, with the bank raising its annual GDP forecast for the UK economy from 5% to 7.5%. The data since then has improved even further with yesterday's flash PMI numbers showing rising orders, as well rising input prices which look set to push inflation pressures up even more than they already are. The bank also took the decision to announce it was reducing the amount of bonds it was buying on a weekly basis to £3.4bn.

Governor Andrew Bailey insisted that this was an operational decision, and designed to give the Bank more flexibility, and not a tapering of asset purchases, however it’s hard to describe it any other way. If it walks like a duck and quacks like a duck, it’s a duck, and it would be hard to imagine the Bank of England embarking on such an action if the economy were struggling, as opposed to about to start on a growth spurt. Recent economic data has reinforced this optimistic outlook, and while there is some disappointment around the extension of some restrictions into July, this merely pushes any resultant economic rebound into July and August, assuming there aren’t any virus variant setbacks.

On the unemployment front the bank also revised its estimates for that to the downside, although they acknowledged the headline rate still has room to move higher as furlough measures get eased back.  Furthermore, it is also Andy Haldane’s last meeting as chief economist and he could well go out with a bang given his recently articulated concerns that the UK economy probably needs a tap on the brakes in case it careers off the road. In May he was alone in voting to reduce the scale of the ongoing asset purchase program to £100bn, from £150bn, and he’s likely to do the same again, or even be more aggressive in his calls for others to go the same way.

His comments that the recovery is going “gangbusters” has seen markets start to price in the prospect of a rate hike in 2023, a not unreasonable position given that rates are still well below the levels they were at the beginning of 2020. Haldane’s departure along with the appointment of former Citigroup chief economist Catherine Mann to replace Gertjan Vlieghe in September should introduce an interesting new dynamic to Bank of England policymaking over the next few months, with the potential, if the data continues to improve at its current rate, that the Bank of England might have to start tapering in earnest before the Federal Reserve.

In the US the latest weekly jobless claims are expected to fall back below the 400k level after unexpectedly jumping to 412k last week.

US banks are also expected to be in focus as the Federal Reserve releases the results of its latest round of stress tests on the US banking system. Last year the central bank stopped all bank buybacks and dividends to ensure the US banking system had enough to cope with the economic fallout from the various lockdowns and restrictions placed on the US economy. At the start of this year that rule was altered so that banks that passed the various stress test scenarios could resume this process on a limited basis.

All US banks that pass these latest tests will see all of these restrictions lifted from June 30th. JPMorgan Chase has already started down this road when at the end of its Q1 it announced it would be restarting its own $30bn buyback program. With bank earnings season for Q2 set to get under way in the coming weeks all eyes will be on which US banks pass this week’s stress tests and which ones will look to resume shareholder pay-outs on a more generous basis.

Before one gets too carried away it is noteworthy that JPMorgan has warned that its revenues and income for Q2 could well fall short of the levels we saw in Q1 as a result of lower revenue from its trading division and lower credit card balances. CEO Jamie Dimon also warned the bank was looking to build up its cash levels over concerns about higher inflation. This could also limit the scope of returns to shareholders in the medium term.    

EUR/USD – continues to consolidate above the 1.1850 area, but need to move back above the 200-day MA to kick on higher. Monday’s key day reversal needs to see the 1.2000 area for upside momentum to be maintained. Below 1.1840 suggests a move to the 1.1704 level.

GBP/USD – wasn’t able to overcome the 1.4000 area yesterday after the rebound from the Monday lows. A break above 1.4020 opens up the 1.4080 area as well as 1.4130. A break below 1.3780 suggests the potential for a move back to 1.3670.  

EUR/GBP – still looking soft with potential for a move towards the 0.8480 area. We have resistance at the highs of the last few days at 0.8600.  

USD/JPY – has continued to edge higher with the prospect of a move towards the 111.70 area on a break above 111.00. A move below trend line support now at 109.90 opens a move back towards the 108.60 area on a break below 109.20.

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