Markets
The Bank of England did what it was supposed to do: raise rates. The MPC agreed on a 5-4 basis for a 25bps hike to 0.5%. The four members voting against were actually in favour of a 50bps bump! Bringing the base rate to 0.5% means the BoE seizes to reinvest proceeds from maturing government bonds. The central bank will also start actively selling from its £20bn big corporate bond portfolio. High inflation is the obvious driver. Price increases are now expected to peak at 7%+ in April. That’s 2 ppts higher compared to the November forecast. Inflation is expected to ease over time on the assumption of stabilizing energy prices, easing supply chain pressures and a decline in tradeable goods prices. Wage growth will strengthen further over the coming year before easing from 2023. This follows a loosening in the labour market as UK GDP growth is expected to slow to subdued rates beyond the near term on the adverse impact of high inflation on UK income and spending. The unemployment rate may rise to 5% by 2024 and excess supply may build to 1%. Growth was revised down to 3.75% (-1.25 ppt) in 2022, 1.25% (-0.25 ppt) in 2023 and 1% in 2024. Short-term though, more tightening is needed. Based on current market projections of the policy rate hitting a 1.5%/1.75% peak by mid-2023, the BoE sees inflation still above 2% in 2023. It won’t be until 2024 before inflation eases back towards/below the 2% target (1.6%). UK yields spiked on the decision on the fact that a 50 bps hike was such a close call. Changes range from 13 bps (2y) over 11.3 bps (10y) to 8.4 bps (30y). Markets now believe the policy rate may hit 1% already in May, triggering the next normalization phase of quantitative tightening sooner. This may explain why long tenors are also rising this sharply. Sterling gets bid with EUR/GBP hitting an intraday low just shy of the crucial 0.8277 support. The pair quickly pared some of those knee-jerk losses to change hands still north of 0.83 ahead of the ECB and even gained afterwards to 0.838 on genuine euro strength.
The European Central Bank as expected hasn’t changed anything to policy (intentions). PEPP will be put to bed end March. APP will be raised to ensure a smooth transition before returning to the original buying pace in Q4 2022. Based on current guidance, this excludes the possibility of a 2022 rate hike. But. President Lagarde hinted this may change in March, saying that they will be looking in close detail to the inflation drivers, the upward risks surrounding it and its impact given the “unanimous concern” on current developments. She(rlock) noted the situation has changed and that it needs to be reassessed based on the data. Policy goals are “much closer to target”, she added. Lagarde also refused to repeat that an interest rate hike is “very unlikely in 2022” when explicitly asked to neither did she want to tell markets they were ahead of themselves. Those same markets got all the confirmation they wanted from the central bank and steam on. A first 10 bps rate hike is discounted for July already with a total of almost 30 bps more hikes priced in this year. Short-term European swap rates soar 10 bps (2y) to 12.5 bps (5y). The complete curve briefly hit positive territory for the first time since 2015. Since the ECB sticks to the official forward guidance, net bond buying needs to end quickly (in the summer?!) for rate hikes to happen. This launches the longer tenors as well up to 9.3 bps for the 10y. Peripheral spreads rise. Italy (+7 bps) underperforms. The euro is unchained: EUR/USD jumps more than a full big figure intraday to test the 1.14 big figure. European stock markets turn red on the clearest sign of European monetary policy finally being normalized.
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The Czech National bank raised the policy rate by 75bps to 4.50%. The move was expected by most analysts, but there was an outside risk of 100bps, as some expected frontloading tightening which would allow the CNB to stop the cycle sooner. Inflation strongly outpaced the 2% (+/- 1%) target, printing at 6.6% in December. Central bank members indicated risks for inflation to move near 10% in the first months of 2022. Governor Rusnok holds a press conference later today and the CNB will update and comment quarterly economic forecasts tomorrow. The koruna touched the strongest level against the euro in more than 10 years near EUR/CZK 24.10 before the decision, but currently again trades in the 24.20 area.
