Markets
The Bank of England did what it was expected to do. After delivering a 50 bps rate hike in a 8-1 vote, the biggest in 27 years, the policy rate now stands at 1.75%. Inflation intensified, amongst others due to near doubling in gas prices. But domestic price pressures remain strong too owing to a tight labour market and low unemployment. Wage growth is expected higher than was forecasts in the May report, adding to the risks of a price-wage spiral. Inflation should peak in Q4 this year at more than 13% compared to the 10% in May and will stay at very elevated levels in 2023 (9.5% y/y in Q3). It should drop materially into 2024 to 2% in Q3 and to 0.8% in three years’ time. This is assuming a market implied peak policy rate of 3%. While this used to be a signal from the BoE that markets are pricing in too much tightening (since 2025 inflation is well below target), this is not the case today. Given high uncertainty, the BoE said its putting less weight on the implications of the assumptions made and even its own forecasts. Instead, it let data guide them in deciding which the next move is going to be. This could be another 50 bps in September but it might just as well already return to 25. The MPC’s economic assessment was nothing but grim. It projects the UK economy to enter into a recession in Q4 all the way through 2023. Real household income is projected to fall sharply in 2022 and 2023 in the worst squeeze in living standards in more than 60 years while consumption growth turns negative. Aside from the rate hike, the BoE also decided on quantitative tightening. It will start selling gilts shortly after the September meeting. In the first 12 months, it plans to shrink the balance sheet by £80bn. Taking into account the natural roll-off, this implies a quarterly £10bn of active sales. The strategy is subject to an annual review.Gilt yields fell off a cliff in a knee-jerk reaction. Moves went as deep as 11 bps for the 2y (or 18 bps even from an intraday perspective). But that changed fast. Markets assume there’s no other option for the BoE to hike further with inflation expected at such high levels. The eventual damage for Gilt yields ranged from -1.3 bps (2y) to -3.2 bps (10y). The steep drop in UK yields caused knock-on effects on European and US bond markets but there too the move (partially) reversed. German yields ease between -2.6 bps and -5.4 bps. A 4 bps drop in US yields retraced about half of those losses, with the wings underperforming the belly of the curve. The British pound, having anticipated today’s move quite in advance, reacted negatively. EUR/GBP jumped from 0.837 to 0.842. Cable (GBP/USD) retreated to 1.21. EUR/USD is eking out a negligible gain and still switches hands sub 1.02. News Headlines
The ECB started publishing the result of its Consumer Expectations Survey, a questionnaire targeting consumers in 6 EU core countries which the central bank started conducting since April 2020. According to the June edition, consumers expect inflation one year ahead still to be 5%. Three years from now, median inflation expectations are at 2.8%, above the ECB’s 2% target. Interestingly, they’ve estimated price increases over the past year up until June to be lower than they actually were (7.2% vs 8.6% HICP). Regarding the economic outlook, households believe the economy will shrink 1.3% in the year ahead while the unemployment rate is seen ticking higher to 11.5%, a significant increase compared to the actual 6.6% today.
The Czech National Bank at the meeting today decided to keep policy rates unchanged at 7%, defying market and analyst expectations for a 25 bps move higher. It’s the first meeting of the CNB in its new composition and with Ales Michl at the helm. Following the decision, Czech money markets assume the current rate to be the terminal one with rate cuts starting around this period next year. Czech swap rates tumble up to 14 bps at the front. The Czech crown in a first reaction lost minor ground, with CNB FX interventions probably capping losses, before staging a remarkable strengthening move that went as far as EUR/CZK 24.50.
