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Will a cautious Bank of England disappoint markets?
In the latest instalment of our “Thoughts of an FX Trader” article series, Head of FX and Interest Rates Trading Demitri Theodosiou looks at the tightrope central banks are walking between balancing faltering economic growth and accelerating inflation.
Following the long bank holiday weekend, a few faces in the office have a suntan after spending some of Saturday in the glorious sunshine. The Theodosiou family, while unfortunately not spending the afternoon at the local pub, did at least manage to get out of the house and walk with the kids to the local playground. My boys are nearing five and seven years old and are becoming little thrill seekers, wanting to be pushed higher or harder on swings and roundabouts.
It’s an interesting balance, hearing the infectious laughter of your child as they fly through the air or whizz around and around, but seeing their knuckles turn white as they cling on for dear life. I know from experience how much it hurts if they lose control. Fortunately, there were no such problems on Saturday, but I certainly paused for a moment, pushing my youngest on the swing as he yelled: “higher, higher.” Knowing his tendency to lose interest, I feared he might randomly try and get off the swing while flying two meters in the air!
As we move into a very big monetary policy week for both the US and the UK, it makes me think of the phrase “swings and roundabouts”. Defined as a situation in which different actions or options result in no eventual gain or loss – something that this week couldn’t be further from the truth. Across the pond, Federal Reserve members have realised they are behind the curve with inflation. With a backdrop of a strong labour market and robust economic performance, the question on Wednesday isn’t “if” but “by how much” will the Fed raise interest rates.
Federal Reserve members have realised they are behind the curve with inflation.
However, a 0.25% move would be a disappointment. So would a 0.50% increase accompanied by a dovish tone, as the market is looking for the Fed to play catch up. In fact, at the time of writing, an additional (yes, additional) 2.5% worth of hikes is priced into US interest rates by the end of the calendar year after a string of hawkish remarks. Little surprise, the US dollar has been rampant, particularly with a risk-averse backdrop of the conflict in Ukraine and tumbling stock markets. That has pushed the euro down to $1.05 and the pound below $1.25 as investors were caught wrong-footed.
It is a slightly different story for the UK on Thursday at the Bank of England’s Monetary Policy Committee (MPC) meeting. While financial markets expect the UK to raise interest rates by 0.25% on Thursday, which would be the fourth consecutive rise, it may be more of a “reluctant” hike. While we’ve all seen the headlines about runaway inflation, rising energy price caps and skyrocketing food bills, economic data has been less buoyant. In fact, GfK’s measure of UK consumer confidence fell to -38 in April, the second-lowest reading on record (the lowest was July 2008 at -39), while the Office for National Statistics said UK retail sales fell by 1.4% in March on the month as a potential cost-of-living crisis starts to bite.
The Bank of England has a difficult job ahead of it – inflationary pressures from external factors are getting higher and higher, much like my boy did on his swing this weekend. And with the cries of “higher, higher” ringing in the ears comes the knowledge that too much intervention could see a damaging fall to the economy, as it would with my son. The MPC will know that stronger inflation will erode household spending power and – much like I did on Saturday – may opt for a small reluctant move with cautionary rhetoric attached, leaving sterling bulls a little disappointed.