This week we will see the response to the continuing rise in inflation from both the Federal Reserve in the US and the Bank of England closer to home, at their monthly meetings.
Both are expected to raise interest rates in what economists believe will be the start of a series of increases in the cost of borrowing as they attempt to put the inflation genie back in the bottle. However, both face the problem of second-guessing the impact of the war in Ukraine on economies. As oil prices rise, fears of a recession increase, and economists now have concerns that we could all now face a period of inflation and recession combined – so-called stagflation. Of course, overshadowing Central Bank meetings in London and Washington is the dreadful situation in Ukraine, and again this will dominate the markets, and we can only hope that some optimism returns soon.
Sadly, the financial markets were again dominated by the headlines coming from Ukraine. As risk sentiment ebbed and flowed, so did the currencies, with sterling falling as it soured and bouncing back when it improved. With the volumes traded in the GBPUSD generally less than in EURUSD, sterling tends to move especially dramatically against the euro when volatility is elevated. The last week was no exception, and sterling ended the week lower against the euro as the single currency recovered against the dollar. The euro was helped by the European Central Bank adopting a more hawkish tone than anticipated after its monthly meeting. Increasing worries over the rise in inflation, set to be exacerbated by the continuing jump in energy prices, was behind the change in the ECB’s rhetoric. Inflation also dominated US markets towards the end of the week after another rise in the Consumer Price Index to a forty-year high of 7.9%.
GBP: With the war in Ukraine showing little sign of having a peaceful resolution, the dollar will continue to stay in demand for its safe-haven status, keeping downside pressure on the pound. Conversely, if any sign of escalation becomes apparent, sterling could be one of the beneficiaries as it remains fundamentally underpinned by the prospect of rising interest rates. The Bank of England is likely to reinforce sterling’s underlying strength at its monthly meeting of its Monetary Policy Committee this coming Thursday. The Old Lady was expected to raise the cost of borrowing before the outbreak of hostilities in Ukraine pushed energy prices higher. Whether accelerating inflation will overrule fears of a recession will give the Bank pause for thought is unclear. The currency markets expect another .25% hike, the third in quick succession. After February’s meeting, it was revealed that four out of the nine committee members had voted for a .5% move. Consequently, there is speculation that we may see such a move this month. Following the MPC meeting, Andrew Bailey will hold a press conference to expand on the reasoning behind the Bank’s actions. Ahead of the MPC meeting, the most recent employment figures are released on Tuesday and following it, on Friday, February’s Inflation data is released.
EUR: As we said previously, the European Central Bank took the markets somewhat by surprise with its hawkishness after its meeting last week. The euro recovered some of its poise after the meeting; however, in the race to tighten policy, the ECB lags behind the US Federal Reserve and the Bank of England, leaving it at risk. With both the BoE and the Federal Reserve set to move rates upwards this week, the single currency could face a tough time made worse by the bloc’s proximity to the war in Ukraine. The only data due out in the Eurozone this week is Industrial Production data on Tuesday. But, with so much uncertainty over the cost of energy and its impact on industry, it’s unlikely that the data will move the market from being driven by geopolitical events.
USD: The Federal Reserve is the first of the two major central banks to host its monthly meeting this week when its members meet on Wednesday. The consensus seems to be for a 0.25% move upwards in the Fed Funds rate, although there remains the possibility, as in the UK, of a .5% move. Last week’s inflation print was close to 8%, and with it set to rise higher still, there will almost certainly be members of the committee who will favour the larger increase. Investors will also be watching out for the latest dot plot diagram detailing how Fed committee members see the course of interest rates in the coming year. The derivative markets predict six hikes in the coming year and will watch with interest to see if the Fed is in sync. As would be expected in these difficult times, Chairman Jerome Powell’s press conference will be significant in setting the tone for the markets. The week also sees the release of Retail Sales on Wednesday and February’s Industrial Production, and the weekly employment data on Thursday.