A tale of two central banks

World Markets

After the diversion of the central bank meetings last week, the week ahead is likely to be dominated by the geopolitical situation and the ramifications of the war in Ukraine.

Currencies will remain susceptible to sudden shifts in risk sentiment, which tend to benefit the dollar and will also be vulnerable to violent moves in the commodity markets. After breaching $130 a barrel, Oil has dropped back to lower levels; however, it is far from guaranteed that it will stay suppressed. Its moves will potentially impact energy importing currencies, particularly the euro. There are also potential shocks to the financial system as the sanctions on Russia continue to reverberate. So far, Russia has managed to make all the payments due on their dollar-denominated bonds, but there remains a risk of a sovereign default the like of which the markets have not witnessed before.

The Federal Reserve and the Bank of England unsurprisingly hogged the financial headlines last week. Analysts and the currency markets initially speculated on what the central banks would do and subsequently digested their actions. First up was the US Federal Reserve, which, as expected, raised interest rates by .25%, but what was a little surprising against the backdrop of the uncertainty caused by the war in Ukraine was how hawkish their tone was. The market is now expecting at least another six hikes in US rates this year. The Bank of England also raised rates by .25%, but they adopted a cautious tone in contrast to their fellow bankers across the Atlantic. The simple fact that one member of the rate-setting committee in the US voted to raise rates by .5% whilst one member of the equivalent in the UK voted to leave rates unchanged highlighted the different directions that the central banks are taking. Unsurprisingly the dollar ended higher over the week against sterling, and the euro also gained as investors started to doubt how much further UK rates would rise.

As we said previously, the Bank of England’s tone and actions were fundamentally cautious following its Monetary Policy Committee meeting last week. With so much uncertainty surrounding Eastern Europe and its effects on inflation and the economy, the Old Lady is understandably circumspect. Fewer rate increases are now expected, and the terminal base rate expectation has dropped to 2%. Consequently, sterling has fallen against the euro as the potential interest rate differential narrows and indeed, the European Central Bank approaches its own tightening cycle. This week, investors will assess whether the Bank of England is too timid when the latest inflation data is released on Wednesday with the Consumer Price Index, Producer Price Index, and Retail Price Index scheduled. Rishi Sunak delivers his Spring budget to Parliament on Thursday, and the preliminary, or flash, Purchasing Manager’s Indexes are released. A busy week for data concludes on Friday with February’s Retail Sales and the GfK Consumer Confidence report. It is also likely that Andrew Bailey or some of his fellow policy setters from the Bank of England will speak during the week.

The European Central Bank (ECB) sat on the side-lines last week and watched its peers raise rates by .25%. The ECB is caught between wishing to raise rates to contain inflation whilst worrying about a possible slowdown in the eurozone recovery. Last week most of the council members from the ECB aired their views, and it is starting to become apparent that they are also worried by the weakness of the euro, particularly against the dollar. Indeed Dutch central bank governor Klaas Knot, a council member of the ECB, said that further EUR/USD weakness would be unwelcome as Europe deals with an energy supply shock. He also suggested that interest rates may rise in the bloc towards the end of the year as he attempted to give the single currency a fillip. He was the most outspoken member of the council, but others also expressed their concerns. Tomorrow’s data docket is the EU Trade Balance, which will show the impact of the war on the bloc. On Thursday, Markit will release its flash Purchasing Managers Indexes for the eurozone and its constituent countries. We can also expect to hear more from ECB council members during the week.

The Federal Reserve and its Chairman Jerome Powell probably had the most straightforward job of the major central bankers last week as the US is essentially the least affected by any commodity shortages caused by the war. Compared to its peers in the UK and the eurozone, the US economy is also in better shape, with unemployment at historically low levels whilst 10 million vacancies exist. However, inflation is a problem, and last week’s interest rate rise was only the first of what potentially will be further increases at every FOMC meeting this year. No less than 15 speakers from the Federal Reserve are scheduled this week to explain their rationale against the backdrop of the ongoing geopolitical crisis, starting with Jerome Powell this afternoon. Data wise, there are Housing reports on Wednesday that rarely move the markets, but the following day has a full schedule, including Markit’s Flash PMIs, Weekly Jobless total and Durable Goods. The data week draws to a close on Friday with the release of the Michigan Consumer Sentiment Indicator. Finally, a friendly reminder that the time difference between the UK and the US remains at an hour less than usual till next weekend when we move our clocks forward.