Published: 01/08/2022 By ECAPSterling continues to move mostly in line with risk assets, and last week's stock rally buoyed it to the top of the G10 rankings, well ahead of both the dollar and the euro. The Bank of England meeting on Thursday is now front and centre for the pound. As of Friday close, interest rate markets were largely, though not fully, pricing in a 50 basis point move, with some investors betting on a 25bp hike. Therefore, it is a solid bet that Thursday trading will be volatile. We think it will be difficult for the MPC to buck the hawkish trend among G10 central banks and expect the larger move, with a consequent rally in sterling as a side effect. This rally may, however, be dependent on the voting pattern among policymakers, and the tone of communications in the bank’s latest Inflation Report.
Eurozone inflation once again surprised to the upside, validating views that ECB interest rate hikes have considerably further to go than interest rate markets seem willing to accept so far. However, the inflation print was overshadowed by the continued reductions in gas flow from Russia, and the announcement of various measures to reduce demand, which understandably are not viewed as euro-positive. Markets mostly overlooked last week’s GDP data, which posted larger-than-expected expansion, in favour of the doom and gloom energy headlines.
While it is true that the US economy has printed a slight contraction in two consecutive quarters, we would not call the current economic backdrop recessionary. The unusual combination of stalling growth, full employment and very high inflationary pressures prompted the Fed to de facto withdraw all forward guidance at its meeting last Wednesday, and announce that further moves will be data dependent. Friday wage and inflation data showed no sign that inflation is pulling back to desirable levels, and the high ECI employment cost index data bore increasing hints of a developing wage-price spiral. Markets now turn to Friday's non-farm payrolls report out of the US, expected to show yet another month of healthy job gains in a context of full employment.