Published: 21/07/2022 By ECAPSterling largely brushed aside yesterday morning’s stronger-than-expected UK inflation print. While the core measure of inflation is showing signs that it may have peaked, the continued sharp increase in food and energy prices has driven the headline rate to fresh multi-decade highs. The cost of living crisis presents the biggest downside risk to the UK economy during the remainder of 2022, and markets suggest that tougher action is warranted from the Bank of England at upcoming MPC meetings. Governor Bailey warned on Tuesday that policymakers would consider a 50 basis point interest rate hike at the August policy meeting. Investors are finally coming around to this view, although with a 50 bp hike yet to be fully priced in by swap markets, analysts suggests that there remains room for a recovery rally in sterling from current levels.
Markets will also be on tenterhooks ahead of this afternoon’s European Central Bank meeting. The ECB is guaranteed to raise interest rates for the first time in more than a decade today, finally following in the footsteps of almost all of its major counterparts in the current cycle. Headline inflation in the Eurozone has continued to far exceed expectations, and has shown no signs yet of easing, rising to 8.6% in June. This could encourage policymakers to front-load the pace of tightening, particularly given the inflationary implications stemming from a weaker euro.
Aside from the rate decision itself, markets will be paying close attention to details on the bank’s new anti-fragmentation tool. There is an expectation that additional details on how the ECB plans to close peripheral bond spreads will be announced this afternoon - a failure to do so will be seen as a big disappointment to markets and may lead to a weaker common currency. Should the ECB convince markets of its ability to calm the situation in the bond market, and accompany this with a 50 basis point rate hike, then the euro would likely rally hard.