MPC Highlights Inflation Concerns

“Rate hikes larger and sooner”

The Monetary Policy Committee of the Bank of England sounded a more hawkish note on inflation at its meeting yesterday. Despite the vote being 9-0 for unchanged rates, the comments made in the minutes and Governor Mark Carney’s press conference left analysts in little doubt over the Bank’s intentions for interest rates.

The interest rate futures market now predicts a 60% chance of a hike in June and are 100% certain of a hike in August. This move towards a more hawkish outlook may have driven a more violent reaction from markets than had been intended but “talking the currency up” has been a significant part of Central Bank’s toolbox for many years.

While Sterling remains strong and rising, it will have a positive effect on inflation that has now become the focus of the Bank’s efforts. In the Quarterly Inflation Report released simultaneously with the rate decision, the MPC unanimously agreed that they cannot tolerate inflation above the 2% target for as long as the next three years.

The pound initially rallied following the rate announcement and inflation report reaching 1.4067 before correcting a little as profits were taken by short term traders. It then fell further as the recent correction in equities started again, driving traders to safe haven currencies like the CHF and JPY.

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Carney ignores Brexit to concentrate on inflation

In his press conference yesterday, Bank of England Governor Mark Carney faced so many questions about the future path of interest rates and the Bank’s rate hike intentions, that Brexit was completely ignored.

Analysts searching for the line of least resistance completely failed to spot the clear intention of the MPC to deliver a statement that had a positive effect on Sterling given that rate hikes will be at a premium as the economy struggles with the headwinds created by the departure from the EU. No matter how vibrant the global economy becomes, the UK faces a unique set of issues going forward with Brexit likely to have a drag of at least 2% and possibly as high as 8% on growth. It could be that two hikes this year, taking the official rate to 1% (still historically low), could be easily reversed in need.

Stagflation is a term that has been confined almost entirely to economics textbooks, but the UK could be developing conditions in which prices could continue to rise due to currency weakness, but activity falls into contraction and the economy contracts as the Brexit reality unfolds.

Dollar holds onto gains as stock fall again

The Dow Jones Index was lower again yesterday by 3.5% as the correction that has hit the markets returned. Last week’s higher than expected wage inflation data in the U.S. caused concerns over the return of inflation to the global economy and Central Banks beginning the “normalization” of interest rates. The market that had gorged itself on cheap money has suddenly become concerned that the tap is about to be turned off.

The dollar index was virtually unchanged on the day, closing at 90.30 having retraced half its January losses. The main victim of the dollar’s recovery has been the Euro. The single currency has lost 1.7% this week versus the dollar and has also fallen against the pound as tightening of monetary policy is more likely in the UK than the Eurozone. The single currency reached a low of 1.2212 overnight and the pound rose to high overnight of 1.1389.

ECB President Mario Draghi is likely to be secretly delighted with events over the past week since he has seen his desired outcome of lower Euro which aids competitiveness across the entire Eurozone and has managed to leave the Asset Purchase Scheme untouched.

Next week sees the release of inflation data in the UK and U.S. and Eurozone Q4 GDP. The UK inflation data will be eagerly anticipated considering yesterday’s MPC comments.