- Weekly update
- 5 minute read
A good week for
- Another positive week for equities in sterling terms, further boosted by sterling weakness.
- Bonds also rallied broadly in local currency terms.
A bad week for
- Sterling weakened further versus main currency pairs by -2 to -3%.
- Oil fell a further c. -8% in US dollar terms.
Bank of England
The Bank of England (BoE) raised rates by 0.5% last week, but softened its guidance on further monetary policy action. In the Monetary Policy Report, Bank forecasts of growth in 2023 and 2024 were upgraded significantly to an average of -0.5% in 2023 and -0.25% in 2024. These upgrades reflect lower energy prices and the greater-than-expected resilience of the labour market. Near term, inflation forecasts were downgraded due to weaker energy prices, though inflation was expected to be higher than previously expected by the end of the forecast period, with a shallower recession expected to weigh less on inflation. Inflation is still expected to be below 2% in 2025. Despite the better outlook for growth, the language of the Monetary Policy Statement no longer explicitly signalled an expectation of more tightening, instead adopting a data-dependant approach. This led market expectations of further hikes to fall, causing sterling to weaken and bonds to rally. Nonetheless, the statement did acknowledge that risks to inflation remain to the upside, given the volatility of energy markets and the risk that labour markets remain tight. If the labour market eases by less than Bank forecasts expect, some further tightening may be judged necessary.
European Central Bank
In contrast with the BoE, the European Central Bank (ECB) took a more hawkish tone. The Bank delivered a 0.5% hike to interest rates, and guided for a further rise in the spring. The statement also indicated that policy makers intend to raise rates “significantly” and “at a steady pace”. Moreover, “keeping interest rates at restrictive levels will over time reduce inflation” implies that policymakers expect to leave the deposit rate at its peak for a long period before considering cuts. Futures markets reflect this, with the refinancing rate expected to end the year almost 1% higher than it is today. In contrast, in the UK and the US, rates are expected to end the year close to current levels.
The hawkish ECB response coincided with better than expected data out of Europe last week, though the devil is in the detail. Instead of a small decline in the fourth quarter, the Eurozone economy is estimated to have risen by 0.1% quarter-on-quarter. While much of this strength came from an outsize increase in the Irish economy, reflecting global companies booking revenues, the data was better than expected in other regions. Germany suffered a 0.2% decline, which is expected to be downgraded, and Italy declined by 0.1%, but France grew by 0.1% and Spain by 0.2%. Inflation was also more favourable than had been expected, slowing to 8.5% year-on-year, from 9.2% in December. There was a delay to Germany’s inflation figures, which instead had to be estimated, making it possible the print is revised higher. Looking forward, the European economy is still expected to slow in the first quarter, given the significant hit to industry and consumption spending from high energy prices. However, energy prices have fallen in recent months, and the region is expected to return to positive growth by the summer.
In the US, the US Federal Reserve slowed the pace of tightening to a 0.25% rise, in a move the market received as dovish. The policy statement continued to indicate that “ongoing rate increases will be appropriate” but shifted focus from the “pace” of hikes to the “extent”, suggesting the end of tightening is in sight. Nonetheless, the Fed clearly remains concerned about core inflation, zeroing in on the non-housing component of services inflation, which tends to reflect changes in wage growth trends. Futures markets are still pricing in a peak to rate hikes in the summer, followed by cuts, leaving the Fed funds rate below its level today by the end of the year. Federal Open Market Committee forecasts suggest members see rates staying higher for longer. Nonetheless, markets responded positively to the rise.
Market exuberance in the wake of the Fed’s dovish policy announcement was tempered by stronger-than-expected jobs data on Friday. Nonfarm payrolls jumped 517,000 in January, with upward revisions to November and December data, and the unemployment rate fell to 3.4%, despite the labour force expanding by 870,000. More reassuringly, wage growth did slow modestly, despite labour market strength, and the Challenger report showed layoffs rose to 103,000. While the labour market tends to tighten after the peak of monetary tightening, this clearly remains a concern for the Fed.
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