Treasury Market Commentary

The European Central Bank (ECB) confirmed on Thursday what markets had been suspecting for weeks: it used its June monetary policy meeting to announce the end of its Asset Purchase Programme (APP), paving the way for the first interest-rate rise in the eurozone since 2011.

The ECB said it expects to raise the deposit rate by 0.25% in July, bringing it to -0.25%. Moreover, it suggested that a 0.50% hike may be needed in September to lift the deposit rate out of negative territory and that a further gradual increase would be necessary to fend off soaring inflation.  

The euro initially spiked to 1.0800 against the US dollar in the wake of Thursday’s announcement. However, new economic projections showed the ECB downgrading growth forecasts for this year and next year and offered a bleaker assessment of where inflation is heading. Despite the more hawkish trajectory for interest rates, the euro subsequently pared its gains and ended the week 1.90% lower versus the dollar at 1.0515. Continued uncertainty over inflation, growth and interest rates may mean yet more volatility to come.

The Reserve Bank of Australia (RBA) also turned increasingly hawkish, raising interest rates by a bigger-than-expected 0.50%, its biggest hike in 22 years. This takes the cash rate in Australia to 0.85 %, as the RBA commits to “doing what is necessary” to rein in broadening inflationary pressures. Meanwhile, ‘peak inflation’ in the US proved ephemeral, as consumer price index (CPI) inflation, which had fallen off in April, rose again in May. The year-on-year measure showed prices 8.6% higher (markets had expected the reading to remain at 8.3%).
 

GBP/USD Year 1

The Federal Reserve meets on Wednesday and has already signalled that it will hike rates by 0.50% for the second meeting in a row: this will take the upper tier to 1.50%. The Fed has also made clear its intention to raise rates by a further 0.5 % in July and markets will be keen to see clearer indications of future hikes following the July meeting. It has been suggested in some quarters that the Fed may slow to a 0.25% hike at the September meeting: it may use the ‘dot plot’, whereby members signal their medium-term outlook on interest-rate movements, to inform its decision.

Markets expect the Bank of England to continue on its rate-hiking path with a fifth consecutive 0.25% hike on Thursday; this would take base rate to 1.25%. However, with inflation at 9% and expected to spike to more than 10% later this year, and with the labour market remaining tight, chances of the Monetary Policy Committee voting to hike by 0.50% have risen.

The fly in the ointment for aggressive hikes is the downside risks to growth. Gross Domestic Product figures, released this morning, show a 0.3% month-on-month fall in April (expected +0.1%) and follow the 0.1% drop seen in March.

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