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ECB turns hawkish, as BoE signals aggressive pace of hikes

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4 February 2022

Written by
Matthew Ryan

Head of Market Strategy at Ebury Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

The European Central Bank and Bank of England both took hawkish turns on Thursday, sending the euro and sterling higher against most major currencies.

T
he euro was one of the best performing currencies in the world yesterday after a hawkish press conference from ECB President Lagarde opened the door to higher interest rates in the common bloc at some point in 2022. No policy changes were expected from the ECB today, nor did we receive any, but the bank updated its assessment on Euro Area inflation. Lagarde noted in her presser that supply bottlenecks may persist for some time and that price pressures are set to remain elevated for longer than expected. While she continued to describe risks to the growth outlook as broadly balanced, she noted that risks to the inflation outlook were ‘tilted to the upside’. The view that inflation was to ‘decline in the course of [this] year’ was also removed from the inflation assessment. She also said that there was ‘unanimous concern’ among policymakers on the inflation overshoot.

Not only did the ECB signal heightened concerns over the inflation overshoot, but Lagarde also did not repeat her line that interest rate increases were unlikely in 2022 when directly asked – a critical change. This makes us increasingly confident in our call that the bank can’t wait until 2023 before hiking rates, a view that markets and economists are now increasingly in favour of. By the end of Lagarde’s press conference, swap markets were pricing in approximately 40 basis points of hikes in the ECB’s deposit rate by the end of this year, with EUR/USD ending London trading around 1.3% higher and around its highest level in three weeks. The March meeting will now be a highly important one – we expect the ECB to recalibrate its asset purchase programme, paving the way for a hike by at least September.

Figure 1: EUR/USD (03/02/2022)

Source: Refintiv Datastream Date: 03/02/2022

Yesterday’s Bank of England meeting also delivered a very hawkish surprise for investors. As anticipated, rates were increased by 25 basis points to 0.5% on Thursday, marking the first back-to-back hikes since 2004. There was, however, a significant hawkish surprise, with four of the nine voting members, Ramsden, Saunders, Haskel and Mann, all in favour of a 50 basis point move in rates. We see this as a clear sign that the MPC isn’t in a mood to mess about when it comes to raising interest rates this year, and that policymakers are growing increasingly concerned with UK inflation. As we anticipated, the BoE has revised its near-term inflation forecasts sharply higher and now expect headline price growth of 5.2% in a year’s time, versus the 3.4% expected in November. UK inflation is also now projected to peak at an unfathomable 7.25% in April, partly a consequence of rising energy costs. The UK government announced earlier on Thursday that the average household energy bill was set to increase by £693 this year, and that is clearly at least partly behind today’s hawkish vote.

Figure 2: Bank of England Inflation Forecasts [February 2022]

Source: Refintiv Datastream Date: 03/02/2022

Governor Andrew Bailey adopted a more measured approach on rates. He urged the market not to get too carried away with expectations for rate increases, noting that it would be a mistake to assume that rates are now ‘on an inevitable long march upwards’. Despite Bailey’s cautious tone, we see today’s hawkish vote on rates as vindication of our bullish sterling view. We expect to see a continuation of this aggressive hike cycle at upcoming meetings, and still believe that the Bank of England will be among the most aggressive in raising interest rates in the G10 in 2022, with another 25 basis point hike on the cards for the March meeting.

Activity in FX is likely to remain high today with the release of the monthly US payrolls report. Expectations are low given the uncertainty created by the spread of omicron, with a number around the 150k mark expected. We think that almost all signs point towards a lower number, although markets will likely overlook the release regardless, given the omicron impact is expected to prove temporary.

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