All eyes on BoE after Powell signals higher rates

Headlines

* Fed’s Powell: More rate hikes are likely this year to fight still-high inflation

* BoE to hike for 13^th straight time as inflation remains sticky

* Traders fully price 4% peak ECB rate for first time since March

* Gold holds near three-month lows, markets assess Powell’s remarks

FX: USD was weaker against its peers, down 0.5% after Powell’s testimony. He said the Fed was likely to raise interest rates in the coming months but more slowly than previously. The markets are still not convinced with only a 72% chance of a 25bp hike in July.  The 2-year yield is consolidating just below three-month highs around 4.75%. The 10-year yield is at the bottom of the recent range above 3.70%.

EUR jumped up to a high of 1.0991 after the breakout from a bullish “flag” formation. The main upside target is 1.1032. GBP dipped to a low of 1.2691 before settling at 1.2768. Hotter-than-expected CPI showed core inflation rose at its fastest pace since 1992. USD/JPY made another fresh cycle high at 142.37 before settling at 141.87. This was the weakest yen since November and came after Powell’s testimony. He underscored the policy gap and yield differentials between the Fed and BoJ.  AUD slid further to a low at 0.6740 before closing at 0.6796. USD/CAD dropped to a new nine-month low at 1.3157. Strong resistance sits at 1.3262. Oil prices rose and stronger-than-expected retail sales bolstered bets for another rate hike. Money markets see a 72% chance that the BoC hike on July 12.

Stocks: US equities dropped as tech declined. Investors were cautious after Powell warned rates would still need to go higher to bring inflation back to target. The benchmark S&P 500 fell 0.52% and the Nasdaq 100 finished down 1.35%. The Dow closed 0.3% lower. All indices saw their third straight day of losses. Tech stocks were hit hard as higher rates reduce the appeal of companies that promise long-term growth. Powell said the tightening campaign still had “a long way to go” before the economy slowed sufficiently to bring inflation back to the 2% target.

Asian stocks were generally lower today after the tech-led declines on Wall Street. The Nikkei 225 sold off, but the downside was limited amid currency weakness. We also had more dovish comments from a BoJ board member. Markets across greater China were closed for a holiday.

US equity futures are indicating a lower open though are relatively muted. European equity futures are pointing to a softer open (-0.6%). The Euro Stoxx 50 closed down 0.5% yesterday.

Gold dropped to a new cycle low at $1919 on Powell’s comments. It settled at $1932 but the 100-day SMA now sits above as resistance at $1942.

Day Ahead – BoE to surprise with a 50bp hike?

Stronger-than-expected inflation data as well as a tight labour market are confronting the Bank of England today. They are set to raise rates from 4.5% for the thirteenth time in a row, but will they hike by 50bps rather than 25bps? The market gives the former around a one in three chance which has increased markedly since yesterday’s ugly upside surprise in the CPI numbers.

The MPC will be wary of hiking rates further into restrictive territory as inflation is expected to fall through the summer due to the energy cap falling off and big base effects softening the spike in energy prices last year. But structural issues in labour markets might mean earnings stay higher for longer meaning the BoE are kind of stuck between a rock and a hard place. The bank needs to materially slow the economy to bring down inflation but not by so much that it causes a recession. Incidentally, two-year Gilt yields are at the same level as when the UK pensions sector went into crisis mode.

Chart of the Day – GBP/USD 1.30 or 1.25?

GBP is still by far the best performing major this year against the dollar. Last week saw 14-month highs at 1.2848 but prices were overbought and have given up some gains. Support sits at the previous year-to-date May high at 1.2679. Any major loss in confidence in the pound could see prices back to the 1.25/1.26 range. A hawkish hike with more to come would see that recent top challenged again and possibly a move towards 1.30.