Bank of England to raise rates, pound will be driven by rate path
European Central Bank could adopt a more optimistic tone
Stock markets edge higher but Facebook shares tank
BoE primed for action
The Bank of England will most likely forge ahead with raising interest rates when it concludes its meeting today. Markets have fully priced in a quarter-point rate hike that would lift the Bank Rate to 0.5%, a level which policymakers previously indicated as the threshold to begin reducing their balance sheet by halting reinvestments of maturing bonds.
Hence, the BoE is expected to raise rates and kickstart the ‘quantitative tightening’ process to cool inflation, empowered by a tight labor market and optimism that the Omicron wave didn’t leave any deep scars on the British economy. That would be great news for sterling in the big picture as a shrinking balance sheet essentially means the BoE will be draining liquidity out of the market, pushing UK yields higher over time. That said, the market reaction today might not reflect that.
With a rate increase fully baked in already and a balance sheet rundown announcement so widely expected, the reaction in the pound will depend mostly on the vote count, the updated inflation forecasts, and the guidance around future rate increases. The latter could mean trouble for the pound as the BoE may signal that the current market pricing for another four hikes this year is excessive.
Fade the ECB optimism?
Across the Channel, the European Central Bank faces a tough balancing act. The euro area economy is clearly improving, with the unemployment rate sinking to multi-decade lows and inflationary pressures firing up.
However, money markets are already pricing in higher rates for this year and conveying an overly optimistic message today could add more fuel to those bets, propelling European yields higher. That’s an outcome the ECB wants to avoid as a premature spike in government borrowing costs could stifle the recovery process.
Ergo, the path of least regrets for the ECB may be to simply strike a more optimistic tone, acknowledging the improvements in the jobs market and highlighting the uncertain profile for inflation, while also warning that rate hike discussions are premature for now.
Markets have a tendency to overinterpret any cheerful signals on ECB decision days, so this could boost the euro. That said, the near-term picture remains unfavorable and any real euro strength may be a story for the second half of the year, driven by stronger wage growth in Europe and ‘peak inflation’ in America.
For now, market pricing around the ECB is already quite generous, political uncertainty could be a factor ahead of the French elections, and the shaky environment in global markets tends to hold back the single currency.
Facebook drags Nasdaq futures lower
The dollar remained on the ropes yesterday after the ADP report disappointed in dramatic fashion, signaling the US economy lost 301k jobs in January instead of adding 207k as expected. This has dampened expectations for tomorrow’s nonfarm payrolls print, which may also come in negative as the survey was conducted during the peak of the Omicron wave and may therefore be heavily distorted.
Wall Street enjoyed another solid session where the S&P 500 rose almost 1%, although that masks a massive rotation under the hood with investors moving towards defensives and quality, and away from riskier growth names with little free cash flow.
However, the mood has turned sour today after Meta Platforms shares got blown to smithereens, tanking by 20% in after-hours trading as Facebook reported its first decline in daily active users ever.
The earnings show will continue with Amazon today, Eli Lilly, Activision Blizzard, and Ford. In data releases, the ISM services PMI from the US will be the last piece of the puzzle ahead of tomorrow’s employment report.