Market Report - 22/03/2023
UK CPI data sends pound higher, markets reconcile following banking woes in wake of FOMC and BoE meetings
Consumer prices rose by 10.4% in the year to February, the Office for National Statistics reports, up from 10.1% in January. The ONS says the largest upward contributions to inflation came from housing and household services (principally from electricity, gas, and other fuels), and food and non-alcoholic beverages.
Economists had forecast a drop to 9.9%, so this is a surprise to the City. Core CPI rose to 6.2% in February, up from 5.8% in January, a sign that inflationary pressures are building in the economy.
This leaves inflation sharply higher than the Bank of England’s target of 2% – giving policymakers something to ponder before they set UK interest rates tomorrow.
Sterling is rallying following this morning’s CPI data, the pound has gained half a cent against the US dollar today to $1.226, and almost half a eurocent against the single currency to notch highs of 1.14004.
Expectations for higher rates at the Bank of England will raise the yield paid on UK government bonds, which in turn supports the Pound. The pound struggled through February as markets slashed expectations for future Bank of England rate hikes, while expectations for hikes from the ECB and Federal Reserve remained elevated.
As a result, this inflation data could therefore shore up rate hike expectations in the UK, which would support the Pound.
The odds of a rise in UK interest rates tomorrow jumped sharply, after inflation jumped to 10.4% in February. The money markets are now indicating a 95% chance of a quarter-point rise tomorrow, with a small possibility of a half-point increase in Bank Rate (which is currently 4%).
At the end of last week, when the banking crisis was raging, the markets indicated the Bank was evenly split between a quarter-point increase and leaving rates on hold. But the sight of inflation roaring in double-digit levels is likely to spur some BoE policymakers to vote to hike borrowing costs again at this week’s meeting (decision due at noon tomorrow).
Prior to the completion of the U.S. Federal Reserve's policy meeting on Wednesday, the dollar was trapped near five-week lows as investors awaited information on the course that the central bank is expected to take in the wake of the crisis in the world's banking system.
Market focus is centered on whether the Fed would maintain its hawkish course to combat high inflation or halt interest rate hikes in light of recent bank turmoil, which has included bankruptcy and last-minute rescues.
Markets are now pricing in about a 15% chance of the Fed not increasing rates, with a roughly 85% chance of a 25 basis point hike, showed the CME FedWatch tool. Just a month earlier, the market was pricing in a 24% chance of a 50 basis point hike.
Investor sentiment remained fragile with worries over the outlook for the banking sector starting to ease after sharp volatility in the market in the past few weeks following high-profile U.S. banking failures earlier in the month and the rescue of lender Credit Suisse Group AG at the weekend.
The Fed faces a difficult choice given a strong labour market alongside February inflation figures that were higher than many market watchers expected. Such circumstances would usually be ripe for a return to a 50 basis point hike were it not for worries over financial stability.