It’s not yet time for the BoE to pause let alone flip the tightening cycle

Markets

The Bank of England policy meeting was widely watched yesterday, not only by UK but also by European and US markets. Governor Bailey’s MPC raised rates by 50 bps to 1.75%, following global peers in larger-sized increases. The BoE will start selling UK gilts actively shortly after the September meeting, tightening policy on another front. Inflationary pressure have intensified markedly. Both external (near doubling of gas prices) as domestic (increased wage pressures) lie at the roots of inflation that may peak at more than 13% in Q4 this year. But the economy is expected to have entered a recession at that same point in time. It is projected to last all the way through 2023 as real household income drops sharply this year and the next and consumption growth turns negative. Regarding future policy moves, the BoE has tweaked guidance into being open-minded but above all data-dependent. The grim economic assessment triggered a hefty repositioning especially at the front end of the UK curve. But much of that was reversed shortly after as markets assume it’s not yet time for the BoE to pause let alone flip the tightening cycle. The 2y UK yield undid an 11 bps drop to finish 1.1 bps higher. Yields with longer tenors shed a mere 1.7 to 2.3 bps. German yields were unable to stage such intraday comeback. They finished up to 7.1 bps lower (10y). Swap yields dropped between 2.9 and 7.2 bps, the belly outperforming. US yields due to recent Fed comments were a bit better protected but not immune. Changes on the curve varied from -3.3 bps in the middle segment to +2 bps at the longest tenors. A further decline in oil prices also weighed on core bond yields. Brent slid 2.75% to $94.12/b amid rising inventories and slowing demand. It’s the lowest level since the Russian invasion. Sterling took a hit. Despite policy rate expectations not having changed that much, the currency did anticipate quite a bit on today’s meeting with some profit-taking as a result. EUR/GBP jumped from 0.837 to 0.843. EUR/USD didn’t budge for most of the day before dollar weakness kicked in as US dealings got rolling. The pair settled around 1.025. Trade-weighted DXY slipped sub 106 again. Equity markets traded choppy and without a clear direction.

Asian stocks this morning trade mostly in the green following a mixed/choppy performance on WS the day before. Core bonds trade flat and the dollar tries to recuperate some of yesterday’s losses as it heads into the US labour market report for July. Analysts expect job growth to have slowed from previous months but to remain at solid 250k. Pay growth is expected to be at 0.3% m/m and 4.9% y/y. In terms of the market reaction, there’s an asymmetric risk. We expect a (more than) decent jobs report that will back this week’s Fed comments and underscore the need for more tightening. Yields may bottom out further in such circumstances. However, as markets are still in a recessionary state of mind an undershoot will be seen as validating their recent dovish repositioning and may trigger a heftier response. In our base scenario though, we believe the USD along with US yields to come out stronger today.

News headlines

The Reserve Bank of India raised rates from 4.90% to 5.40% today. Consensus expected a smaller increment to 5.25%. The decision was unanimous and brings the policy rate at levels last seen before the pandemic. Inflationary pressures are broad based and core inflation remains elevated, governor Das said. He added that price pressures, 7.01% y/y in June are expected to remain above the 2-6% target range for some time. Relieve from softening global commodity prices are unlikely to pass through in the short run because of the dramatic weakening of the rupee to record lows. USD/INR hit 80 mid-July. The rupee has recovered only marginally since then. The couple is trading around 79.10 in the wake of the RBI decision.

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