BoE hikes while ECB acknowledges changed situation

• The European Central Bank (ECB), marking a remarkable policy turnaround, finally acknowledged mounting inflation risks, opening the door to a potential interest rate increase this year. ECB President Christine Lagarde said that while inflation is likely to remain elevated for longer than previously expected it will decline over the course of this year. However, compared with expectations in December, risks to the inflation outlook are tilted to the upside, particularly in the near term.  Adding that the “situation has indeed changed”. Lagarde said the ECB would not rush into any move, declining to repeat her previous guidance that an interest rate increase this year was "very unlikely". She insisted that the sequence of the ECB's future policy moves will not change, so asset buys, now set to run indefinitely, will have to end before borrowing costs can be increased. She added that the March meeting will be crucial as new economic projections could provide the justification for any policy move.
• The Bank of England (BoE) raised interest rates to 0.5% on Thursday and nearly half its policymakers (four of the nine Monetary Policy Committee members) wanted a bigger increase to 0.75% in to combat rampant inflation, which the British central bank warned could reach 7%. Had it come through, it would have been the biggest increase in borrowing costs since the BoE became operationally independent 25 years ago. Bailey said not to assume the BoE was embarking on a long series of rate hikes and said there would have to be a trade-off between strong inflation and weakening growth as many households see their incomes squeezed. The BoE said consumer price inflation - which was 5.4% in December - should peak at around 7.25% in April, which would be the highest rate since the early 1990s and far off its 2% target
• The number of Americans filing new claims for unemployment benefits fell by 23,000 to a seasonally adjusted 238,000 for the week ended Jan. 29, lower than the forecast 245,000 applications as Covid-19 infections subsided, suggesting that an anticipated slowdown in job growth in January was likely temporary. This is the second straight weekly decline reported by the Labor Department, and partially unwound the recent surge which had boosted initial claims to a three-month high in mid-January.
• Turkish CPI inflation accelerated for the eighth month in row to 48.7% y/y in January, up from 36.1% in December and higher than consensus projections for 48.0%. This is the highest rate since 2002, and following the 500bps of cuts to the benchmark one-week repo rate through the second half of 2021, real interest rates in Turkey are now at -34.7%. On a monthly basis inflation slowed moderately, from 13.6% to 11.1% but this still just exceeded projections of 11.0%. On a moderately more positive note, PPI inflation eased in January, falling to 10.5% m/m from 19.1% in December. This compared to projections of a further 11.2% m/m increase. However, this remains high and suggests that the pressure on the CPI index will remain in play for the time being, if at more moderate levels. At 93.5% y/y, PPI inflation is at levels last seen in 1995.
• The Central Bank of Egypt kept its benchmark overnight deposit rate on hold at 8.25% yesterday, in line with expectations. The bank’s communiqué noted that real GDP growth was a robust 9.8% y/y in Q3 2021 and that the labour market was stabilising. The bank did acknowledge that global monetary conditions were going to tighten sooner than previously anticipated, but still judged a hold on rates the correct course of action. We anticipate that the bank will start to tighten policy in the second quarter, barring a significant upside surprise on inflation prior to the March meeting. However, the recent shifts by the major central banks increase the risk that the CBE will move at the next meeting.

Today’s Economic Data and Events

• 13:30 UK Construction PMI (Jan) Forecasts 54.3 
• 17:30 US Nonfarm Payrolls (Jan) Forecast 155K  
• 17:30 US Unemployment Rate (Jan) Forecast 3.90%         
• 19:00 CA Ivey PMI (Jan) Forecast 45

Fixed Income

• A hint of hawkishness from the European Central Bank helped to push benchmark government bonds lower overnight. The ECB board agreed that a rate hike could be possible this year, views that were highlighted by president Christine Lagarde in her comments after the meeting. Bunds led the move higher in yields with 2yr bund yields adding 12bps to -0.344% while the 10yr settled at 0.139%, up 10bps and its highest level since 2019.
• A rate hike from the Bank of England also did for gilt markets. yields at the front of the UK curve added almost 12bps on the 2yr, closing at 1.142% while the 10yr added 11bps to settle at 1.367%. With the BoE warning of persistent price pressure, the chances of more sustained hiking from the BoE look strong, weighing on gilts. By comparison the UST market was relatively subdued. Yields on the 2yr did push above 1.20% at one point but then faded those cash price losses and closed up 4bps at 1.1959%. The 10yr was up 6bps at 1.8306%.
• In emerging markets the tone was generally positive. Yields on South African 10yr bonds fell almost 4bps to 9.638% while Turkey saw a drop of 19bps on its 10yr local currency bonds to 21.78%. Indian bonds were broadly stable.

FX

• The Euro surged following the ECB’s hawkish spin, adding almost 1.2% on the day to push up to 1.144. The single day move erased all of EURUSD’s losses for the year and the pair is now up 0.6% since the start of 2022. We still expect the Fed to be far more aggressive in its policy normalization, helping to keep yields differentials in favour of the USD. Among other major pairs USDJPY popped higher by 0.45% to 114.97.
• The hike from the Bank of England was likely widely expected and moves in GBPUSD were relatively muted. The pair closed up by 0.15% at 1.3598. Among commodity currencies USDCAD stabilized at around 1.2678 while AUDUSD settled marginally higher. NZD added 0.4% to close at 0.6661.

Equities

• With the focus very much back on tighter monetary policy from the major central banks yesterday, global equity markets were under pressure. The UK’s FTSE 100 losses were relatively muted compared to its peers, with the index continuing to benefit from the preponderance of value and cyclical stocks compared to some of the other major benchmarks. It dropped -0.7%, compared to -3.7% on the US’s NASDAQ, which is heavy on speculative technology stocks.
• The S&P 500 lost -2.4% yesterday, while Germany’s DAX dropped -1.6%.
• Within the region, the ADX dropped -0.1%, the Tadawul -0.4%, and the DFM -0.7%.

Commodities

• Oil prices moved considerably higher after an earlier indecisive response to the OPEC+ meeting in the week. Brent futures settled up 1.8% at USD 91.11/b while WTI closed above USD 90/b for the first time since 2014. Rising geopolitical tensions in Eastern Europe will add to worries about supply buffers this year and any near-term incident could pop prices considerably higher, putting USD 100/b in play.

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