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Markets weaken as Bank of England delivers another hawkish surprise

The British pound is consolidating gains after the Bank of England joined its Commonwealth counterparts in wrongfooting markets with a bigger-than-expected half-point hike at this morning’s meeting. Responding to “material news” of an acceleration in wages and consumer prices, the Monetary Policy Committee voted seven to two in favour of raising rates to the highest levels since 2008, with Governor Bailey saying “Bringing inflation down is our absolute priority”.

From today’s 5 percent, traders now expect the Bank Rate to peak above 6 percent in early 2024. This should, in theory, generate a lot of carry support for the pound – speculators borrowing in other currencies and investing in the UK stand to earn significant returns – but the growing likelihood of a slowdown could mitigate further gains as markets position for a an eventual policy u-turn. And on that, we sympathize with the Bank: officials, who are confronting the most stubborn price pressures in a generation, have little choice in moving onto an aggressively-hawkish policy stance today, even as a violent economic contraction, which brings inevitable comparisons to the seventies, looks increasingly probable – and necessary.

In yesterday’s semiannual Congressional testimony, Federal Reserve Chairman Jerome Powell said the central bank remained likely to raise interest rates in the coming months, but that it would move at a more gradual, measured pace in doing so.

Other Fed officials expressed cautious views, with Chicago’s Goolsbee saying“We are in this weird foggy environment where it is hard to figure out where the road is,” and calling last week’s pause a “close call”. Atlanta’s Bostic – a non-voting member – doesn’t want to raise rates again this year, arguing in an essay published on. The The job market has cooled, moving nearer to a place consistent with lower inflation, mainly because of a reduction in the number of job openings without a meaningful rise in the unemployment rate. If we simply press on with additional rate hikes, we could needlessly drain too much momentum from the economy”.

This has left market positioning largely unchanged: Investors are still assigning near-75-percent odds to a hike in July, yet remain convinced that declining inflation pressures and slowing growth will put a damper on rate increases later in the year.

The dollar is up modestly, equities are set to open lower, and the yield curve is deeply inverted, suggesting that traders are bracing for a policy-induced downturn in the months ahead, despite the broadly-positive newsflow that continues to seep out of the real economy. In the latest release, the number of initial claims for jobless benefits held at 264,000 in the week ended June 17, with the four-week moving average sitting near the 255,000 mark – far below levels that would point to an incipient slowdown in the economy.

The Canadian dollar is pulling back from yesterday’s gains, but is stronger on the week, supported by signs of resilience in consumer spending and real estate markets, narrowing rate differentials, and ongoing talk of Chinese stimulus.

Still ahead today: At 10:00, Jerome Powell will deliver a second round of largely-identical testimony, this time in front of the Senate Banking Committee. At the same time, the Conference Board’s leading economic index for May is likely to show signs of softening.  And the Fed officials including Governor Bowman, Cleveland’s Mester, and Richmond’s Barkin are scheduled to speak.

The Bank of Mexico (Banxico), known for presiding over the carry-fuelled “super peso” over the last two years, is expected to keep rates unchanged at this afternoon’s meeting. With policy settings the tightest since 2008, both headline and core inflation showing signs of cooling, and the exchange rate holding near post-2015 highs, officials look likely to follow their US counterparts in moving onto a data-dependent, pause-heavy footing – but given spectacularly-wide rate differentials against the dollar, relative political stability, and significant inward remittance and investment flows, the peso could maintain its momentum for a few months yet.

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