The Pound made great gains against the Euro, Dollar and Rand in the afternoon’s trading session following the Monetary Policy Committee’s split decision on raising interest rates.
The vote came in at 5-3 just after noon today to keep rates on hold at the record low 0.25%. Kristin Forbes surprisingly found support from two others to raise rates to 0.5%.
Markets were surprised and rightly so since this was the first time since 2011 that there has been 3 dissenters on the committee. Sterling reacted accordingly trading up aggressively against all major currencies, in particular recovering losses against the USD after yesterdays Fed announcement.
This announcement has acted as a smokescreen for the poor retail sales figures which came out in the morning session. Retail sales fell sharply last month pouring more uncertainty on the UK economy as we head into the Brexit negotiations.
As expected the Federal Reserve raised interest rates by 25bps to 1.25%. Furthermore, a new programme of balance sheet reduction will be underway by clearing a fixed amount of assets each month, though the start date is yet to be confirmed.
An update to the ‘dot plot’ graph shows the median expectation among policymakers of one more rate hike this year, possibly scheduled for September. Furthermore, this will be followed by a continued pattern of hikes in 2018 and 2019.
This is a result of new economic growth projections which indicate that the most powerful economy in the world is on the rebound following Q1 slowdown.
US Dollar strength has inevitably occurred in the morning trading session on the London market with Cable down 1 cent from Wednesday mornings open at 1.2725.
The Federal Reserve, the world’s most powerful central bank, is set to raise interest rates overnight and signal that another rise is planned for later in 2017. The headline looks almost certain to be another 25 basis point increase to 1.25%. A third hike in 7 months shows that the US monetary policy committee is well and truly awake after lying dormant for the whole of 2016.
As with the last move from the Fed the FX market began to price the hike in so analysts do not expect too much strength from the USD based on this alone. What is likely to cause ripples through the market is the prognosis from Chair Yellen regarding future rate rises this year and next. The sentiment around this is polarized.
The position to base any predictions stems from the ‘dot plot’ graph which was last updated by the Fed in March. This anticipated a further 2 25bp increases in 2017 and 3 in 2018 leaving the US with a policy set at 3% by Q1 2019. Markets, however remain unconvinced that this is a realistic target so much so that current predictions expect rates to rise only once more by the end of 2018.
The likelihood of the Fed conceding to market analysts is uncertain at present. Looking at the hard data, the jobless claims and fall in unemployment rate drives the assertion for continued hikes. However, inflation has not yet surpassed the level necessary for central bank intervention. CPI has fallen below 2% for the first time since 2015 with modest rises on the horizon.
Should the Fed continue to carry on its projected path expect USD strength, however if the sentiment is cautious and monetary policy tightening is suspended the USD will inevitably be under pressure.
Following the election result in the UK last week Sterling has maintained its downward projection as uncertainty surrounding the nature of Britain’s exit from the EU clouds investors.
Prime Minister May had been set to employ a harder style Brexit with her promise of ‘a good deal or no deal’ however her failing to obtain a substantial majority in the polls last week has weakened her positon. A much softer than anticipated exit is now being mooted by political correspondents and market analysts however with negotiations not set to begin until next week this is merely speculator.
Sterling, being a sentiment driven current has no significant reason to strengthen while the country lies in political limbo. Economically, central bank policy is something that needs to be watched closely with the Bank of England set to meet on Thursday. Despite no rate hike forecasted, attention needs to be paid towards the rhetoric from Governor Carney about the overall health of the UK economy. Should inflation continue to rise and wages continue to flat line there may be some further downside surprise in Sterling.