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Bank Of England’s Gov Bailey Signposts Longer Period of Inflationary Pressures

Sterling gained an element of support from a firmer tone surrounding risk appetite even though there was still significant caution amidst the political drama surrounding Prime Minister Johnson. The market awaits the Sue Grey report which is rumored to be released next week. The contents could have an impact on PM Johnson’s leadership as letters of no confidence continue to increase to the 1922 Committee. In addition, PM Johnson announced that COVID-19 restrictions in England will be eased from next week.

Bank of England (BoE) Governor Bailey testified before the Treasury Select Committee and stated that the labour market is very tight and that the bank was seeing some evidence of second-round inflation effects. Bailey went on to state that inflation would take longer to decline than expected two months ago. Currently, there are concerns that energy prices would not start to decline until the second half of 2023.

If inflation remains longer than expected and energy prices fail to decline before the second half of 2023, then it is feasible that we could see more than the three rates forecasted for 2022 at the beginning of the year. According to the CME BoE Watch Tool, the probability of interest rates being 1.20% is circa 38%; this suggests either 4 hikes, or potentially a super hike in one of the three hikes forecasted.

It’s a quiet day in terms of economic data with Sterling likely to follow the risk-based moves of equities and other assets classes. In the meantime, the market will keep a close eye on political developments.

Greenback Remains Subdued but Supported on Rising Treasury Yields

Another relatively quiet day of data releases yesterday, however, the greenback remained supported on higher treasury yields. The benchmark 10-year yield reached a 2-year high of 1.9% on Wednesday as markets prepare for further signalling of tightening ahead of the Federal Open Market Committee (FOMC) meeting next week. Although we do not expect a rise in interest rates at the next meeting, swap markets are increasing speculation around a 50-basis point hike in March, following the end of the Federal Reserve’s (Fed) tapering program. US stock markets fell sharply touching a multi-week low over concerns of higher treasury yields.

Elsewhere, US President Biden warned over escalating tensions between Russia and Ukraine, however, he doesn’t think at this stage that Russia will launch a full-scale invasion of Ukraine. Biden also signalled his support yesterday for Fed Chairman’s, Jerome Powell’s comments indicating a tighter monetary policy to combat higher inflation.

A busier day of economic releases today as markets will review the weekly Initial Jobless Claims data, existing Home Sales and Philadelphia Fed Manufacturing Survey which will provide direction for the Dollar in the latter part of this week.

Eurozone Interest Rate Outlook Improves

Reviewing the limited data we saw yesterday from the Eurozone, the Current Account Surplus read higher than forecast at 23.6B versus a forecast of 20.3B and a previous figure of 19.4B. Elsewhere, the German Final CPI month-on-month figures reading remained unchanged and in line with expectations at 0.5%. Neither provided much direction for the Euro, which remained under pressure from its major rivals.

European equity markets edged slightly higher yesterday, with the Euro Stoxx 50 gaining approximately 0.2%. Additionally, German Bund yields turned positive for the first time since May 2019 reflecting a more positive outlook for an increase in Eurozone interest rates.

Looking ahead at today, Eurozone Final CPI Year-on-Year figures take centre stage. The Eurozone December CPI update is not expected to be revised from its previous release, remaining at 5% and a record high for the single market. German PPI Month-on-Month has already been released this morning and read significantly above forecast at 5.0% versus a consensus of 0.8%. Finally, the European Central Bank (ECB) Monetary Policy Meeting minutes are due at midday which will provide in-depth insights into their recent monetary policy decision.

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