Thursday's European stock market losses were triggered by another large interest rate hike by the US Federal Reserve. This is likely setting the stage for aggressive monetary tightening by the Bank of England and the Swiss National Bank.
Fed’s rate decision
In line with expectations, the Federal Reserve raised interest rates by 75 basis points, causing the Fed funds rate to reach 3%-3.25%, putting the US dollar at a new 20-year high, and sending the two-year yield over 4% for the first time since 2007.
Moreover, the Fed projected that the benchmark interest rate would rise to 4.4% by the end of this year, and then rise to 4.6% in 2023 before falling to 3.9% in 2024.
He reiterated the FOMC's commitment to driving inflation lower and signalled that more rate rises are on the way. He continued to say that there was no easy way to drive inflation lower and that it is quite likely we will see another 100 bps in inflation by the end of this year at the very least, if not more.
There is no surprise that US equity markets were not happy with the hawkish tone of the Fed. This is despite the possibility of slower growth and higher inflation, as the Fed has altered its guidance on both fronts. The US economy is expected to contract by 0.2% in 2022, and Powell acknowledged the possibility of a recession. The core inflation rate is expected to decline to 4.5% this year, and then to 2.1% by 2025.
Bank of Japan came with no surprise
As the US markets saw in the wake of yesterday's decision, they ended the day lower. Meanwhile, the continued rise of the dollar has posed a huge challenge to the likes of the Bank of Japan, which met earlier this morning, as well as the Bank of England, which saw its pound fall below 1.1300, a 37-year low, to present itself as a major concern.
Following the slide in US markets last night, European markets look set to give up yesterday's gains after shrugging off Russian President Vladimir Putin's aggressive rhetoric.
In spite of the Bank of Japan checking the USD/JPY rate earlier in the month, rates were left unchanged this morning by the central bank.
Bank of England follows Fed’s approach
As for the pound, the ability of the Bank of England to get a grip of the UK’s inflation problem got a lot more difficult last night, with the Federal Reserve’s doubling down on its own hawkish narrative.
The decision to delay the UK rate decision by a week may have worked in the MPC's favour. This is because they now have a clear idea of how the Fed views its rate path.
Of course, that only works if they come to the correct conclusion from last night’s events. In the aftermath of last night's Fed decision, the pound is now down 16% for the year and even more over the past 12 months.
It is widely expected that the BoE will raise interest rates for the sixth consecutive meeting later in the session, with an increase of 75 basis points to match the Fed's move - the current market consensus.
There is, however, a question as to whether such a move will really boost the pound. This will be especially true if the government is forecast to be in deep recession by the end of the year, according to the Bank of England's own forecasts. This is because the government is likely to have to borrow heavily in order to pay for the recently announced energy cost assistance for businesses.
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