ECB to hike rates, but by how much? – Daily Market Brief, September 8, 2022

The ECB is due to raise interest rates for a second straight meeting. The central bank could agree on a 50 or 75 basis point hike, although euro bulls could be disappointed with the smaller raise.

·         Evidence of cooling US inflation helps US stocks close higher & puts Europe on track for a positive start

·         GBP/USD remains depressed ahead of the energy relief package

·         Federal Reserve Chair Jerome Powell could reignite the USD rally

The FTSE underperformed its European peers yesterday, pulled lower by resource stocks following disappointing Chinese data and as oil prices tumbled.

Meanwhile, Wall Street booked gains across the board after the Fed’s Beige Book analysis showed weaker growth and cooling inflationary pressures, helping treasury yields turn lower while also pulling the USD southwards.

The positive close on Wall Street and softer USD is translating to a positive start in Europe and some relief in the forex markets.

Energy relief package

The FTSE is set to open higher, and the pound is under pressure ahead of Liz Truss’ eagerly awaited energy support plan. Draft reports have indicated that she intends to cap household energy bills at £2500, a move which, according to BoE’s Andrew Bailey, could slow inflation, at least in the near term. 

The primary worries surrounding the programme are how it will be funded. While the final cost is unknown, as it will depend on how high energy prices rise, it is expected to be more costly than the furlough scheme. Government borrowing is expected to do the heavy lifting here, which, given ballooning government debt, could start to see demand dampen in the bond markets, impacting the pound on a medium-term basis.

GBP/USD fell yesterday to 1.1407, a level that was last seen in 1985. Today the pair trades around 1.15.

ECB

The ECB is due to announce its interest rate decision today. The big question is will it be a 50 or 75 basis point rate hike? Following the July meeting, when the ECB raised interest rates for the first time in over a decade, another 50 basis point hike was expected in September. However, recently, ECB officials have adopted a more hawkish tone, speaking of the importance of front loading and fighting record-high inflation aggressively.

ECB President Christine Lagarde is more cautious, reportedly supporting a more conservative 50 basis point hike given the risks of a recession in the bloc. An overly aggressive rate hike could accelerate the region’s fall into recession and push yields higher in parts of the eurozone. However, with the euro struggling around parity, a smaller hike could send the currency lower still, adding to inflationary pressures in the bloc.

Both sides have strong arguments.  The money markets are leaning slightly in favour of a 75-basis point hike. The euro could be disappointed with 50.

Fed Chair Powell

The USD rallied relentlessly across the European session yesterday. The USD index rose to a new 2-decade high of 110.79. Meanwhile, USD/JPY rose to within a breath of 145.00, a 24-year high, and GBP/USD tumbled to its lowest level in 37 years.

Today the USD bulls are pausing for breath as attention shifts to Federal Reserve Chair Jerome Powell, who is due to speak. However, should Fed Powell choose to hammer home the message that the Fed is serious about tackling inflation, the pause in the USD rally could be short-lived. Powell could use this opportunity to tee up a 75-basis point rate hike for the September meeting. Expectations for a 75-basis point rate hike sit at 76% at the time of writing.

Disclaimer: This article is not investment advice or an investment recommendation and should not be considered as such. The information above is not an invitation to trade and it does not guarantee or predict future performance. The investor is solely responsible for the risk of their decisions. The analysis and commentary presented do not include any consideration of your personal investment objectives, financial circumstances, or needs.

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