Federal Reserve expected to hike rates as Sterling slips

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13 June 2018

thomasdodds

The Pound sank to a more than one week low against the US Dollar this morning, after another underwhelming set of UK inflation data continued to dampen expectations for an interest rate hike from the Bank of England this year.

T
he rate of headline inflation was unexpectedly left at its one year low of 2.4%, after investors had eyed an upward revision to 2.5%. This is another blow to Sterling bulls who are hoping that the BoE could surprise the market by hiking interest rates when it releases its next set of quarterly economic projections, at its August meeting. Sterling briefly rallied on Wednesday on some positive Brexit news, although failed to hold onto any gains. Prime Minister, Theresa May, managed to hold off a rebellion within her own party yesterday, with MP’s narrowly voting by 324 to 298 in favour of amendments to the Brexit bill. Further discussions on the bill will continue today.

Activity in Europe was fairly limited yesterday, although the latest ZEW economic sentiment data missed expectations once again. The Euro trailed off against the greenback during afternoon trading, following an impressive set of inflation data out of the US, which showed that consumer price growth jumped to 2.8% in May, its highest level in six years. This further supports our view for a faster pace of interest rate hikes from the Fed than the market is currently pricing in.

FOMC to raise rates, update interest rate projections

This evening’s meeting of the Federal Reserve, in Washington, is shaping up to be a potentially very important one, with a fair amount of more uncertainty than usual going into it.

The central bank is almost certain to raise interest rates by another 25 basis points, making it its second hike this year and seventh since the current rate hike cycle began in December 2015. We think that the ‘dot plot’ will show that the current course will be maintained this year, with policymakers likely to signal a total of three hikes in 2018, while keeping its option open for a fourth hike later in the year, should conditions warrant it.

What remains far from certain is the FOMC’s projections for future rates beyond 2019. Following the recent dovish rhetoric out of the Fed’s last meeting minutes, which implied that the FOMC would be willing to allow a ‘temporary period’ of above target inflation, there was a fair amount of speculation that the central bank could moderately revise its long term rate expectations. It will also be interesting to see whether Chair Powell discusses recent developments surrounding global trade, or whether the latest political uncertainty in Italy and sell-off in European equity markets could impact its view on global growth.

Given the high level of uncertainty going into the meeting, we think that volatility in the major currencies will be amplified when Powell speaks just after 19:00 UK time this evening.