LONDON, June 22 (Reuters) – The financial markets took a sharp intake of breath on Thursday as the Bank of England lobbed an interest rate “grenade” at Britain’s inflation problem with a big rate hike after Fed chief Jerome Powell had also backed more U.S. rate increases.
There were falls on the FTSE, other European bourses and Wall Street futures .US while even the pound initially lost ground as the surprise half-point hike from the BoE to 5% revived recession angst.
“There has been significant upside news in recent data that indicates more persistence in the inflation process,” the Bank of England said after the move, warning of “second round effects” too.
Neil Birrell, Chief Investment Officer at Premier Miton Investors, said: “The Bank of England has opted to aggressively tighten policy and launched a rate grenade at the spectre of ongoing inflation.”
With bond market borrowing costs going up again “the fear is that this could rapidly tip the economy into a recession”.
Though the size of the hike surprised markets, expectations for BoE rate tightening have surged in recent days – sharply raising the cost of new mortgages.
Before Thursday’s decision investors expected the BoE’s Bank Rate to peak at 6% by the end of the year. By contrast, economists polled by Reuters last week saw a 5% peak.
The 1.2% drop on London’s FTSE and 0.6%-1% falls elsewhere in Europe left the MSCI All-World index (.MIWD00000PUS) down 0.15%. It was on course for a fifth straight day in the red and its longest losing streak in three months.
Last week, the Fed held its benchmark interest rate steady at between 5% and 5.25%, but officials projected rates will have to increase another half percentage point by year’s end to tame inflation.
Powell said in remarks to lawmakers in Washington that the outlook for two further 25-basis-point (bps) rate increases are “a pretty good guess” of where the central bank is heading if the economy continues in its current direction.
Markets, though, remain unconvinced, pricing in a 72% probability of a 25 bps hike next month, but no further hikes after that, according to the CME FedWatch tool. Powell speaks for a second day again later.
FED AHEAD
The dollar was barely changed on the day and Kevin Cummins, chief economist at NatWest Markets, said Powell’s testimony on Wednesday had not shed any new light on the Fed’s thinking or the likely future path for monetary policy.
“It’s clear that the FOMC wants the market to understand that a hike will be on the table for debate at the next meeting. The Fed’s data-dependent approach in this tightening cycle suggests upcoming data releases could shift expectations.”
A trio of other Fed rate setters are also due to speak later. Atlanta Federal Reserve President, Raphael Bostic, had said on Wednesday the Fed should stop raising rates or it would risk “needlessly” sapping the U.S. economy.
The comments highlight the growing debate at the central bank over when and if the central bank should hike further.
“The next six months, as much as we would like to stop talking about the Fed, it’s going to be the continued driver of sentiment in the market,” said Michael Dyer, investment director, multi assets at M&G Investments.
U.S. stock futures , fell 0.2%-0.3%, indicating a weaker start on Wall Street later.
The S&P 500 index (.SPX) is heading for a third successive quarterly gain, thanks in large part to mega-cap technology stocks that have benefited from the growing interest in artificial intelligence, but also down to the resilience of the underlying economy.
“As long as economic activity doesn’t weaken too far in the face of rate hikes, then stocks should be OK as well,” Daiwa Capital Markets head of economic research Chris Scicluna said.
“The hope is still that the Fed and the ECB could get away with another couple of rate hikes without necessarily causing recession down the track.”
HOW HIGH?
Sterling , which has gained nearly 4% this quarter thanks to the expectation of more rate hikes from the BoE, was last steady at $1.2780, not far off last week’s 14-month peak at $1.2849.
The euro was flat against the dollar at $1.0992, but down 1% against the Norwegian crown after the Norwegian central bank had also delivered a much larger rate rise than expected earlier.
Emerging market traders were also digesting news that Turkey’s new central bank governor had raised its interests to 15% from 8.5%. Though it marked a long hoped-for policy pivot, that was not as high as the 20%-25% some analysts were predicting.
The Turkish lira has repeated hit record lows since last month’s election and the central bank’s hike took it past 24 to the dollar.
“It would have been better if it was a bit higher but it’s going in the right direction,” said Peter Kisler an EM portfolio manager at Trium Capital, adding that the central bank had said further moves were possible.
U.S. crude fell 0.7% to $72 a barrel, as did Brent crude futures , which fell 0.7% to $76.56, while gold dropped 0.3% to $1,926 an ounce, just above Wednesday’s three-month low.
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